You should be investing even if you’re in debt. Here’s how.
In 2017, the only thought on my mind was my crushing, overwhelming debt.
Back then, my understanding of money consisted of three things:
Debt was bad.
Savings meant money I could use when I ran out of money in my checking account.
If I had debt, I would never have enough cash in my savings account.
I had no idea about retirement accounts, how to invest or where to even start when it came to healthy finances. I just knew that the debt kept me up and night, and I couldn't be bothered to look into anything else.
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What I didn't know then is that the best thing we can do to build wealth is to appreciate the value of time, which works its magic in several ways when it comes to debt vs. building wealth.
Let's start with breaking down debt. High-interest debt is overwhelming and frustrating. For example, say you’re paying 23% compounding interest on purchases you made three years ago. If you just pay the minimum, you could double your total debt by the time you pay it off.
On the flip side, if you only focus on debt repayment, that usually comes at the expense of savings. Then, as soon as an emergency comes up, you're back to using your credit card or investment accounts for support. You need to strike a balance between paying off debt and making sure you’re still saving.
How do we give ourselves the gift of time when it comes to debt? The absolute best thing you can do is utilize 0% interest balance credit cards and transfer your debt. Balance-transfer credit cards typically give you 15-21 months interest-free to pay off your debt. By spreading your debt over months, you're giving yourself precious time to save for the inevitable things that pop up –– like weddings, vacations, and car repairs –– while also setting up your retirement and long-term goals for success.
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Now that we’ve eliminated the recurring average interest rate of 22.19% on every purchase by using debt to pay off debt, we can open up the world of compounding interest. The critical piece to using debt to pay off debt is being able to afford the monthly payment.
Compounding interest is the most powerful simple way to build wealth. Let's use Sally as an example.
Sally is 25 and has $30,000 in collective debt. She has an extra $500 a month in her budget to put toward debt and to invest. Let's keep things simple and say she has no interest.
We will use the stock market 100-year annual return of 9% interest rate for these scenarios.
Scenario 1: We put all $500/month toward debt repayment. It will take Sally five years to pay off the debt. After the debt is paid off, she then invests $500 per month for five years.
Scenario 2: We put $250/month towards the debt for 10 years and invest the other $250/month from ages 25-35.
If we look at Sally from age 25-35 in Scenario 1, she contributes $30,000. In Scenario 2 she will also contribute $30,000. But here's where things get interesting. After five years of investing in Scenario 1, Sally will have $38,779. Because she contributed over 10 years in Scenario 2, Sally will have $49,358.
Do you want to see something even crazier? If Sally decided never to contribute again, 30 years after Scenario 1, she would have $571,405. In Scenario 2, she would have $727,286. That’s a $155,881 difference!
By starting earlier, even though she contributed less, Sally earned more and could contribute less over time.
Let’s say your debt is not transferable — such is the case with student loans — and you don’t qualify for a 0% interest balance transfer card, we need to pivot to improving our debt psychology.
Let's be honest; it's very rare to have $30,000 in debt with 0% interest, especially if you have student loans. So here's where we have to shift perspectives. While high-interest debt is very difficult to manage, low-interest debt allows you time to build wealth. Yes, you will pay interest, but is the interest more than you will earn over time in the market? If you are consistent with your debt repayment plan and investment strategy, you will always outperform your debt.
You don't have to be “rich” to start investing in the stock market. Here are some simple ways to start now. Take advantage of your employer's retirement benefits. If you don't have that option, open up a Roth IRA. You can also set up a taxable brokerage account with a trusted firm like Vanguard, Swabb, Betterment or Ally and contribute a little each month. By starting today, you're giving your future self the greatest gift of all — freedom.
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