Most Americans have debt such as mortgages, student loans, credit cards, and car loans but all debt is not created equal.
Paying off high-interest-rate credit card debt before investing is a good move, according to planners and advisors at John Hancock and Fidelity — just two of the many investment companies clamoring for your attention who want to give you advice on how to spend your extra cash if you have money left over at the end of the month.
There’s a big difference between your 5.05 percent federal student loan and 16.99-to-23.91 percent credit card debt. High-interest credit card debt costs more as time passes, making it much more difficult to pay off. By paying credit card debt before investing, you could save hundreds or thousands of dollars in interest, freeing up cash to add to an emergency fund or get an investing plan started, according to John Hancock.
Younger people are less likely to invest than their parents. Just 37 percent of people under age 35 invest in the stock market — down from 52 percent before the 2008 crash, according to a recent Gallup poll. It’s normal to fear the stock market but the alternatives are just as scary. No one can predict what the future will look like, especially now that crypto exchanges are collapsing like a house of cards.
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However, John Hancock wants you to know that failure to invest early in your career means missing out on years of building wealth.
Fidelity offers this guidance on whether you should pay down debt or invest: If the interest rate on your debt is 6 percent or more, you should generally pay down debt before investing toward retirement.
The 6 percent rule assumes you have at least 10 years before retirement, that you’re investing in a balanced portfolio with about a 50 percent allocation to stocks, and that you’re investing in a tax-advantaged account such as a 401(k) or IRA, according to Fidelity Viewpoints.
If the interest rate on your debt is less than 6 percent, it may make more sense to invest those extra dollars instead. That’s because at lower interest rates, there’s a greater chance your long-term investing returns will beat the bang for your buck you’d get by paying your debt off faster.
Although 6 percent is the number to remember if you have a balanced asset allocation, you can consider a higher or lower threshold if you invest more or less aggressively.
Before you even get to the question of paying off debt or investing, Fidelity suggests doing the following:
- Pay the minimum on all debts
- Put away some emergency savings.
- Capture any employer match on retirement savings
While paying off low-interest debt sooner may not be best, personal risk tolerance varies greatly from person to person. Debt can cause a lot of stress. “If the weight keeps you awake at night, there is nothing wrong with paying it down sooner. You can’t put a price tag on your peace of mind,” Fidelity pros said.