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July 16, 2020

Should I pay off credit card debt before investing?

For many people, credit card debt is just a fact of life. Our lifestyles are subsidized by a credit card, simply because an average American’s expenses are as much as, if not more than, their income. Because of this, debt can be a sensitive and stressful topic to talk about.

If you have credit card debt and it’s holding you back from investing, you might be wondering if you should focus on investing first and pay off credit card debt later with the remainder of your savings. If you are young, you might be even more frustrated because you missed out on some great time in the market due to credit card debt. It can often feel like you’re putting “real life” on hold while you pay down credit card debt. So, should you pay off all your credit card debt before investing in the market? Here are some simple steps that can help you answer this question for yourself and help you prepare for the future.

Build your base

No matter what your financial situation is right now, building your emergency fund can bring you a sense of peace and security. The dollar value of your emergency fund depends on your circumstances; if you have a family to take care of, live in a high cost of living area, or have other necessary expenses, it’s a good idea to save up for about six months of expenses. Ideally though, three months of savings would be a great start to your financial journey.

When it comes to debt, you should be paying at least the minimum payment on all your debts. If you ignore your minimum payments in order to build your investments, you’re digging yourself into a deeper hole down the line.

Finally, you should take maximum advantage of your company’s 401(k) match, if available. Not doing this means you’re leaving money on the table and ignoring a big part of your compensation plan from work.

Pay off predatory rates

Not all credit card debt is equal. Credit cards can vary from 0% introductory interest rates to upwards of 10%. It is important to take inventory of all the different short-term debt you have, including store credit cards, financing for electronics and other goods or services, lines of credit, and credit cards.

Once you have a list of all your short-term debt, you can form a plan on how to tackle it. Most financial planners recommend the debt avalanche method, in which you tackle debt from the highest interest rate. Once it is paid off, you can add that amount to the minimum payment you were already making on the debt with the next-highest interest rate.

Credit card debt is a symptom

Emotions are a huge stimulus for how you spend or save your money. If you racked up credit card debt with emotional spending, you have to address the emotions that led you to a shopping spree, or the pressures that lead you to accompanying your friends on a vacation you can’t afford. If you do not examine the behaviors and circumstances that led you to incurring high credit card debt, you might find yourself in the same situation again despite your best efforts.

It can help to create a budget and plan how much you will spend each month. Part of your budget should be the minimum payments on all your debt. When you subtract your expenses (including the debt minimums) from your income, you will see how much money you have left to save, invest, or pay down additional debt each month. Do your best to stick to your bare-bones budget, for at least six months, while you pay down debt and build an emergency fund.

At this point, also look into increasing your income by working overtime or finding a side-job if you have the capacity to do so. This is a great measure for the short term, as it allows you to pay off credit card debt fast and get started on your investment journey.

How to start investing

Once you’ve paid off your credit card debt and eliminated the need for further short-term debt, you can start investing. A great way to start investing for cheap is to make use of ETFs, which follow market trends, and invest in a variety of companies to offer you diversification benefits. Once you are ready to diversify into other asset classes, REITs and fixed income securities will round out your portfolio.

The Bottom Line

Ultimately, the question comes down to this: will you make a better return on investment by putting your money in the market or by paying off your credit card debt? The answer, almost always, is that you will make a better return on investment by paying off credit cards. Put another way, would you borrow $500 from your credit card company at 20% interest to make an average, unguaranteed return of 10% in the market?

When you make paying off toxic debt a priority, you will start to see the benefits in your financial and emotional well-being. The peace of mind that comes from better financial habits means that when you are finally ready to start investing, you’ll be able to make consistent and long-term positive changes for your future self.

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