In the U. As a result, they're missing out on compound interest that could help their savings grow over time. With compound interest, not only do you earn returns on your initial investment, but you also earn returns on those returns at the end of each compounding period. If you start investing early and let your money sit, it will grow exponentially. The power of compounding is a much-needed tailwind to any investment portfolio," says Malik S.
Lee, certified financial planner and founder of Felton and Peel Wealth Management. Even if you can only contribute a small portion of your paycheck to retirement, it's better to start early and invest small amounts than to put away nothing at all. But if you can make enough sacrifices early on, then you won't need to make these sacrifices later on in life," says Ryan Marshall, a New Jersey-based certified financial planner. Finding ways to make your money go further can help ease the burden of trying to save for retirement while also paying off student debt.
Tax-efficient savings tools are one way to help grow your money faster. A k — if offered by your employer — is funded by pre-tax dollars that are funneled straight from your paycheck. In many cases, your employer will match whatever contribution you make up to a certain percent. The average employer k employer match for is 4. That means if your employer contributes up to 4. This type of match is sometimes referred to as "free money," but you can think of it as part of the total amount your employer owes you.
If you don't have an employer-sponsored retirement plan, you can also consider signing up for a Roth IRA , which is another type of tax-advantaged savings plan that can help you grow your retirement fund. Like this story? Get Make It newsletters delivered to your inbox. All Rights Reserved. He presumably knew he could put his money to work elsewhere in his investment portfolio, rather than spend it all at once on a home. As you calculate your potential returns from investing, don't forget to consider risk-adjustment.
There are a lot of unknowns with investing, and you must account for those risks to accurately compare potential benefits. Your goal should be to both invest and pay off your debt, but a hierarchy might help you decide when to put money toward each cause. The following order is meant to achieve these goals:.
Fund any retirement account you and your spouse have at work, such as a k plan , up to the amount of free matching money you receive. Many employers offer matching contributions, though there may be stipulations on how much they're willing to match. Learn the limits and maximize your benefits. Next, build your emergency fund in a high-interest savings or money market account. It may seem counterintuitive to save cash when you're trying to pay off debt, but having an emergency fund can help you avoid worsening your debt as you work to eliminate it.
A common rule of thumb for how much to save is between three and six months' worth of expenses, but any amount will help. If you meet the eligibility guidelines, fully fund a Roth IRA. These retirement accounts allow savings to grow tax-free. Roth IRAs have contribution limits , which are partially determined by your income level. After you've put some money toward retirement and emergency funds, shift your focus to high-interest credit card debt, student loan debt, or other liabilities.
You can start with the debt that is most difficult to discharge during bankruptcy, such as student loan debt, and then work your way through your outstanding balances. Keep at it until you are debt-free—and stop adding to it so you don't build it back up. Now that your debt has been handled, circle back around and top off any retirement accounts by maximizing your contributions up to the limits.
Tax regulations and company policies will affect your contribution limits. If applicable, this may also be a good time to consider funding a college savings plan for your children or grandchildren. After you're debt-free and have hit your retirement contribution limits for the year, begin building assets in fully taxable brokerage accounts , dividend reinvestment plans , directly held mutual fund accounts , and other cash-generating investment assets.
The order above offers a balanced approach to investing while paying down debt, but it isn't the only way to approach this issue. There are a lot of benefits to focusing all your effort on debt, especially if you have a substantial amount you need to pay off.
A major advantage of focusing on debt is that it allows you to protect your assets—if you don't have debt, assets can't be taken away as a collateral payment or as part of a bankruptcy settlement. Your money may not have as much time to grow in an investment account, but once you've paid off your debt, you can put all your spare cash toward investments and quickly grow your savings. Behavioral economics need to be factored into your decision—you and your financial situation are the variables that matter most.
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If you are older, nearing or in retirement, or have pressing concerns, such as high healthcare costs, you may opt to be more conservative—less risky—in your investment choices. Rather than investing excess cash in equities or other higher-risk assets, however, you may choose to keep greater allocations in cash and fixed-income investments.
Debt is one of those life events that most people experience. Few of us can buy a car or a home without taking on debt. Sometimes unforeseen events happen like medical expenses or the expense you may have after a hurricane or other natural disaster. In these times you may find you don't have enough readily available funds and need to borrow money.
Besides loans for large purchases or unforeseen emergencies, one of the most common debts is credit card debt. Credit cards are handy because there is no need to carry cash. However, many people can quickly get in over their heads if they do not realize how much money they spend on the card each month. However, not all debt is created equally.
Keep in mind that some debt, such as your mortgage, is not bad. The interest charged on a mortgage and student loans is tax-deductible. You will have to pay this amount, but the tax advantage does mitigate some of the hardship.
When you borrow money, the lender will charge a fee—called interest —on the money loaned. The interest rate varies by lenders, so, it is a good idea to shop around before you decide on where you borrow money. Also, your credit rating will affect how good of an interest rate you receive on a loan.
