This is a question that many people struggle with. As with many other things, we all want to get the best value or most bang for our buck. The problem is that there are multiple good things to do when you have a little extra cash. I think everyone would agree that all of these options would be beneficial.

Pay Down Debt

You’ve probably heard that paying down a debt at some interest rate is like earning an investment return of the same rate. For example, your car loan is at 8% and you pay off $100 of the balance. You have now saved yourself from paying $8 in interest over the next year. This is the same as investing that same $100 and earning an 8% rate of return, except the return is gauranteed.

This is all well and good except that not all debt is the same. Credit card debt is usually accompanied by very high interest rates, but that’s not always the case. Some have credit card debt held at 0% percent interest as part of a promotion. Some forms of debt are also tax deductible such as mortgages and student loan debt. Depending on the situation it may not always make sense to pay off debt first.

Save

Putting money into savings doesn’t usually earn a high rate of return, but there are other important factors to consider besides this. It’s always nice to some money stashed away in case of an emergency or other abrupt financial situation. Without anything in savings, you may be forced to take on even more debt, and even then, not everything can be paid for with a credit card (cash advances carry such high interest rates I don’t even care to consider them).

There is also a peace of mind that comes with money held in savings. This peace is worth different amounts to different people, but it is a factor worth considering.

Invest

Investing has the potential to yield great returns, but it remains just that, potential. Only you can determine your specific risk/reward scenario. Just as with savings though, there is a mental aspect of the equation. Having some form of investments will help take some of the weight off your shoulders that debt can load on you. It’s can be very hard emotionally to be in debt, and investments can help to counteract those negative feelings.

Also, tax advantaged retirement accounts have set limits of how much one may contribute in any given year. If you wait to invest until after you’ve paid off all your debts, you won’t be able to make extra contributions in later years for years past.

As with most decisions, there is no real clear answer because every situation is very different. You may choose to do all of these things in tandem. I would recommend that you keep at least a small reserve in savings at all times, but you have to ultimately decide what you feel most comfortable with. If you’ve got any questions regarding your specific situation, feel free to email me at fiscalmusings@gmail.com

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