I love getting this question because of two reasons:

1. Either way you go, you are doing the right thing – if you pay off your debt first then you have no debt. That is a great situation to be in. If you invest more first, you are building up assets that can make you more money later on in life. That is a great position to be in, as well. And if you do both at the same time, it will be slower to improve each individually, but eventually you should have no debt and a decent amount of assets, the same as the other scenarios. Just don’t blow your money on stuff, and use it to improve your net worth, and you will win in the end.
2. The answer will always be “it depends”, which is the number one answer used to irritate people. And sometimes its funny to irritate people. Unless its me getting irritated, an then I am more bias toward it not being as cool.

As far as a detailed answer to actually help you make the decision, let’s go through a number of ideas you should think about when trying to figure out the best directions for yourself.

1.  How do you feel about debt?

There are all walks of life out there. Some people (I am definitely not one of them) are very comfortable having a whole bunch of debt at all times. Now, I will say that those people are unlikely to be reading this blog because the people who are comfortable having tons of debt probably are not worried about being financially free, in comparison being worried about owning stuff that makes themselves look cool. On the other side of the spectrum of humanity are the people who absolutely cannot stand having any debt. And then, for most American’s, you are somewhere in between.

Regardless of what I or others tell you, the more you loathe debt the more likely you are to focus on paying off debt over investing. And I am here to tell you that is perfectly fine. Go ahead and get it out of your life, forever. If you are going to have anxiety throughout your days because you have debt, I would rather tell you to pay it off and improve your quality of life, even if mathematically it is not the most optimal choice.

Either way, you need to decide your level of comfort with carrying debt. If you have no comfort, pay it off as your focus. If you have comfort carrying some debt (say a mortgage), and you can put yourself in better long-term positions through investments, then proceed that way.

2. What is Your Comfort with Investment Risk?

The last line in the last paragraph transitions us to another consideration, which is what is your investment risk tolerance? Investing over paying off debt as a recommendation is largely focused on investing your money aggressively in order to get higher returns of 8% to 12%, which is hopefully higher than your debt interest rates of 3% to 7% (not including credit card interest rates, of course). But, what if you are not comfortable taking the level of risk with your investments to give yourself the likelihood of those higher returns?

If you are not comfortable with that amount of investment risk, that is perfectly fine. Just like hating debt or not minding debt are both perfectly fine. In order to get hopeful returns of 8% or more, you have to likely be invested in more risky investments. Those investments can have years where your accounts could drop in value by 20% to 30% or more (or if you own physical real estate, you could have large repair bills of $10,000 or more pop up). Many people want more consistent and less volatile investment experiences, and they are willing to invest in lower average return portfolios in order to curb their likelihood of years with losses that would worry them. If you are in that camp, it likely is not going to make as much sense to focus so much on investing and getting 5% or 6% returns if your student loans or other debts average 6% or 7% interest rates. You can instead focus more heavily on paying off that debt and getting guaranteed savings by avoiding the high interest payments.

So, what type of investor are you? A risk accepting investor or a risk-adverse investor? Your investor type should help you determine what direction is better for you.

3. What Percentage of Your Income is Being Spent on Debt Payments?

What is your Debt-to-Income Ratio? In the finance class that Midwest Money Mentor has available for you to purchase, you learn heavily about your debt-to-income ratio and why it is so important to focus on having that ratio at a low range. If a large amount of your gross income is going towards minimum payments on debt monthly, it will likely be heavily recommended that you put investing to the back-burner and focus on getting rid of that debt.

Your Debt-to-Income ratio is calculated by taking your monthly minimum debt payments (total, including mortgage) and dividing that by your gross monthly income. So, if you have monthly debt payments of $2700 a month (car, student loans, mortgage, credit cards, etc.) and your gross monthly income is $5000 a month, your DTI would be 54% (2700/5000=.54). We want to focus on your debt-to-income to be below 40%, and preferably below 35%, before you start focusing more-so on investing first.

Debt payments not only steal your money so that you cannot put as much of your money towards things like investments and fun in your personal life, they also add a higher degrees of risk to your financial life. Many people, if they get laid off from a job will have their credit destroyed, their savings wiped out, and worse, in a very short amount of time after the negative event. This is because they have to make these debt payments regardless of life events (and they do not have much money saved for emergencies because all their money is going to debt). Now think of someone who has those same life events pop up but they already have their debt paid off. How much more likely is it that they would have no negative issues with their credit and would possibly have longer periods of time before their savings is used up? Those debt payments can make bad situations, worse. So, if you have a large amount of your income going towards debt payments, you need to focus on paying down that debt first.

