If you owe money on your credit cards or have an outstanding balance on your mortgage or on a personal loan, you may be focused on paying down your debt. This could seem like a more important financial goal than funneling money into your brokerage account in order to invest.
There are, indeed, some kinds of loans you should prioritize paying off. If you have payday loan debt, for example, the exorbitant interest rate you’re likely being charged means you should focus absolutely on paying those loans off right away.
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But, in many situations, it doesn’t make sense to put off investing until your loans are paid off for good — especially if you’re dealing with something like a mortgage or personal loan. Here are three reasons why.
1. You could miss out on free money if you don’t invest
In some circumstances, you can actually get free money to invest. For example, if your employer offers a 401(k) and you qualify for employer matching funds, you could earn up to a 100% return on your investment if your employer offers dollar-for-dollar matching.
You could also be eligible for government tax credits or deductions, such as the Saver’s Credit or a deduction for IRA or 401(k) contributions. These government subsidies also enable you to invest without reducing your take-home income by the full amount you’re setting aside.
If you don’t take advantage of your employer match or the tax credits or deductions each year, you pass up that chance forever. It could take you years to pay down your loan, leaving you without this free money during all those years. This is a huge mistake.
2. You will miss out on compound growth if you don’t invest
As soon as you start investing, you can start earning returns that can be reinvested. Your money starts making money for you when this happens. This compound growth can allow you to build your wealth much more easily and with less out-of-pocket spending — if you give it time to work.
If you put off investing as you try to pay down loans, you miss out on years of compound growth. You end up having to invest a whole lot more later on because of lost time. If you want to end up with an $800,000 nest egg and you earn 10% average returns, you’d need to save about $406 per month if you had 30 years to save. But if you had only 20 years, you’d need to save $1,163.97 per month.
It is not worth putting off investing if you end up having to invest so much more just to end up in the same place.
3. You could earn a higher ROI by investing than by early loan payoff
In many situations, the ROI you can earn with a reasonably safe investment is higher with investing than early debt payoff.
For example, if you have a personal loan at 6% interest and you can make an average 10% annual return by investing in an S&P 500 fund, you’re better off investing extra cash rather than using it to pay down your personal loan. Making an average of 10% a year is better than saving 6% per year on interest costs.
For each of these three reasons, you should seriously consider starting to invest ASAP rather than devoting all your money to paying off loan debt — unless you are paying a truly exorbitant interest rate. If this is the case, focus on getting that debt paid off quickly so you can start making your invested funds work for you sooner rather than later.
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