Your lender may use compound or simple interest to calculate the interest due on your loan. Simple interest has a basis on only the principal amount borrowed. Compound interest included both the borrowed sum plus interest charges accumulated over the life of the loan.
Also, there will be a date by which the funds must be paid back to the lender—known as the repayment date. The interest charged on loans will usually be higher than the returns most individuals can earn on investment—even if they choose high-risk investments. When paying down debt, there are many schools of thought on what to pay first and how to go about paying it off.
Again, a banker, account, or financial advisor can help determine the best approach for your situation. Financial advisors suggest that working individuals have at least six months' worth of monthly expenses in cash or a checking account. Paying off debt takes planning and determination. A good first step is to take a serious look at your monthly spending. Look at any expenses you can reasonably cut back on such as eating lunch out instead of brown-bagging a lunch.
Determine how much you can save each month and use this money—even if it is only a few dollars—to pay off your debt. Paying down debt saves funds going toward paying interest that can then go to other uses. Create a budget and plan how much you will need for living expenses, transportation, and food each month.
Do your best to stick to your budget. Avoid the temptation to fall back into bad spending habits. Dedicate yourself to sticking to your budget for at least six months. Some advisors suggest paying off the debt with the highest interest first. Several different budgeting methods allow for both debt repayment and investments.
Financial advice author and radio host Dave Ramsey offers many approaches to budgeting, saving, and investing. Once all debt is eliminated, Ramsey advises returning to building an emergency fund that contains enough money to cover at least three to six months of expenses.
The type of debt or type of investment income can play a different role when it comes time to pay taxes. Whether to pay off debt, or use the money to invest, is a decision you should make from a number's perspective. Base your decision on an after-tax cost of borrowing versus an after-tax return on investing.
However, this deduction phases out at higher income levels. Income earned from investments is taxable. This tax treatment includes:. Federal Reserve Bank of New York. Wells Fargo. Dave Ramsey. Home Equity. Reverse Mortgage. Refinancing A Home.
Your Money. Personal Finance. Your Practice. Popular Courses. Part Of. Consumer Debt Basics. Credit Card Basics. Debt Repayment Options and Advice. Retirement Planning K. Paying off Debt vs. Investing Further: An Overview People who find themselves with extra cash often face a dilemma.
High interest debt can be expensive, but past-due balances can affect your credit and financial well-being for years. If you're delinquent on any of your debts or you have accounts in collection, work on paying those off before you take any other steps to invest or pay off other debts. Delinquencies and collection accounts can hurt your credit as long as they remain on your credit report.
The faster you can get current, the better. Once you have your basic needs taken care of, the easiest way to decide whether you should pay off debt or invest is to look at the interest associated with both choices. If you know the rate your investment portfolio—or an investment such as a mutual fund or stock you're considering if you don't already have a portfolio—earns, use it as a benchmark to determine which debts to pay off before you invest.
Say your portfolio yield is 7. On the flip side, if your only debt is an auto loan that charges a 3. Debts such as payday loans, auto title loans and personal loans with repayment terms of less than one year generally charge very high interest rates, and thus paying them down should almost always take priority over investing.
In some cases, you may see an interest rate instead of an APR—the two are not the same. While an interest rate represents how much interest the lender is charging you to borrow money, the APR represents the full cost of financing, including fees and other charges. Use an online APR calculator to find out what you can expect to pay on your debt. How to Pay Off Debt As you work to pay off high interest debt , here are some tips to help you achieve your goal more quickly: Check Your Credit Report Before you start paying down debt, take a look at your credit reports to get a comprehensive view of all your debt accounts in one place.
Checking your credit will help you understand the balances of your loans and credit cards, your credit limits, and any accounts you may be behind payments on. If you have accounts in collections or credit cards you're close to maxing out, those accounts may become your priority when paying down your debt. You can get a free copy of your credit report through AnnualCreditReport. Take a look at your budget and determine how much of your monthly income you can use to pay down debt. Be realistic about your capacity and make sure to give yourself a buffer so you don't overextend yourself.
Depending on your situation, you may have some opportunities to score a lower interest rate on some of your debt. With credit cards, for instance, you can call and request a lower rate—there's no guarantee you'll get one, but it doesn't hurt to ask. You can also use a debt consolidation loan and replace some debt with a loan that carries a lower interest rate. It goes without saying that you should make at least all of your minimum monthly payments on time to avoid late fees and damage to your credit.
To accelerate your debt payoff, consider the debt avalanche strategy , especially for revolving debt such as credit cards. With this method, you'll take stock of your current debt situation by listing each card account, along with its balance and APR. Then you'll focus on tackling the account with the highest interest rate first. Make minimum payments on all your debt except debt with the highest interest rate first, which you'll pay the minimum on plus as much as you can spare in your budget.
Once it's paid off, you'll apply that amount to the regular payment you were already making on the debt with the next-highest interest rate. Continue this process until your debts are paid off. Paying off debt is an essential step in improving your financial situation, but it may not solve the root problems that led to the debt in the first place.
