What’s smarter: paying off debts or investing?
If you’re just starting out in your career, you will need to be prepared to face some financial challenges along the way — but here’s one that’s not unpleasant: choosing what to do with some extra disposable income.
When this happens, what should you do with the money? Your decisions could make a real difference in your ability to achieve your important financial goals.
Under what circumstances might you receive some “found” money? You could get a year-end bonus from your employer, or a sizable tax refund, or even an inheritance.
However the money comes to you, don’t let it “slip through your fingers.”
Instead, consider these two moves: investing the money or using it to pay off debts.
Which of these choices should you pick? There’s no one “right” answer, as everyone’s situation is different. But here are a few general considerations:
Distinguish between “good” and “bad” debt. Not all types of debt are created equal. Your mortgage, for example, is probably a “good” form of debt. You’re using the loan for a valid purpose — i.e., living in your house. On the other hand, consumer debt that carries a high interest rate might be considered “bad” debt — and this is the debt you might want to reduce or eliminate when you receive some extra money. By doing so, you can free up money to save and invest for retirement or other goals.
Compare making extra mortgage payments vs. investing. Many of us get some psychological benefits by making extra house payments. Yet, when you do have some extra money, putting it toward your house may not be the best move. For one thing, as mentioned above, your mortgage can be considered a “good” type of debt, so you may not need to rush to pay it off. And from an investment standpoint, your home is somewhat “illiquid” — it’s not always easy to get money out of it. If you put your extra money into traditional investments, such as stocks and bonds, you may increase your growth potential, and you may gain an income stream through interest payments and dividends.
Consider tax advantages of investing. Your debts likely won’t provide you with any tax benefits. But you can get tax advantages by putting money into certain types of investment vehicles, such as an RRSP or TFSA. When you invest in an RRSP, your contributions are deductible, and any growth is tax-deferred. (Keep in mind that taxes may apply to withdrawals.) TFSA contributions are not deductible, but any growth is taxfree and your money can be withdrawn at any time, tax-exempt.
Clearly, you’ve got some things to ponder when choosing whether to use “extra” money to pay off debts or invest. Of course, it’s not always an “either-or” situation; you may be able to tackle some debts and still invest for the future.
In any case, use this money wisely — you weren’t necessarily counting on it, but you can make it count for you.
Kevin Dorey is a Financial Advisor with Edward Jones. Based in Tantallon, Kevin specializes in helping individuals reach their serious, long-term investment goals. He can be reached via email or at (902) 826-7982. Edward Jones is a member of the Canadian Investor Protection Fund.