Should you start investing when you still have debt?
Author: Maurie Backman
Source: The Motley Fool
Many Americans are familiar with the concept of debt -- namely, because they have some. While mortgage debt is the healthy type to have, credit card debt is the opposite. Not only can a lot of credit card debt cost you money in interest charges, but it can also result in credit score damage, making it harder to borrow affordably when you need to.
What if you're sitting on credit card debt but happen to have some cash at your disposal? At that point, you have a choice. You could chip away at your balances, or you could put your money to work by investing it.
Investing is definitely a great way to grow long-term wealth. But if you ask financial expert Dave Ramsey, he'll tell you that it's imperative you pay off your high-interest debt before you put a dollar of your money into a brokerage account.
Why it's essential to pay off debt first
Dave Ramsey is not a fan of debt. He thinks your first financial priority should be to eliminate it.
To be clear, in this context, he's talking about unhealthy debt, like the balances on your credit cards. Ramsey does not think you should try to whittle down your $300,000 mortgage before beginning to invest.
But either way, Ramsey insists that before you invest a dime, you should tackle two important goals:
- Paying off high-interest debt
- Building an emergency fund with enough money to cover three to six months of essential expenses
Ramsey's logic is that your income is the most important wealth-building tool you have at your disposal. If your earnings are tied up in monthly debt payments, it will stop you from building wealth. Or, as he puts it, it's like trying to run a race with your leg tied together.
What’s more, if you begin investing before having a fully-loaded emergency fund, you might end up having to cash out investments when they're down and lock in permanent losses when a need for money arises. That's not a good situation at all.
Paying off unhealthy debt is something you should do before putting money into an investment account like a brokerage account. Plus, there's a good chance the interest rate you're being charged on your debt will exceed the return you can generate by investing. And so that's another reason to pay off debt first.
Imagine you're able to generate an average annual 10% return in your portfolio. That's roughly what the broad stock market has averaged over the past number of decades. If you owe money on a credit card charging 20% interest, guess what -- you're not coming out ahead.
A good way to tackle debt
If you have high-interest debt, it pays to explore your options for consolidating it. Doing a balance transfer or taking out a personal loan could lower the interest rate on your existing debt, making it easier to pay off.
If you own a home, you might even consider doing a cash-out refinance and using that money to knock out your credit card balances. Or, you could wipe out your credit card debt with a less expensive home equity loan, and then pay that loan off as quickly as you can.
Either way, take Ramsey's advice to heart in deciding when the time is right to start investing. It's good to want to grow your money, but it's important to knock out your unhealthy debt before focusing on longer-term wealth-building opportunities.
This article was written by Maurie Backman from The Motley Fool and was legally licensed through the Industry Dive Content Marketplace. Please direct all licensing questions to firstname.lastname@example.org.