Paying off debt can feel like an endless battle, and it’s a battle countless Americans are fighting every day, with average household credit card debt balances of $15,252 in 2014. And while reducing your liabilities is a great thing, it’s easy to feel like you’re just throwing money down the drain with each debt payment you make. Should you be saving money for your future while paying down your debt, or is it important you focus all of your energy on one thing at a time?
The short answer is—it depends. The long answer is a bit more complicated.
You should save and make minimum debt payments
If you don’t have money set aside for emergencies and irregular expenses, you need to focus first on saving. I don’t mean “make your money work for you” saving, I mean “embrace that less-than-1% interest you get from your savings account” saving.
The last thing you should do when you are trying to pay off your debt is go into more debt when emergencies arise or expenses pop up. You will almost assuredly deal with some type of emergency between now and whenever your debt is paid off. You’ll blow out a tire, or your water heater will break, or a family emergency will require you to buy a last-minute plane ticket home. Be prepared.
Irregular expenses you will likely have this year include two six-month car insurance premiums, Christmas and birthday gifts, property taxes and basic car maintenance. They’re not monthly expenses, but that doesn’t mean you can’t adequately plan for them. Have money set aside for emergencies and expenses before you start making headway on your debt.
You should invest and make minimum debt payments
After you have established a sufficient amount of savings for your needs, you’ll want to earn a higher return on your money. Some people will find this higher return in investments, while others will benefit more from paying off their debt at an accelerated pace.
Conservatively, the stock market will earn you 4-5% returns, after taxes and fees. If your interest rate on debts is lower than this, you may want to consider focusing on investing over debt payoff. Mortgages and financed vehicles tend to have very low interest rates, and unlike with credit cards, the minimum payments on these debts have a specific end date. Provided the rate you pay on your debt is lower than the interest you earn on your investments after taxes and fees, investing will likely give you more bang for your buck.
You should focus completely on debt payoff
If you have enough in your savings account for emergencies and irregular expenses, and you have high-interest debt, you should be focusing your efforts on aggressively paying down your debt before investing. Most credit cards have double-digit interest rates, and it will be difficult to find returns this high in the stock market.
When you are paying down your debt, focus on paying off the highest-interest debt first, especially if it’s credit card debt. The returns are hard to beat, and consumer debt is the worst!
Paying off debt offers you a guaranteed return for your money. And while it can be disheartening to throw money at the purchases of your past, becoming debt-free is liberating and reduces stress significantly. With each debt you pay off, your fixed monthly expenses decrease, freeing up more money for you to enjoy and invest in the future.
» MORE: How to pay off debt
You should find balance between investing and paying off debt
Even if your interest rates are higher than you would expect to get in the stock market, if your employer offers a match on your retirement plan, you should invest up to the match before focusing on debt payoff. Traditionally, these matches offer a 25-100% return on your contributions, and you will be hard-pressed to to find these guaranteed returns elsewhere. In this case, all “extra” funds should still be funneled into debt payoff.
If your only debt is at 0% interest for a period of time, such as a balance transfer introductory rate or a student loan grace period, you should invest and pay off debt. Make sure to pay enough toward the debt to avoid paying interest, but use the rest of your available funds to invest.
While this guide is a good start, in the end, you may decide to pay down low-interest debt quickly or continue to fund your retirement accounts while paying down high-interest debt. And if you decide to go against this while still making financial progress, it’s fine! In the end, your own preferences and tolerance of risk will influence what you choose to do to reach financial independence.