Due to FOMO, or Fear Of Missing Out, most people will want the answer to be Investing. In reality, paying off debt is the better option for most people and most situations. As a velocity banker, I definitely prefer to pay off debt.
Investing
When it comes to Investing, there are many different ways to invest. You can invest in real estate, stocks and ETF’s, bonds, index funds, and start up companies. Within stock market investing, you can choose to go after bluechip, speculative, growth, or dividend stocks, among others.
Investing is not guaranteed. You could make lots of money or you could lose everything. Investing is a long term game. It can take years before you can withdraw your money, especially with a retirement account. If you are a day trader or regularly buy and sell stocks within a year, you pay more taxes. As a long term investor who is invested in the total stock market or S&P 500, you can expect annual returns of 5% to 10%.
Paying Off Debt
In terms of Debt, there are two main types of debt – Loans and Lines of Credit. These two types of debt include credit cards, mortgages, student loans, personal or home equity loans, margins, and portfolio lines of credit. Depending on the type of debt, you may be paying simple interest or your interest payments may be amortized, meaning you pay more interest than principle in the first half of your term. An example of an Amortized loan is your mortgage or student loan and an example of simple interest is your credit card or line of credit. A 3% interest $250,000 30 year mortgage does not mean you will spend 3% in interest over the life of the loan. In reality, you will spend about $129,000 in interest over 30 years for a total loan cost of $379,000. Home Equity Loans work in the same way as mortgages while Home Equity Lines of Credit work in the same way as credit cards. You will pay much more in interest for a $20,000, 3% Home Equity Loan when compared to a $20,000, 3% Home Equity line of Credit because they calculate their interest in different ways.
Paying off Debt is guaranteed. You realize the benefits immediately in interest and time. The worst kind of debt is typically student loan debt because it is an amortized loan with high interest ranging from 6% to 10%.
Maxing out for 401k for 10 years versus Paying Off Your Mortgage in 10 years
Let’s say you max out your 401k at $19,500 per year with an average annual return varying between 7% and 8%. Let’s also assume your employer does not match your contributions as many don’t. After 10 years, you could earn just over $90,000. This assumes the stock market performs as expected and yields a good return each year. Let’s go back to the example of a $250,000, 30 year mortgage at a rate of 3% interest. You will pay approximately $129,000 in interest over 30 years if you make the minimum mortgage payment every month. What if you decide to double your mortgage payments? Then you would have paid off your mortgage in less than 12 years with a total interest payment of $47,344, saving you just over $80,000. What if you apply $15,000 towards your principle every January while making the minimum payments every month? In this case, you will finish your mortgage in 10 years and only pay $39,477 in interest, saving you about $90,000 in interest.
As you can see, both maxing out your 401k every year for 10 years and paying off your mortgage in 10 years with large annual principle chunks, will yield about $90,000. When it comes to investing in an individual brokerage account, 401k, or Traditional IRA, you will have to pay taxes on your $90,000 earnings. Investing is a risk and a bet. You could also lose $90,000 over 10 years. When it comes to paying off your mortgage, you could save $90,000. It is a major cost avoidance. Paying off your debt early in life will allow you to max out your 401k, Traditional IRA, and Roth IRA while having extra “play” money for stock market YOLO’s on GameStop and DogeCoin.
Conclusion
You should invest and pay off debt at the same time, but focus most of your money on paying off debt, especially amortized loans. When focusing on paying off your debt, you should still invest what your employer matches in your 401k. Think of it as your unclaimed salary that you need to claim every month with your 401k contributions. With your debt paid off, your borrowing power and credit score will go up and your ability to save will be multiplied.
