You may be keen to invest. But what if there is a pile of debt hanging over your head?
- Investing is a great way to grow your money into a bigger sum.
- If you have high-interest debt, you may want to work to eliminate it before investing your money.
Many Americans are familiar with the concept of debt, partly because they have it. While mortgage debt is the healthy kind 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 damage your credit score, making it harder to borrow affordably. when you need it.
What if you’re sitting in credit card debt but have cash on hand? At that point, you have a choice. You could reduce your balances or make your money grow 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 that you pay off your high-interest debt. before you put a dollar of your money into a brokerage account or IRA.
Why paying off debt first is essential
Dave Ramsey is not a fan of debt. He thinks your first financial priority should be to eliminate him.
To be clear, in this context, he’s talking about unhealthy debts, like your credit card balances. Ramsey doesn’t think you should try to lower your mortgage by $300,000 before you start investing.
But either way, Ramsey insists that before you invest a penny, you need to tackle two important goals:
- Pay off high interest debt
- Create 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. If your income is tied to monthly debt payments, it will prevent you from building wealth. Or, as he puts it, it’s like trying to run a race with your leg attached.
Additionally, if you start investing before you have a fully loaded emergency fund, you could end up having to cash out investments when they run out and lock in permanent losses when you need the cash. This is 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 or an IRA. Moreover, there is a good chance that the interest rate you are charged on your debt will exceed the return you can generate by investing. And so that’s another reason to pay off the debt first.
Imagine that you are able to generate an average annual return of 10% in your portfolio. That’s pretty much what the stock market has done on average for the past few decades. If you owe money on a credit card that charges 20% interest, guess what: you won’t come out on top.
A good way to fight against 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 it off.
If you’re a homeowner, you might even consider doing a cash refinance and using that money to clear your credit card balance. Or, you can wipe out your credit card debt with a cheaper home loan, then pay off that loan as quickly as possible.
Either way, take Ramsey’s advice to heart when deciding when the time is right to start investing. It’s fine to want to grow your money, but it’s important to eliminate your unhealthy debt before you focus on longer-term wealth-building opportunities.
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