A lot of the time, we see this question of priorities come up in personal finance forums. Should you prioritize investing money or settling your debt?! The simplest answer is that 99% of time, the priority should be settling debt. The explanation is not that simple though.

What is personal debt?

When your expenses rise above your income, you run into debt. First of all, it is best to avoid getting into debt the best you can. But, we do understand that debt has become part of our lives today. The financial system, including banks, relies on debt.

You might be forced into student debt, your credit card carries debt, a house mortgage is a fancy word for debt, a car loan is a debt, and any personal loan is a debt. Oftentimes, these debts might not even be avoidable. Sometimes, these might be downright necessities.

In fact, we even encourage you to use a credit card that carries rewards and perks for using it. But always use it for what you can settle immediately.

The major benefit of all these debt sources is that they increase our purchasing power, temporarily. A credit card’s limit, say $4,000, is actual legal money we can spend to buy goods and services. But, we have to settle the credit card balance in a month, hence, the ‘temporary’ increase in purchasing power.

The major pitfall of debt is that they carry interest. This is how the lenders of these debts make money. This interest is quite deadly. For example, credit cards usually carry interest rates of above 20% on any unsettled balances. This is an insanely high rate which is also the standard among credit card companies.

A car loan can carry interest rates anywhere from 4% to 30% depending on many factors. Mortgage rates can vary anywhere from 3% to 15% depending on several factors.

One major factor affecting all these rates is your personal credit score. So, always keep that in check to be eligible for the best interest rates.

Either way, debt is costly.

Debt vs Investing

Investing is the opposite of getting into debt. Investing is when you have extra money and you put it aside in some source where this money can grow over time. Instead of you paying interest, this one gives you the opportunity to earn money back on your investment.

The good thing about investing is that it can grow your wealth. You put some money in the stock market and let it grow along with the growth of the companies you picked. You can also invest in dividend-paying companies and receive cash dividends. Either way, there is a possibility to increase your wealth by investing.

The problem with investing is that it takes time. You are most likely to see single-digit growth within 1-2 year periods. For example, the S&P 500 Index, which consists of some of the best and biggest companies in the US, has seen on average 10% – 11% annual returns since its inception in 1926 to date.

The term ‘average’ can be deceiving though. These average returns have evened out negative returns as large as 38% (2008 financial crisis), and positive returns as high as 38% (1958). See the below graph that shows the annual returns of the S&P 500 Index throughout the years.

This shows that the stock market is volatile and you cannot always expect your money to grow. It is also theorized that given enough time, all stocks appreciate in value. But you cannot hold off settling your credit card until this ‘enough time’ realizes for your stock picks.

If you hold off paying your mortgage to invest that money in hopes of growing money in a month or a year and then come back to settle your mortgage, you are living on the edge. You could easily lose all your money in the stock market and deep dive into a potential debt trap.

We are a pro-investing platform. So, it is not easy for me to tell you ‘hold off investing.’ But investing does not make sense with outstanding debt.

So, always, always prioritize settling off your debt before investing in the stock market. In settling your debt, prioritize the highest interest debts first.

If you have any questions about this article, do drop them in the comments below. We will get back to you as best as we can.