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Why Managing Your Debt Comes Ahead Of Investing2021-08-29T01:15:52+00:00

Why Managing Your Debt Comes Ahead Of Investing

If there are three things an average adult will taste about finances they would be debt, investment and taxes. 

Apart from taxes, the other two are likely borne out of our personal decisions or choices. Debt is a choice, so is an investment. 

Depending on the nature, each of these takes money from you at some point in time. However, the two are not the same.

Debt is simply money you choose to enjoy now and pay later. Investment is the money you choose to grow (or sacrifice) now so you can enjoy it later. 

Just by this simple definition, it is only reasonable to avoid debt at all costs and focus more on investments. Once we have more than enough in investments, we can choose to buy or enjoy whatever lifestyle we seek later. 

But, what if you have debts huge enough to make you feel there is no way you can pay off, is it right to think of investments? 

A school of thought, usually finance experts, would advise you to invest first or focus on investments. If you are lucky to find a great investment with high returns, you could earn twice as much as your debts, and then you can pay it all off. That sounds reasonable, doesn’t it?

Another school of thought would suggest a 50-50 split. You put 50% of your income into debt repayments and the remaining 50% into investments. In the end, you profit from any high returns from your investments, while closing your debt “gap”. It’s like killing two birds with a stone. Wow, that’s even better, right?

But, what if you decide to do almost the opposite of both schools of thought to focus almost all your income on paying off your debt first? Let’s call this approach the third school of thought. 

How harmful or beneficial will such a strategy be? Besides, is such a strategy even feasible?

Well, as crazy as it may sound, it is the best way to go. Here are some reasons why managing your debt should always come ahead of investment.

1. It Takes You Out Of The Debt Pit Faster:

Debt is easy to manage when it is taken once, with a clear plan or timeline to pay off. However, debt can be a habit that becomes harder to break away from overtime. For instance, while putting all your income or half of it in your investment may be good, it may make you borrow even more. If you took a loan because your income was not enough, how bad will it get when you are forced to live on half of it or nothing at all. You only tend to borrow more. However, if you pay off your debts first, you can gain full access to your income even if you decide not to invest.

2. Not all investments are profitable: 

Between debt and investment, the one with a certain future is debt. It is so certain, you can tell what would happen if you pay off early or default payment. Unlike debt, investment, no matter the type of size has an element of risk. Thus, there is no full guarantee that everything will work out as planned. Markets do crash. What then becomes of your debt should you lose everything in your investment? Meanwhile, when debts are paid off first and later investments do not go well, at least, you don’t end up in more debts.

3. Wealth is about net worth, not amassing stuff:

Growing up, we all use to think that amassing stuff, especially ones we don’t need, was a way of showing how rich a person is. Unfortunately, that was wrong not because there is anything wrong with amassing stuff, but because we judged it from one side – income or spending. Yet, many people live lavish lifestyles on credit. To be precise, some people owe more debt than what they own. True wealth is calculated using the same parameter used to measure the wealth of the world’s high earners and billionaires – net worth. Your net worth is simply what you are left with if we should deduct or pay off all your debts (liabilities) with your assets. Therefore, having a net worth of $0, may not mean you’re bankrupt. It means you are at a break-even point. Nonetheless, how do keep a “positive” net worth if your debt is more than your income? By paying off your debt first, you only increase your net worth over time, which should be more preferable.

4. You Discover & Invest In Yourself:

One of the major reasons why most people choose not to pay off their debt first is because it spread them too thin. For instance, deciding to pay off a 10-year mortgage in 4 years means you have to make a lot of sacrifices. You may take on other jobs, work longer hours, cut down your already modest expenses. That is a bold step. However, this is usually one of the best opportunities to discover yourself and invest in yourself. If you only trained for a job, now you may have to acquire new skills for a second job. Sometimes, you have to learn things on your own. Through all this, you just get to discover talents, skills and passions you never realised you had – all because you didn’t “play it safe”.

5. Builds You Up To Take Even Bigger Risks:

If you choose to be debt-free in the midst of your struggling times, and you eventually achieve that feat, you simply become open to more challenges. For instance, some people can switch jobs or turn the side jobs they started in their quest to become debt-free into full-time jobs. Others become trainers and consultants to help others become debt-free too. You simply apply the strategy you used to become debt-free to other aspects of life, and they just fit in. You just become unstoppable.

6. You Make Up For The Time Lost:

Let’s say you earn $25,000 net income a year and owe $100,000 in debt. If you decide to do a 50-50 split between debt and investment (paying $12,500 into each account per year}, you end up paying off your debt in 10 years with $125,000 in your investment account (minus profits, losses, and taxes). Juxtapose that with paying off your $100,000 debt in 4 years, with almost all your income at $25,000 per year. You end up not only saving 6 years, but you also end up with $150,000 in investment (minus profits, losses, and taxes) in 6 years (at $25,000 per year). Therefore, despite seemingly missing potential returns if you invested earlier, you make up for that with more capital to invest.

6. It Gives You Peace Of Mind:

Not all debts are equal. Some investors see debt as “good”. Well, if you borrow money and invest in a venture that churns high returns so fast to pay all borrowed monies plus interest and still make money, that initial debt can be “good”. Unfortunately, that is not the situation for most people. To some people. Owing debt is like carrying a heavy load with you everywhere you go. This “load” then controls what you eat, drink, or wear. It simply controls your life. You become enslaved by it. Then, suddenly, such debt is not more. I bet you will be relieved. That is exactly what happens when you finally pay off all your debt. You get your sense of self and peace of mind back to focus on what matters to you. You become free again!

All these and more are the reasons why it is recommended to pay off your debt first. However, that is not to say you should not invest at all. In some cases, you just have to do both. However, if you want to pay off all debt first, then do not completely stop investing until you:

  • Commit to a realistic payoff strategy with clear but strict deadlines.
  • Pay off the most pressing loans first.
  • Organise your accounts and automate where necessary.

Once you finally become debt-free and turn on the investment gas:

  • Invest urgently and aggressively just as you paid off your debt
  • Choose investments that suit your goals.
  • Don’t forget to diversify.

In the end, debt is an aggressive “master” only if you allow it to linger around for so long. It only takes a lot of courage, sacrifice, and hard work to get off its grips completely. It is financially better to focus more on paying off your debt than investing due to the reasons discussed above. Moreover, when you finally do, apply the same approach to your investment and life in general.

Links that may help you

Read our article Why It’s Important To Avoid Building A Big Credit Card Balance

If you’re in debt and need help visit Step Change, a charity to help people stuck in debt

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