A common debate in personal finance is whether you should pay off debt or save for retirement with your extra cash savings at the end of each month. Some investors can’t fathom holding onto any type of debt, good or bad and insist on paying it off immediately. Others believe in holding onto “good debt,” which is commonly associated with a mortgage, which can eventually increase your net worth. While bad debt, is brought on to purchase something that may not appreciate in value or generate future income. Regardless, it is entirely dependent on an individual or family’s financial situation.
There are a few things to consider when deciding whether to pay down debt or contribute towards retirement.
- It starts with determining which debt payments have the highest interest rates.
- At the very least, you should be making the minimum payments on all debt payments.
- This means determining which debts need to be paid down more aggressively vs just making the minimum payments.
On the other hand, maximizing your retirement contributions should come prior to paying your bills in certain cases. Both debt payments and investment savings can be automated. However, it may make more sense to automate savings first in order to pay yourself first. In many cases, people have a strong desire to build up their emergency fund or general retirement savings, hold enough to make minimum payments on any debt, and then use any extra cash to pay down high interest loans.
In general, there are many ways to maximize your investment return, but you can also take advantage of the low interest rate environment (this includes: refinancing your home, student loans, etc.).
If you can estimate a larger return on your investment than the rate at which your loan is growing, over the long-term, it mathematically makes sense to put your extra dollars towards retirement.