Everywhere they look, young Americans see headlines about how it’s always best to start investing at as young of an age as possible because doing so can help harness the full power of compounding returns and minimize the risk of short-term market fluctuations.
At the same time, personal finance experts urge consumers to pay down debts and stress the high toll that interest payments can take on personal finances over time. With these seemingly mixed messages, it’s understandable for Americans to be confused about how to prioritize debt, saving and investing to best prepare for the future.
The stock market may be hitting record highs and the employment rate may be at 16-year lows, but Americans are more bogged down by debt than at any other time in history. In May, government data revealed total household debt in the U.S. reached $12.73 trillion, surpassing its previous peak back in 2008.
Nearly one in five Americans surveyed by GoBankingRates as part of a New Year’s resolution survey in December 2016 said paying down debt was their top financial priority in 2017.
“Millennials may be strapped with student loan debt, but those aged 18 to 24 were least focused on paying it down in 2017 compared to other cohorts,” says Jessica Rabe, research associate at Convergex, a global brokerage company based in New York. Instead, younger Americans are more focused on saving more money and spending less, she says.
But when it comes time to start preparing for retirement, deciding whether or not debt repayment should be the top priority can be more complicated than it seems.
According to Michael Batnick, director of research at Ritholtz Wealth Management, saving, investing and debt repayment are all part of a delicate balance.
“There is no universal answer – it is case-specific,” Batnick says.
Some of the choices may be easier than others. For example, Batnick says it’s a no-brainer to pay off credit card debt prior to investing.
According to Bankrate, the average interest rate on a variable-rate credit card is 16.6 percent, a rate so high that it’s unlikely any safe investment returns would be able to offset it. In other words, investors would be losing more money in accrued interest than they would be gaining from investing.
“Should you pay off your credit card debt before investing? Of course you should,” Batnick says. “Should you wait until your student debts are paid off before you start investing? Probably not.”
Interest rates on federal student loans are currently in the 4 to 7 percent range, according to Bankrate. Mortgage rates are even lower, mostly in the 3 to 4 percent range. Since 1926, the rolling 30-year annual return of the Standard & Poor’s 500 index has stayed between about 8 percent and 15 percent, suggesting investors with low-interest debt may come out ahead by investing in stocks in the long-term. Other classes of investments, such as gold, bonds and real estate, typically have lower historical returns than stocks and may be less profitable to own in lieu of paying off debt.
With all the variables in play, deciding the best course of action to take can be a bit overwhelming. Betterment financial planner Nick Holeman says Americans need to carefully consider their options, form a long-term plan and then follow it.
“Balancing paying down debt and investing for retirement is critical,” Holeman says. “Like most things in personal finance, the answer is one part math and one part behavior. You need to find the approach that makes sense mathematically and leaves you feeling comfortable.”
While each person should have a unique, personalized plan, Betterment offers several rules of thumb for how Americans should approach debt and investing.
First, people with debt should always prioritize making all minimum payments on-time and in full to avoid damaging credit scores. Once all minimum payments are completed, any excess cash should go toward eliminating the highest-interest debt first. More often than not, credit card debt should be the first target.
Only once high-interest debt is paid off should you consider setting cash aside for financial emergencies and saving or investing for retirement, Holeman says.
Paying off debt and investing are…
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