Step By Step Guide:

Many people, though understanding the information above, still would like a roadmap to follow in regards to what they should do with their finances. Though I have to point out that every person’s situation is different, here is a normal recommendation of what to focus on first, for the average person.

1. Get All The Free Money You Can – Many of you will work directly for an employer as a W2 employee. This affords you the benefit of having benefits (employee benefits that is). Some of these employee benefits will come with employer matches, which are free money benefits. Usually the places you will see these employer matches are in employer sponsored retirement accounts (typically within the designations of 401k, 403b, 457, Simple IRA, or SEP IRA) and in Health Savings Accounts. Therefore, you should do what you need to do so you can get your free money from your employer, which typically involves you putting a certain percentage or dollar amount in these accounts and your employer matching your contributions. This is like getting a raise from your employer without having to do any more work. Take the money they are willing to give you!
2. Pay Off High Interest Debt – After you get your free money you should then heavily focus on paying off any debt you have that has high rates of interest (outside of a mortgage – which likely isn’t high interest anyway). You can decide what you quantify as high interest debt but I’m typically going to stick with anything 7% and above. With these debts, you are guaranteed to save yourself 7% a year (or more) once paid off. There are no other likely investments that could guarantee you above 7% a year in returns (especially without significant risk), so take the guaranteed win and get rid of that debt.
3. Create a 3 to 6 month savings account/safety net – After getting your free money and wiping out high cost debt, you want to put yourself in a position where if something breaks down, you get sick, you lose a job, etc. you can live for a while and not have to go into more debt. We want you to make sure you have at least 3 months of expenses put aside in a money market savings account, or even better, 6 months of expenses put away in a liquid investment brokerage account, so you have the financial protection you need. The importance of this emergency fund (money to be used in emergency ONLY), is that it gives you extra comfort to move forward quickly with your next steps, and it makes sure you do not go backwards ever again. If you ever need to use some of your 3 to 6 months savings, make sure you replenish that savings again before you do anything else.
4. Check Your Debt-To-Income Ratio – As mentioned before, if you have high debt-to-income ratios, the next step would be focusing on your middle interest rate debt and getting that paid off so your DTI is in a safer and more sustainable range. Try to get your Debt-to-Income ratio down to 35% or so to free yourself from debt and to free up more money that you can put towards investments. If your housing payment, alone, is above 35% of your income, then you likely want to focus on paying off all debt outside of the mortgage (and/or develop a less expensive living situation) so you can build as much wiggle room as you can. If your debt-to-income ratio is already in-check, go on to the next step.
5. INVEST MORE!!!!!!!!!!!!! – If your DTI is now down, or it is already good, we can begin focusing on investing heavily to speed up your timeframes to financial freedom. Since you are already getting your free money from your employer, you can choose to invest more in your employer sponsored plan or your can choose to invest in your own individual account so you can control the costs to a greater extent. We won’t go into which one to choose on this post, but we will say that to start off, make sure you are investing solely in passive, index mutual funds so you can make sure you are paying the lowest fees in either situation.
6. Optimize – For simplicity’s sake, and so this post is not 100,000 words in length, we are not going to dive into all the detailed information on where to invest, what to invest in, costs to focus on, and all the other important information that we will cover in other posts and in the Midwest Money Mentor Courses. For now, we are going to conclude the steps by saying that after you are investing more (preferably 20% to 50% of your income) you should then focus on optimizing your investments and looking for opportunities. Optimizing your investments means finding the most opportune way to grow your wealth in a fashion that has you paying the least amount of taxes (for the life of the investments), incurring the least amount of costs (for the life of the investments), and improving the consistency for which you can count on those investments to last your lifetime. See other posts to expand on this information.
7. Opportunity– And partner to number six -Optimize, is you need to keep an eye out for opportunities. Opportunities are out there for everyone to see, but most do not pay attention. Opportunities that could pop up would be seeing an investment property opportunity that you notice may be sold by someone in your area for well under market value. Or maybe it is buying a business that you could partner with someone to run that would immediately create extra cash flow for you. You need to be very picky with the opportunities you take action on to make sure they are very safe and profitable. But if you do all your required due-diligence and they still pencil out to a great investment, you want to be on a position to take advantage of the opportunity. This is where people can really grow their net worth fast. This is because they can find a deal that improves their net worth by $30,000 or $50,000 in one shot. More on this in further posts as well.

For more information on all of these steps, keep reading through the other posts. More and more posts will come available to improve the information at your finger tips. Use it to grow you knowledge and go Tony Stark smart with your finances.

Also, for something completely unrelated to this post, check out one of the “Best Science Images” of 2024 –