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You Just Got a Raise: Do You Pay Off Debt or Invest?

Many of us know it’s important to invest both for retirement and pay down debt. We know that earlier is better when it comes to investing but high-interest debt can constrain your ability to invest. So, when that hard-earned raise or unexpected bonus lands in your bank account, what’s the financially responsible thing to do? Should you make additional debt payments or invest the money?

It depends. Balancing the need to save with the need to reduce debt can be tricky. It depends on many factors, so assessing your individual situation is an important first step. Consider how much and what kind of debt you have, the interest rate(s) on the debt, how much you have already saved, the expected return on an investment, your income, age, tax situation and credit score.

However, before we explore which option may be better for you, let’s address an “emergency fund,” which many people lack. As a general rule, you should ideally have three to six months of living expenses saved or ready access to cash in case of an unexpected job loss or illness. If you don’t have that much accumulated, then building up your reserves should be your first priority.

Decision A: Make More Debt Payments

First, remember that not all debt is necessarily bad. Some debt could be considered an investment, such as a mortgage, student loan or business loan. Debt also varies in terms of the interest rate it carries and whether it has tax advantages. Interest paid on mortgages, subject to certain restrictions, and business loans are generally tax deductible. Interest up to $2,500 on student loans is deductible each year as long as income guidelines are met. These debts generally have low interest rates, and the interest deductibility makes those rates even lower.

However, reducing a credit card balance with a high interest rate should be a priority. According to CNBC, the average U.S. household has about $7,000 in revolving credit card balances1 and the average credit card interest rate, according to, is over 16% (over 25% if you have bad credit).2 That’s over $1,000 in interest each year, assuming the balance remains constant.

Reducing high interest rate debt may also be a better option to potentially improve your credit score. A low credit score could inhibit your ability to borrow and will likely result in paying higher rates.

Decision B: Invest in Your Retirement While Carrying Debt

There are various reasons to invest in your future first before paying off debt. For example, the average annual return for the stock market (as measured by the S&P 500 Index) over the past 50 years has been approximately 10%3, but that is an average and not a return that investors can expect every year. Even so, if your debt has a very low interest rate, it may be wise to maintain the loan and invest the money instead in various types of investment accounts.

Another consideration is your age. The younger you are, the more you could benefit from the compounding aspect of investing. Compounding is when the interest on your investment earns interest and growth becomes exponential. For example, if you invested $1,000, compounded at an annual interest rate of 10%, you would have almost $2,600 in 10 years without adding any additional money.

Further, if your employer matches any of your 401(k) or 403(b) contributions, make sure you take advantage of this. Many employers match your contribution up to 6% of your salary so long as the match is fulfilled. You can consider the match as a guaranteed 50% return on the first 6% of your contribution. There can also be tax advantages to investing in your 401(k) or 403(b) as that money can be contributed tax-free which reduces your taxable income.

Decision C: Increase Debt Payments AND Your Retirement Investment

Many people don’t like to carry debt, no matter how low the interest rate. If that’s you, you may want to split your extra money to increase your debt payment each month while also increasing the amount saved for retirement. The impact won’t be as significant on either your debt status or your retirement outlook, but both will be moving in the right direction.

When it comes to your individual situation, many factors need to be considered and often there is no “right” decision. The key step is to get your money working for you as efficiently as possible while also prioritizing what’s important to you.

The Financial Advisors at Jemma understand that your financial situation and life goals will change. We are here to help you with these and other money and investing questions.

1. “2020 American Household Credit Card Debt Study,” 1/12/21
2. “Average credit card interest rates,”, 4/28/21.
3. Morningstar

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