3 Questions To Ask Before Investing Or Paying Off Your Debt

3 Questions To Ask Before Investing Or Paying Off Your Debt

The decision of whether to invest or clear one’s debt is a tough one. People who find themselves with extra cash might face an important dilemma: should they use their excess money to have investments that will grow in the future or pay off their debts that have accumulated over time? Both options have their advantages and disadvantages.

In essence, either choice can make sense in the end, but this entirely depends on your circumstances. Before deciding whether you will invest your extra money in a stock market index fund or use it to pay off accumulating short-term loans in Singapore, be sure to consider your financial needs and goals first. It would be best to consider certain factors to ensure that you make the right choice.

Read on to find out the vital questions to ask yourself before deciding whether to invest or use your extra cash to clear your debts.

Question #1: Have you saved up for a cash cushion?

Leaving a sufficient balance of money in your bank account or an emergency fund is essential to protect yourself against financial distress in case an unexpected money problem arises in the future. In simpler terms, a cash cushion refers to your savings. It is the money that you can pull out whenever an unforeseen event, such as a severe illness or sudden unemployment, occurs.

One essential thing to keep in mind when deciding to either make investments or clear your debts is whether you have an adequate balance of money in your cash cushion to invest. According to financial professionals, an average working person must have at least six months’ worth of monthly expenses saved up in cash before investing.

Naturally, investing comes with unpredictable risks. Without backup money, your investments might result in a severe financial bump. So, before investing, it is a good idea to ensure you have a comfortable amount of cash saved up first.

Question #2: What is your debt-to-income ratio?

The total amount of debt you have is also an essential factor that you should consider before deciding whether to invest or pay extra on your loans. One of the most popular and easy-to-use measures that can help you make the right choice is the debt-to-income ratio. This measure compares your total amount of debt to your pretax income. It is a quick and easy way to determine your overall financial health.

According to many financial experts, a healthy debt-to-income ratio should not go beyond approximately 30% of your pretax income. For instance, if you earn $50,000 pretax income per year, your total accumulated debt should ideally fall below $15,000. If your amount of debt exceeds the prescribed percentage, you should always direct your extra cash towards paying off your debts first. Being aware of your debt-to-income ratio essentially helps you avoid being aggressive or impulsive with your financial decisions.

Question #3: Is your expected rate of return from your investment higher than the interest rate you pay on your debt?

Aside from having enough cash cushion and a healthy debt-to-income ratio, you should also identify whether your investment will give you a higher rate of return than the interest rate you pay on your loans. Comparing the return you can expect from your investment with the rate you are paying on your debt is vital in investing your money wisely.

Returns on investments are not always guaranteed. In many cases, the market may perform less well and leave you with a lower rate of return than you expected. Hence, it is crucial to carefully choose the kinds of investments you will make, whether bonds, stocks, money market funds, mutual funds, or others.

By evaluating the investment’s expected rate of return, along with the interest rate of your loans, you can determine whether investing is worth the risk. If you expect a rate of return from your investment that is considerably higher than the interest rate you pay on your debts, then it indeed makes sense to invest. Otherwise, it would be a good idea to focus on paying down your loans first.

Conclusion

Choosing between investing and paying off your debts can indeed be a tough decision to make. Risks and benefits should always be weighed when it comes to money matters. Before you choose to invest your extra cash or use it to clear your loans, it will be beneficial to consider your savings, debt-to-income ratio, and expected rate of return first. These considerations will surely aid you in making an informed and wise financial decision.

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