Which of the following statements is true?

1) You shouldn’t invest until you’re completely debt-free. 

2) Invest as soon as possible, even if you’re in debt. 

Think you know the answer? 

Well, that’s actually a trick question- both answers CAN be right. 

I’ve seen the question so many times, and the answer is never straightforward- but I’m going to help you through that. 

Let’s walk through the steps to assess your finances and make this decision based on your financial situation.

Step 1: Assess Your Debt Situation

Step 1: Assess Your Debt Situation

Let’s take a quick look into your debt situation. 

Start by opening up your debt payment statements, whether you have them on paper or online. 

When you’re ready, start with these questions!

What Kind of Debt Do You Have?

Understanding your debt is more than just saying “I’ve got credit card debt,” or “I have student loan debt.”

Let’s figure out what each type of debt is. 

Check out those debt statements and find your interest rate. Your lender might list this as your APR, or annual percentage rate. 

Is your interest rate above 10%? That means you have a high-interest debt.

Is your interest rate below 10%? That means you have a low-interest debt.

If you have anything that qualifies as high-interest debt, it’s not a good time for you to invest. 

There is no stable investment that can reliably and consistently provide a return comparable to your high-interest debts. 

Focus on using any leftover cash in your budget to pay down your debt using a debt snowball or debt avalanche

When you pay off your high-interest debt, come back and evaluate your next step again. 

If all of your debts are low-interest debts, hold onto these notes- we’ll use them for Step 3. 

Are You Making Minimum Payments?

Take another look at your debt statements and make a note about the minimum payment for each debt.

Are you making at least the minimum payment each month? 

If you’re not making the minimum payment each month, stop here. It’s not a good time for you to invest. 

If you’re making the minimum payments, covering your cost of living expenses, and still have room in your budget, then you’re in a good state to move to the next step. 

If you don’t have additional room in your budget yet, hold off on investing until your monthly budget is stable and sustainable. 

Step 2: Assess Your Savings Situation

Step 2: Assess Your Savings Situation 

Before you start investing, it’s crucial that you have a plan in case of emergencies. 

Your investments should be focused on long-term goals, NOT an emergency fund. 

If your investments drop for any reason, you could be forced to sell at a loss and lose a lot of your money to cover your expenses. 

Make sure you have a separate dedicated emergency fund before you start investing. 

Don’t have an emergency fund? Check out my post about how to calculate what you need in your emergency fund and where to save it.  

If you don’t have an emergency fund ready to cover at least 3-6 months of your living expenses, save up before you invest. 

Is your emergency fund loaded and ready to go? Proceed to step 3!

Step 3: Assess Your Opportunity Cost

Step 3: Assess Your Opportunity Cost

What is Opportunity Cost?

Opportunity cost is defined as “the loss of potential gain from other alternatives when one alternative is chosen.” 

Okay, but what does that ACTUALLY mean?

Simply put, opportunity cost is the cost of missing out on your next opportunity.

Imagine it like you’re in a car with the “low fuel” light on. 

You see a gas station, and you debate stopping. 

The price of gas at the next station might be lower or higher- you don’t know. 

But the price of not stopping here might mean your car breaking down before you reach the next one. 

That’s your opportunity cost. 

Of course, maybe you’ve done your research. 

Maybe you know how far away the next gas station is, what gas costs there today, and how many miles you have left on your current tank of gas. 

Thanks to your research, you know that you won’t run out of gas before you get to the next gas station AND their gas is cheaper. 

It’s a lot more comforting to know that you’re risking a lot less!

The best thing you can do to fully understand your opportunity cost? Do your research!

Let’s Talk About Risk

I will say it over and over again until I’m blue in the face: 

Investing is risky- but there are ways to decrease your risk. 

I will never recommend investing in individual stocks- it has never been part of my portfolio. 

I know some people have made a lot of money by investing in individual stocks, but a lot of people have lost everything they have the same way. 

This Is Why I Invest in Index Funds.

Index funds are portfolios of stocks are bonds that mimic the composition and performance of the ENTIRE market. 

If the entire stock market goes up, your investments will go up. 

If the entire stock market goes down, your investments go down. 

Your risk is a lot lower than a single stock, so your gains will likely be lower in the short-term- but you won’t lose everything if one company has a bad day. 

For example, you might think that Tesla is a great investment- but you also might watch your investment plummet because of a single tweet.

When calculating opportunity cost, let’s look to the S&P 500’s historical 10% rate of return as our potential gain. 

Now, that number is an average of gains and losses almost 100 years, so I adjust this to a more conservative 7% to reflect the ups and downs of the last few years. 

Remember that we’re looking at investing from a long-term perspective, so approximating somewhere between 7% and 10% will provide you with a solid estimate. 

For this exercise, we’ll stay conservative and use 7% as our potential investment interest rate. 

Calculating Your Opportunity Cost 

Remember those debt types and interest rates you wrote down in Step 1? Here’s where they come in. 

If your potential investment interest rate (7%) is HIGHER than your debt interest rates, you are in a safe place to invest. 

This means that your opportunity cost is low, so you should be able to gain more by investing than by paying off your debt. 

If your potential investment interest rate (7%) is LOWER  than your debt interest rates, you should wait to invest.

This means that your opportunity cost is high, so you should be able to gain more by investing than by paying off your debt. 

For example, if you have an 8% interest rate on a student loan, you should hold off on investing until you’re able to either refinance under 7% or pay off the debt. 

Have I Invested While in Debt? Yes!

Have I Invested While in Debt? Yes!

After Refinancing My Student Loans 

When I graduated, I found myself with about $35,000 in student debt, with an average interest rate of 8.6% thanks to a private loan. 

Once I consolidated and refinanced my student loans down to 4.5%, I began investing in my 401K up to my employer’s match. 

While Paying Down My Mortgage

Shortly after buying my home, I was cash poor AND ended up with an unexpected major renovation (if you haven’t, read my home buying misadventure here). 

While I was not able to initially invest (thanks to renovation loans), I was able to start investing the day they were paid off. 

My initial mortgage interest rate was 4.125%. I’ve refinanced my mortgage rate down to 3.125%.

I’ve increased my monthly investment contribution to match the decrease in payment. 

With 0% Balance Transfers

We decided to take a balance transfer to cover our final wedding bill, thanks to an 18 month offer. 

Because my interest rate was 0% for 18 months, I continued investing while we paid off the credit card. 

And One Time I Didn’t: Paying Off Our Car Loan Instead

When we paid off the credit card, we decided to snowball the payment to debt instead of investing. 

At that time, we evaluated our investments and decided that 2 ½ years with no car payment was our highest priority- even though it was a 4.5% debt. 

Sometimes peace of mind is the highest opportunity cost on the list! 

Breaking It Down

Let’s review!

Investing while you’re in debt is NOT a good idea if:Investing while you’re in debt IS a good idea if: 
You have high-interest debt,
You have only low-interest debt, 
You don’t have an emergency fund, or
You have a fully-funded emergency fund, and 
Your financial situation is not stable and sustainable.Your financial situation is stable and sustainable. 

Take the time to do your research, evaluate your options, and decide if your opportunity cost is worthwhile! 

Are you considering investing while paying down debt? Are you interested in more posts on investing and investment options? What other questions do you have about investing? 
Share your answers in the comments! 
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Related Debt, Savings, and Investing Posts:
Budgeting 101: Your Complete Guide to Building Your Budget
Emergency Fund 101: Why You Need an Emergency Fund
5 Steps to Crush Your Debt with the Debt Snowball Method
How to Use Your 401K Contributions to Save on Your Taxes