We only endorse products that we truly believe in. Some of the links below may earn us some extra guac at no additional cost to you. Please pass the chips & thank you for feeding our habit.
When I first started to think about investing, I knew I needed to do it but had no idea how to go about it. I still had some pretty massive debt that was accruing interest. How was I supposed to invest some of my income when I was still making major monthly payments to pay down my debt? I wondered if I should even be investing at all when I still had debt to pay off.
In the end, I decided that investing was a smart decision for me because I had low interest rates on my debt and could earn more by investing.
However, the answer may not be as simple for you as it was for me. Investing is an important tool to create more wealth for yourself, but there are a few considerations you need to make if you are still in debt. You need to learn how to wisely invest your funds while balancing your debt payments at the moment.
If you are considering a new investment strategy, you need to figure out whether you can really afford to invest and how to do it. This breakdown will equip you with all of the tools you need to get started.
Considerations for Paying Off Debt
As a general rule, it is typically best to approach paying off debt and investing with a balanced mindset. It can be beneficial to work toward both goals simultaneously, but there are some important things to consider when it comes to paying off your debt.
In certain circumstances, it may be better to pay down some of your debt with that spare cash before jumping into a new investment strategy.
If you are currently carrying debt, here are a few things to think about when it comes to paying it off.
The first and most important thing to consider here is the interest rate on the debt you have. Credit cards typically have the highest interest rates as opposed to the low rates typical on mortgages and other types of debt.
If your average APR on your credit card or other debt is higher than the average return of your investment, then it is best to pay off that debt before you start to investigate investments.
For example, the average credit card APR is 20.25 percent. If you are investing in the stock market, you may face an average return of 10 percent. Because it does not outweigh what you will be accumulating in interest on your credit card, you will want to pay off that card before you redirect your funds to investments.
On the other hand, you may have debts with low rates such as federal student loans. If the interest rates are low enough, you may actually earn more by investing your money wisely as opposed to spending every spare cent paying down debt.
Most lenders refer to your FICO credit score when deciding whether to issue you a new loan or credit card. This score consists of five main areas: payment history, credit utilization, length of credit history, new credit lines, and credit mixture. For our purposes, the important factor here is your credit utilization.
Credit utilization refers to how much of your available credit you are currently using. Let’s say that you have a credit card with an available balance of $5,000. You carry a balance of $2,500 on the card. This gives you a 50 percent credit utilization rate because you are using half of the credit available to you.
Why does this matter? Your credit score is likely to be lower when your credit utilization is higher. Most lenders prefer to see a credit utilization rate that hovers right around 30 percent.
Anything higher can send up red flags that you are unable to afford your lifestyle because you are spending enough to max out your credit cards without paying the balance each month.
A lower credit score can spell problems for you. It will be more difficult to qualify for new loan products whether that means a car loan, a mortgage, or a new credit card. If you do qualify, you will typically face higher interest rates that can cost you thousands of dollars over the course of the loan.
If you have a high credit utilization rate, you may want to consider paying down some of your debt prior to investing. This can boost your credit score and make you more likely to qualify for other loans with better terms in the future.
Whether you plan to take out more loans or not, it is always good to be prepared for this. With a higher credit score resulting from a lower credit utilization, you could save thousands in interest that could then be redirected to investments.
Time Left Until Retirement
If you are close to retirement, you should consider aggressively paying down debt. Carrying your debt into retirement can spell trouble for your financial health when you are typically on a reduced or fixed income.
Most experts recommend paying down high-interest debt before making huge investment decisions. The exception to this is saving for retirement.
Consider contributing even a small amount to your retirement fund each month. It will earn interest and compound year after year, yielding large dividends for you later in life.
Consider how close you are to retirement and how close you are to your goal. For those who are close to retirement age and far from their goal, you may have to consider investing a bit more aggressively. You may need to work a few years longer to make everything possible.
Those over the age of fifty are able to make catch-up contributions. Alternatively, you could do your best to minimize your expenses to slash the amount you need in your retirement savings account.
Considering Your Budget
How much room do you have in your budget for paying down debt or investing? If you don’t have a budget at all, this is the best time to start one. You need to know how much money you bring in each month and how it gets spent.
This can help you see where to cut unnecessary expenses, see just how much you have to spend each month to cover your debt payments, and to know how much money you have left over at the end of the month.
