One of the biggest dilemmas when managing personal finances is deciding between paying off debt vs. starting investments.

The right choice depends on several factors, including interest rates, risk tolerance, and financial objectives.

In this guide, we’ll explore the pros and cons of each approach and how to strike a balance between them. Keep reading to know more!

Good debt vs. bad debt

Not all debts are the same; some can be beneficial, while others can harm your financial well-being.

Good debt

Certain types of debt can provide long-term financial benefits.

Mortgages, student loans, and business loans can be considered good debt if they help you build wealth or increase your earning potential.

Bad debt

High-interest debts, such as credit card balances, payday loans, and personal loans for non-essential purchases, often lead to financial stress and should be avoided or paid off as soon as possible.

By understanding this difference, you can make informed decisions about whether to focus on repaying debt or investing.

Should you invest while in debt?

It can be tempting to start investing even when carrying a debt, but there are a few factors to consider before making that choice.

Facts to consider

If your debt has high interest rates (for example, credit cards with 20% APR), it’s usually better to pay it off first rather than invest in assets that may not yield the same return.

Also, investments can fluctuate in value, whereas debt obligations remain fixed. If you’re uncomfortable with uncertainty, prioritizing debt repayment may be the safer choice.

Finally, consider your long-term financial goals. Do you want to buy a house? Retire early? Your strategy should align with these objectives.

The “debt snowball” vs. “debt avalanche” method

There are two common strategies for paying off debt.

In the debt snowball method, you focus on paying off smaller debts first to build momentum and motivation.

By using the debt avalanche approach, you pay off debts with the highest interest rates first to save the most money over time.

Both methods can work, but the most appropriate approach depends on your financial discipline and preference.

Balancing debt and investments

A balanced process can help you reduce debt while still growing your wealth.

When to prioritize paying off debts

You should focus on paying off debts if they carry high interest (above 8 to 10%), if the monthly payments are a significant burden on your budget, and if carrying debt is causing financial stress or anxiety.

When investing makes more sense

You should start investing if your debt has a low interest rate and manageable payments, if your employer offers investment benefits that provide guaranteed returns, and if you have a solid emergency fund and can afford to allocate money toward investments.

High-interest debt vs. low-interest debt

Low-interest debts can sometimes be leveraged to grow your wealth.

How to evaluate the opportunity cost

Compare the interest rate on your debt to the expected return on an investment.

If your debt carries a 5% interest rate, but you can invest in an asset with an 8% return, it may make sense to invest rather than pay off the debt early.

Refinancing and consolidation options

If you have multiple debts, consider refinancing or consolidating them to secure lower interest rates.

This can free up extra cash to invest while keeping your debt manageable.

Common mistakes to avoid

Let’s take a look at some frequent errors that can impact your financial situation:

Ignoring emergency savings

Before making any financial decisions, ensure you have an emergency fund with at least three to six months’ worth of expenses.

This will prevent you from accumulating more debt in case of unexpected expenses.

Over-leveraging investments while carrying debt

Investing with borrowed money can be risky, especially if you already have existing debt.

Avoid putting yourself in a financially vulnerable position by taking on more debt to invest.

Conclusion

There isn’t a right answer for everyone regarding debt vs. investments.

The right strategy depends on your financial situation, risk tolerance, and goals.

If your debt carries high interest, it’s best to pay it off first.

However, if you have low-interest debt and an opportunity to invest in high-return assets, a balanced approach may be a reasonable option.