If you racked up debt because of overspending, it's important to take steps to avoid ending up back where you started. You may, for example, consider switching from credit cards to debit cards. It's also important to get on a budget and track your spending every month. Do whatever you need to in order to avoid high interest debt going forward. If you don't have any high interest debt, investing your extra cash flow can help you create a better life in the future.
In general, the best place to start with investing is your retirement account. Whether you do that through a work-sponsored retirement plan or an individual retirement account IRA is up to you, but make sure you're never leaving any money on the table, such as from an untapped employer match to your k. Beyond retirement, the right investments for you will depend on your risk tolerance. Risk tolerance is a term used to describe your ability to withstand a certain degree of volatility in your investments.
For example, stocks are generally riskier than bonds, and mutual funds can help provide diversification among stocks, bonds and other investments to reduce the risk from each one individually. Factors that help determine your risk tolerance include your age, income, lifestyle and when you'll need the money.
Someone who is 30 years away from retirement may have no problems with an aggressive stock portfolio, because their long-term investment can weather the ups and downs of the stock market. If you're two years from retirement, however, a market downturn could wipe out a significant chunk of your investment right when you need it for living expenses. In that case, you might have a lower risk tolerance. It Doesn't Have to Be All or Nothing As you approach saving, investing and paying off debt, keep in mind that you don't have to focus on just one thing at a time.
If you do, it could end up taking longer to start working on each of your goals, which could delay your success. Look to find a balance between your savings, investing and debt payoff plans. While it can take a little longer to achieve each goal this way, it can give you a more well-rounded financial foundation and pay off in the long run.
Also, it's important to keep your emotional needs during this process. For example, if you're experiencing significant stress over your low interest car loan, the peace of mind that comes from paying it off may be more worth it to you than your investment returns.
But after you reach those initial hurdles, there are some key things to consider when deciding where to put your extra money to get the most bang for your buck. The first thing you want to look at when deciding where to focus your money is the interest rate you are paying on your student loans versus the return you would expect to earn on your investments.
If the interest on your student loans is 5 percent, it might be hard to match that return on an after-tax basis through your investments, she said. If you have a longer time horizon, say 30 or 40 years until retirement, that could make it easier to out earn the interest rate by investing in a long-term stock and bond portfolio. If you have a company retirement plan or an individual retirement account, you will get a tax break either when the money goes in or out, depending on what kind of account you own, Benz said.
Traditional k plans and individual retirement accounts take pre-tax money. Roth k plans and IRAs let you put in post-tax money, which then may be used for tax-free income in retirement. If you're a lower income saver, you may be eligible for a saver's credit on your IRA or k contributions.
At the same time, you want to mind the potential tax deductions you may receive for your student loan debts. But high-income individuals may not qualify, Benz noted. As new tax rules go into effect this tax year, many more people will generally claim a standard deduction rather than itemizing their deductions. The good news for borrowers is that student loan debt is not one of those itemized deductions, Benz said.
If you have not done so already, refinancing your student loans can be an opportunity to lower the rates you are paying on your debts. Many debtors are paying in the range of 6 percent to 8 percent on their loans today, according to certified financial planner Douglas A. Boneparth, president and founder of Bone Fide Wealth, while some are paying higher rates. And some refinancing options may bring what you're paying down to rates as low as 3. If you currently have a federal student loan, you need to be aware of the flexibility you will give up by refinancing with a private lender.
That includes the ability to participate in income-driven repayment plans or forbearance options. As such, you want to be comfortable that you're going to be able to make the loan payments from the time you refinance to the time that note matures, Boneparth said. Refinancing your federal student loans with a private lender will also prevent you from participating in the Public Service Loan Forgiveness Program, said financial advisor Roger Ma, founder at Lifelaidout.
Lenders currently offering competitive rates for refinancing include SoFi and CommonBond, according to Ma. First Republic Bank also offers attractive rates for refinancing student loans into personal loans, Ma said. But you must live in an area the bank serves, and meet credit score and loan balance requirements. Even if it makes more sense to put money towards retirement over the long haul, some student loan borrowers cannot get past the debt looming over them.
In that case, it's perfectly OK to prioritize paying down the debt over saving for retirement. You also want to be sure you keep your overall financial situation in mind. If you have high interest credit card debt that is 20 percent or 25 percent, you need to focus on that before you take on your student debt that is at 10 percent, Ma said.
And you should take the time to review your financial picture — including your student loans — annually. If you have private student loans, you have less to lose by prioritizing their repayment — and potentially more to gain by refinancing. Student loan refinancing can decrease your interest rates, letting you pay loans off faster and free up money for other financial goals, like saving or investing.
Refinancing will save you the most money if you have a credit score at least in the high s and stable income. Some people are more focused on being debt-free than others. If paying off student loans early is a major personal goal — and doing so would bring you more joy than having a hefty investment account beyond your retirement savings — go for it.
Some lenders will let you make multiple payments a month automatically as well. Other ways to prioritize loan repayment include applying tax refunds and extra income from side jobs to your balance. Take advantage of an employer student loan repayment program if one is offered where you work as well. Tips for quick payoff.
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