Many people, myself included, have a hard time crafting their budget. Before I made a budget, I had no idea where all my money went at the end of the month, but I knew it wasn’t staying in my bank account. If this describes you too, here is what I finally did to make a budget.
I went through previous statements from my bank account and categorized each line item. Then, I just simply added them all up and was then able to get a pretty accurate picture of my finances.
I still use this method to this day, and it allows me to track all of my spending so that I know how much I need to save, spend, or invest each month.
If you have some money left over at the end of the month and very little savings, your first step instead of investing should be to come up with an emergency fund. An emergency fund can help cover unexpected expenses such as a major car repair. It also helps cover your living expenses if you were to lose your job.
It is generally recommended to have three to six months of living expenses set aside in an account that you can access quickly such as a savings account that earns interest.
Once you have an emergency fund established, you can start to evaluate what to do with the rest of your leftover money. High-interest debt should be paid off first because it will cost you more in interest than you could earn with the average investment opportunity.
However, if all of your debt is relatively low interest, you could start to create a line item for investments.
Make it a priority to “pay yourself” and to add to your investment portfolio. Set an alarm on your phone each payday to remind you to set money aside or to go ahead and add it to your investment strategy.
If you are using an investment platform that allows automatic transfers, set them up so that you never spend the money you have earmarked for investment.
I personally use automatic transfers to contribute to my retirement and investment accounts. This prevents me from spending that money on things that don’t really serve me financially such as expensive lattes, clothing, or entertainment. I want my money to work hard for me, so I make it a priority to invest and I tell my dollars when and where to go.
Types of Investments to Choose
Once you make the decision that investing is in your best financial interest, the next step is figuring out what investment strategy is the best for you. This is a highly personal decision based on the amount of risk you feel comfortable with, the amount you have to invest, and how soon you will need to access your funds.
You may decide to go with a combination of some of these investments to diversify your portfolio. Consider which options may align with your values and your budget.
Certificates of Deposit
For those who want to play it safe with their investment, you can invest your money in a certificate of deposit (better known as a CD) at your bank. The benefit to this investment opportunity is that your principal investment is protected and you earn a guaranteed interest rate.
Unlike the stock market that can be highly volatile, your money is safe in this investment.
Unfortunately, you won’t earn much for this safe investment strategy. Compared to riskier investments such as purchasing stock, you will see a much lower rate of return on a CD.
In most cases, you will earn just a fraction of a percent and your money is tied up for a set period of time. For example, you can sign up for a one-year CD or a five-year CD. If you decide you need that money before your agreed-upon time is up, you will have to pay an early withdrawal penalty fee that could eat away at what you might have earned.
High-Yield Savings Accounts
While a CD may tie up your money for years, you might be more interested in the liquidity of a high-yield savings account. This is another safe option for those looking to invest but worried about losing their money. As long as you choose an FDIC-insured bank, your money is safe in this type of savings account.
You will earn interest on the money placed inside this account, but the rates may be a bit lower than those seen with CDs. Online banks typically offer higher interest rates than brick and mortar locations.
On the other hand, the major benefit to this account is that you have immediate access to your funds if you need them. Some banks may limit you to six withdrawals per statement period, but aside from this, the money is available whenever you need it. This is a good option for storing your emergency fund.
Bonds and Bond Funds
Another relatively safe investment opportunity is bonds or bond funds. These are essentially an I.O.U. to repay debt from a borrower to an investor. In general, the borrower is typically a corporate company or the government.
The bond is issued with a specific end date when the principal of the loan is scheduled to be repaid by the borrower along with interest payments in exchange for the loan.
This is a good investment strategy if you are relatively risk-averse, particularly if you invest in US Treasury bonds. The only way to lose your investment in these bonds would be if the government became insolvent, a highly unlikely situation. Corporate bonds may be a bit riskier, but they also have a higher interest rate or yield.
Exchanged-Traded Funds (ETFs)
Do you have very little time to consider your investment opportunities? Exchange-traded funds are great for investors who want a more passive investment strategy. These funds follow a specific industry or index and help you invest your money in a number of different things at one time.
All you have to do is buy shares of a specific ETF. Much like buying stock, you will want to buy and hold your shares for long-term investments.
The benefit of an exchange-traded fund is that you can choose what you want to invest in. There are funds geared toward specific types of stock such as international, large-cap, or small-cap. You can also invest in a variety of short-term or long-term bonds. The possibilities of what you can invest in with an ETF are practically endless.
