Should you pay down debt or invest - Part 2

Should you pay down debt or invest? Part 2 – Find how to start now!

Should you pay down debt or invest? Part 2 – Find out how to start now!

OCTOBER 28, 2017     AUTHOR: SHAUN

We know it’s good to pay down debt and invest, but it’s important to know how do it, and do it consistently


Earlier this week, I addressed one of the age-old money questions:  Should you pay down debt or invest with your extra money?  Answering such a simple question the right way can save you thousands of dollars over a lifetime! 

In Part 1, you learned that everyone making this decision is faced with a “risk-reward” trade-off.  You see, paying down debt is a sure thing and will increase your net worth dollar-for-dollar.  On the other side, if you invest, there’s no guarantee on how well your investments might do – you could do better, you could do worse. By taking on this extra risk, you need to make sure you’re appropriately rewarded.  After all, why would you invest if you can go with a sure thing?

Ultimately, we came to a conclusion if your debt is costing you more than 5% interest, pay it down first.  Of course, like anything, there are a few nuances and exceptions to that rule, but for most people, it’s a good guideline.  If you’d like to learn more on this, feel free to look back at my earlier post!

Today, I’d like to make things very real for you.  I want to take this one step further and talk through very simple ways to either pay down debt or invest.

It’s one thing to know you should do something, and it’s another thing to understand how to actually to do it.

Let’s jump right in!

What are the best ways to pay down debt?

Congrats!  Now that you’ve decided that the best course of action for you is to pay down debt, where should you start?

I always recommend this 3-step process:

Picture of arrow chart showing a three step process

1)  Pay off all high-interest debt

This is likely burning a hole in your wallet!  At anywhere from 12%-22% (and more!) this could cost you a lot of money – especially when you consider the impact of compound interest! It is very rare to make over 12% investing.  That’s why it makes sense to focus on paying down this type of debt rather than trying to earn money elsewhere. 

Remember, paying off debt has the same impact on your net worth as earning money investing (and it’s guaranteed money!).  Find where you’re paying high-interest debt (likely credit cards) and get rid of them ASAP.

Related post:  Learn why Einstein called this the 8th wonder of the world

2)  Consolidate all other debt

For all other debts, I recommend you bundle it all together through something called a “consolidation loan.”  I know, the name can sound a bit intimidating, or even harmful, but it’s a good thing!  By bringing all of your debts together into one place, lenders/banks will likely give you a better rate than if they were scattered individually.  To learn more about consolidation loans, check this site out.

3)  Build a plan to pay it off each month

Now that you’ve packaged all your debt together, it’s time to start paying it down!  Set up regular payments, so you’re continually chipping away at it.  I’d recommend a bi-weekly payment schedule if you can (monthly at a minimum).  The more frequent you’re paying it down, the smaller your payments will be, and the easier it can seem to meet your goals.  Remember, the idea here is to reduce your debt as fast as possible so you can move from paying down debt to investing. 

And most importantly, don’t just package your debt together and then run up more!  I hear of this happening a lot, especially with credit cards.  People work so hard to consolidate the debt, only to rack it back up again!  This will not only defeat everything you did, but it will set you back even more!  Once you’ve built a plan, stick to it!

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What are some ways to start investing?

Congrats!  It’s time to start putting your money to work!

So what’s the best way to invest?  That’s the magic question!  To be honest, if I knew that answer, I’d be well-retired by now 🙂

While there’s no 3-step process, I will share with you sound ways to invest your money.  To be honest, your final decision on how to invest will depend a lot on how much risk you’re willing to take on.  

Below are two ideas that I recommend to most beginner-investors to get the ball rolling.  Please use these as thought-starters though, and be sure to do more research before jumping right in 🙂

1)  Invest in index funds or low-cost mutual funds

A mutual fund is like a bucket of money, where investors pool resources, leaving it for a professional to reinvest.   All the gains and losses from the investments are shared back to the group, and the professional manager takes a cut for doing the work. 

Mutual funds are an excellent way to buy different kinds of investments, without having to shell out tons of money.  As an investor, you benefit from scale, and advice from a professional.  Of course, that advice is not free.  You will owe a percentage of your portfolio to the mutual fund manager (typically between 1-2%).

Index funds are quite similar, with one small exception.  Rather than being managed, Index Funds follow a set amount of investments called an “index.”  To learn more about index funds, check this site out.

2)  Invest in dividend growth stocks

Dividend growth stocks are often high-quality businesses that have a history of providing stable returns.  I like to think of them as “Steady-Eddies.”  They won’t make you millions tomorrow, but they are often big-brand businesses that have grown through both good and bad times.  Some popular companies that come to mind include P&G, Coke, Unilever, banks, and utility companies.  Of course, not all stocks are created equal so you will need to do your research before buying.

Related post:  The gems of the stock market – dividend growth stocks

Why aren’t bonds on the list?

You might be surprised that I don’t recommend Bonds in the list above.  Why’s that?

In my experience, they typically don’t generate a return high enough to apply the 5% rule above.  Now I am generalizing here, but if you’re earning between 3-5% through a Bond, why wouldn’t you just go for a sure thing and pay down your debt? 

Again, big generalizations here, but I think you get my point.  I’m trying to build a framework that maximizes wins for you while minimizing the amount of risk you need to take on.

Closing thoughts – consistency is key to unlocking long-term wealth

I’ll close this week’s series by reinforcing the need to be consistent regardless of which path you take – paying off debt or choosing to invest.  Making a one-time decision to invest or pay down debt isn’t going to change your financial situation overnight.  You need to be committed long-term to see the real benefits. 

Making small positive changes is better than making one big change, and falling back into bad habits.

If you’ve made the decision to start paying down debt or invest, start small.  Get comfortable in what you’re doing.  Get a feel for it first.  You can always increase your commitment over time. 

By taking small steps you’ll build confidence in what you’re doing – and that’s key to sticking to it!

Constant refinement and small consistent wins in your finances will lead to a lot of benefits over the long-term.

Think it through

  • How has your mindset changed when it comes to debt? How about investing?
  • What do you need to change to maximize your net worth?
  • What’s preventing you from being aggressive in paying down debt, or investing?

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