Should You Pay Off Debt or Invest?

Should You Pay Off Debt or Invest?

Have you ever seen a world champion win a tournament and say, “Hmmm.. I really wonder how I got there?” Very unlikely.

Winning is a very intentional act. You don’t accidentally become a world champion. It takes a lot of sacrifices, determination and hard work to win.

Personal Finance Is More Than Just Math

If there is one question you’ll have a hard time answering, during your wealth building journey, it has to be – “Should I pay off debt or invest?”. Some of the most common ways people rationalize being in debt include:

  • I can make more money investing than paying off lower interest debt.
  • My monthly payments are not high. Why should I pay off my debt?
  • I could lose the benefits of compounding by not investing during my debt pay off period. 

Human beings are very irrational creatures. Our behaviors drive the quality of financial decisions we make, more than we anything else. E.g. It is a very well known fact that a brand new car loses nearly 50-60% of it’s value during the first 2-3 years of its purchase and still people rationalize buying a new car with all sorts of reasons ranging from “reliability” to “feels great to drive”. It makes no sense mathematically to buy a new car, yet people make that choice. 

Should You Pay Off Debt Or Invest?

Earlier this year, we were faced with a very unique situation. We realized for the first time, how sloppy we had been with our finances. Even though our household income was high, we knew we didn’t do a good job managing it. As I wrote about it earlier here and here, we had to make a very important decision at that time. We were contemplating 2 choices:

Pay Off Debt or Invest?

1. Stay in debt and pay minimum on each of the debts but continue to invest. 

2. Stop all investments temporarily and focus on paying off all our debt. 

Our Debt Situation

We owed approximately $25,000 in debt which including both of our cars and a small balance on a rental property. One of the car loans was nearly 40 months old it still carried a balance of $5,500. The other car loan was relatively new and it had almost $12,000 balance on it.

We had our retirement investments going on as usual towards our 401(k) (maxing out each year) and also our Roth IRA contributions. We didn’t understand in the beginning as to why we should pay off debt instead of grinding through the debt payments as before. If we went with option #1, we were looking at almost another 24-36 months before we could become debt free. Something didn’t feel right about that.

How can we make so much money and still take so long to pay off these relatively small debt?

What We Learnt From Our Debt Free Journey?

I consider our decision to become debt free, to be one of the best decisions we have ever made in our lives. My wife and I simply kept the math aside and asked ourselves one question: 

How would our lives look like if we didn’t have any payments in the world? Could we sleep better at night knowing that we don’t owe any money to anyone?

Answering these questions didn’t take us a lot of time. I am very fortunate that my wife and I share a common philosophy towards money  We hated being in debt. We wanted to be debt free more than we wanted anything else in life. 

Related:  How To Stay Motivated When You Are Paying Off Debt

Our debt free journey has helped us learn a lot of valuable lessons which will stick with us for a lifetime. Some of them include: 

1. Always Have A Written Budget

One of the best skills we learnt during our debt free journey is to do a budget. Before this, we spent money impulsively buying random stuff on amazon or eating out. We rarely said no to anything. We saw every expenditure as a portion of our salary and it obviously appeared minuscule. When we did our first budget, we felt constrained. But it was only a matter of time, we realized how much we had been throwing away on random stuff. We plugged all those gaps. We suddenly felt like we got a raise. Budgeting is actually a permission to spend money on things that matter.

2. Avoid Credit Cards

Prior to the debt free journey, we had about 7 credit cards I had opened (what was I thinking?) and we were deep in the weeds, playing the reward points game. This journey helped us identify how credit cards made us spend more than usual since we didn’t really “feel” the pain of parting with our hard earned money. Check out this article – Does It Matter Whether You Pay With Cash Or A Credit Card? that talks about how paying by card makes spending friction-less causing you to spend more than usual. Once we decided to stop using credit card and switch to debit cards, we decreased our spending considerably. Now we are so used to our debit cards, we rarely use our credit card. I have just retained only 1 credit card and it’s usually used to make bigger purchases like airline tickets or booking hotels. We also pay off any transaction from a credit card such as this, immediately and carry no balance.

3. Always Pay Yourself First

Another big change we did was to pay ourselves first before we paid anybody else. It meant, we fund our retirement accounts, our dream fund accounts before we start paying anybody else. A lot of books I read during this time talked about this principle and implementing it made us realize why. You work too hard to earn the wonderful income, so don’t make others rich with that money. Pay yourself first!

Related:  My Debt Free Journey – Part II

4. Introduce Artificial Barriers To Your Purchases

One of the coolest hacks we discovered in this journey is to introduce artificial barriers to purchase an item. E.g. If we wanted to buy something online on Amazon or any other site, we used to leave the items in the cart and sleep over it. If we felt the same urge to buy it after 24-36 hours, we went ahead and bought it (given it was budgeted for). This simple hack has helped us avoid a lot purchases which would have earlier made it to our door step. It has taught us to say No!

5. Work With Your Spouse As A Team

A great side effect of this journey is that, my wife and I are now on the same page when it comes to money. It has helped us set our priories right. This journey has helped us build the muscle needed to take on long term goals and how to go about achieving them. We now agree and spend on items which really matter to us and cut down ruthlessly on items we don’t care. E.g Eating out has been our favorite and we balance it out by reducing our grocery budget. At the same time, we had slashed ruthlessly on our subscriptions and impulse purchases on Amazon. We have also decided to drop our amazon prime membership in 2019.

Becoming debt free has helped us build the right habits needed to not just earn a good income, but also spend it wisely. I don’t think, we would have been this disciplined with money, had we continued with our old habits. I am very happy we chose this path. The lessons we learnt are for a life time. Being debt free also allows you to be generous. Broke people can’t be generous! That’s a good enough reason right there, to become debt free!

What did you choose to do? What do you think is the right choice to make – Should you pay off debt or invest?

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