Another benefit is how convenient it is to diversify your portfolio this way. Instead of spending your time researching individual stocks for investment, you can choose one specific ETF and gain access to a variety of assets.
Automated Investing or Robo-Advisors
Another key investment strategy is to enroll with a robo-advisor for automated investing. While this is not exactly a specific type of investment, it is more of a hands-off style that makes it easy for you to diversify your portfolio and spend very little time actively managing your investments.
A good robo-advisor will start out by asking you some questions about your investment goals, your tolerance for risk, and when you plan on accessing the funds (for example, if you are using them to save for retirement, you might need access to the funds twenty years from now).
They create portfolios based on your risk tolerance with many of them being labeled by their risk tolerance. For instance, they may have a conservative portfolio and an aggressive portfolio.
This is actually how I choose to invest my own money. My robo-advisor selected an aggressive portfolio for me since I am still rather far from retirement.
It consists of 90 percent stocks and 10 percent bonds. The benefit of these robo-advisors is that I can also set up automatic transfers from my bank account. I schedule a small sum to transfer each payday so that I am consistently growing my investment portfolio.
A mutual fund is a great investment strategy if you want a portfolio managed by a professional who aims to generate capital gains. In a mutual fund, many investors come together and pool their money to invest in a collection of assets that may include stocks, bonds, and other types of assets. You earn a portion of the income relative to the amount that you have invested in the fund.
There are a number of benefits to this type of investment strategy. First, you receive portfolio management from an expert who curates the assets, buying and selling as necessary.
It may come at a small cost, but most investors deem this a worthwhile expense. As the mutual fund earns money, you can reinvest those dividends to purchase more shares of the mutual fund which allows your income to continue growing.
One of the main benefits is risk reduction. Each mutual fund is different, but they typically invest in 50 to 200 unique assets which diversifies your portfolio and offers some protection from the volatility of the market.
If you have a lot of time on your hands and don’t mind spending it learning the ins and outs of the stock market, you can purchase individual stocks for your portfolio. They have the potential for higher returns, but investing all of your money in just one type of stock is quite a risk.
Chances are that you will want to spread out your investment across several different types of stock and shares. That way if one of your investments daily, you’ll have many others to count on, which means your retirement or other investing goals won’t be put at as much of a risk.
Unfortunately, there are some real downsides to investing in stock. As most people know, you run the risk of losing your entire investment if you choose the wrong stock. It takes a lot of time to research and make a wise investment decision that will serve you well for the long haul.
You may feel frustrated by the constant fluctuations in stock price, making it tempting to buy and sell frequently. It can really take a toll on your emotions.
Bitcoin and other types of cryptocurrencies have surged in popularity over the past few years. This is still considered to be a relatively new investment opportunity and has proven to be quite volatile. Some lucky individuals have earned excellent gains on buying and selling their cryptocurrency compared to what they may have earned on other types of investments.
However, this extreme volatility means that you may lose money as well.
Cryptocurrency essentially is digital currency that is stored and operated on a blockchain. Miners will create coins using tons of computing power and then get paid for that transaction. They then place the coin on the open market for investors to buy.
The reason this market is so volatile is due in part its long-term stability. No one really knows if it will be valuable in ten years or tomorrow, which has led to major jumps in price and crashes over the last few years. But at the moment, investors can still use crypto to build wealth and invest, but it may emotionally drain you like a stock, so be sure you have the tolerance for an asset like this before you buy your first coin.
Making Wise Investment Decisions
Even if you still have some debt to pay down, it might be in your best interest to consider starting an investment portfolio as well. It is always wise to start setting aside small amounts of money toward retirement as it can really add up over time. However, it might be best to focus primarily on paying down debt if you have a high interest rate or a high credit utilization rate.
Be sure to set aside an emergency fund as well before you start to heavily invest your extra money.
There are quite a few different investment opportunities for you depending on how you can tolerate risk and how much time you want to sink into your investment strategy.
Some yield low returns but protect your initial investment such as bonds, CDs, or high-yield savings accounts. You can even passively invest through ETFs, robo-advisors, and mutual funds. If you want a more active role, you can invest in individual stocks or cryptocurrency.
No matter how you decide to approach your investment strategy, there are lots of different options. Consider which one aligns closely with your financial goals and prepare to get started as soon as possible!