Typically, it's better to pay off debt first because the interest rates are higher on debt than what you may earn investing. We typically hear 7--8% is the average gain in the stock market over a relatively long period of time but that got flipped upside down with covid.
They stay away from debt.
Car payments, student loans, same-as-cash financing plans—these just aren't part of their vocabulary. That's why they win with money. They don't owe anything to the bank, so every dollar they earn stays with them to spend, save and give! Debt is the biggest obstacle to building wealth.
In general, it is mostly best to pay down debt before investing. The risk of investments is usually greater than the risk of paying debt. Investing money that will be matched by an employer is better than paying off debt as you get ``free'' money.
Speaking generally, $20K in debt is not very much in the grand scheme of things. Your first house will likely put you well over $100K in debt, after all. $20K is more like a car loan, which should be quite manageable.
Key takeaways
Debt-to-income ratio is your monthly debt obligations compared to your gross monthly income (before taxes), expressed as a percentage. A good debt-to-income ratio is less than or equal to 36%. Any debt-to-income ratio above 43% is considered to be too much debt.
Paying off your debt as fast as possible may seem like the responsible thing to do, but not having an adequate emergency fund or saving for your future could leave your finances at a permanent disadvantage down the road.
Wealthy family borrows against its assets' growing value and uses the newly available cash to live off or invest in other assets, like rental properties. The family does NOT owe taxes on its asset-leveraged loans because the government doesn't tax borrowed money.
Equity funds have the potential for higher returns, but they also come with higher risk. This risk level usually varies depending on the type of equity fund. On the other hand, debt funds aim to preserve capital. Hence, they generally have lower to moderate risk compared to equity funds.
Others will object to taxing the wealthy unless they actually use their gains, but many of the wealthiest actually do use their gains through the borrowing loophole: They get rich, borrow against those gains, consume the borrowing, and do not pay any tax.
If you don't have a heavy debt burden, like if you're simply paying off a small car loan on a monthly basis, then rushing to pay off debt might not make sense. “Selling stocks to pay your debt could be a big mistake if your debt burden is manageable.
The people who have all the money often go by unnoticed, dressing well, but without flash, driving used cars and living in the first house they bought in a modest neighbourhood. The authors called them the quiet millionaires. They often work in, or own, unglamourous businesses that spin off steady streams of cash.
Building up your savings each month as you pay down debt ensures you'll have funds on hand to cover unplanned expenses that would otherwise put you deeper into debt. For many, the best solution is to strike a balance between saving money and paying off debt.
Prioritize paying down high-interest debt
As inflation rises, central banks have been raising interest rates to make consumers spend less. These increased rates make it more expensive to borrow money, and make existing debt even more costly. For most consumers, the biggest impact of these rate hikes is on credit cards.
Paying off a mortgage has its benefits, but consider other factors such as the tax deductibility of mortgage interest and low loan rates. Investing the money instead may generate higher returns than the loan's interest cost, but markets also come with the risk of losses.
Ninety-three percent of millionaires said they got their wealth because they worked hard, not because they had big salaries. Only 31% averaged $100,000 a year over the course of their career, and one-third never made six figures in any single working year of their career.
Families like the Waltons, Kochs, and Mars can avoid capital gains taxes forever by holding onto assets without selling, borrowing against their assets for income, and using the stepped-up basis loophole at inheritance. That loophole allows the increased value of assets to be passed to their heirs tax-free.
A general rule of thumb to consider is that if your expected rate of return on investments is lower than the interest rate on your debt, you should pay down debt first. Historically, the stock market has returned an average of between 9% and 10% annually.
Being debt-free is a financial milestone we often hear about people striving for. Without debt, you can focus on building more savings, investing those extra funds and just simply having more peace of mind about your finances.
High-interest loans -- which could include payday loans or unsecured personal loans -- can be considered bad debt, as the high interest payments can be difficult for the borrower to pay back, often putting them in a worse financial situation.
If you're carrying a significant balance, like $20,000 in credit card debt, a rate like that could have even more of a detrimental impact on your finances. The longer the balance goes unpaid, the more the interest charges compound, turning what could have been a manageable debt into a hefty financial burden.
Given an average 10% rate of return on the S&P 500, you need to save about $1,400 per month in order to save up $1 million over 20 years. That's a lot of money, but the good news is that changing the variables even a little bit can make a big difference.