Many people feel like they have to choose between investing for the future and paying off debt now — but you can do both with smart advance planning.
At a recent Twitter Spaces event entitled “How to Invest and Build Wealth When You Have Debt” — part of Insider’s Master Your Money series, presented by Fidelity — experts Mandi Woodruff-Santos, co-host of the Brown Ambition podcast, and Kevin Matthews II, founder of BuildingBread, broke down different options for debt management and the best ways to get started investing.
You need to know what your financial situation looks like before starting to make a budget.
“The first step to a solid budget that gives you room for investing and also paying down debt is to start with how much money you actually have coming in and what is left over,” Woodruff-Santos said during the event. “You can put that toward goals such as paying down debt and paying yourself so that you can start investing.”
She emphasized that a budget shouldn’t feel limiting or prevent people from doing the things they want. Instead, she encouraged people to think of a budget as a plan that enables them to do what they truly value.
If, in the course of crafting your budget, you find there’s not enough money left over to reach your goals, consider cutting back or finding additional streams of income to reach your goals instead.
Matthews offered a structured approach to budgeting.
“Try to get as close as you can to the 50/30/20 rule,” Matthews said. “Fifty percent of your expenses should go to your bills, your debt, your rent. Thirty percent is for you to enjoy — because you should be enjoying some portion of your money. The last 20% is for saving and investing.”
If you want to free up money to contribute more toward your investments, you may consider refinancing your debt — just be sure to weigh the pros and cons before doing so.
“It certainly can be a good idea,” Matthews said. “I want to emphasize ‘can’ because it’s not 100% definitive. There are cases where it could make sense. You do want to be very, very careful about what debt you decide to refinance.”
Refinancing a federal student loan could cause you to lose key protections, such as eligibility for the Public Service Loan Forgiveness program and income-driven repayment plans. However, it could make sense to refinance credit card debt, personal loans, and private student loans if you can get a lower rate or a shorter term length to pay off your loan faster and lower its overall cost.
If you’re not sure what programs are best for your situation, call your loan servicer. Make sure you keep track of your communication with your lender, as well.
“You can’t entirely trust your servicer to keep tabs on everything,” Woodruff-Santos said. “Document those conversations, make sure that you are aware of where what types of loans you have and what your balances are, and call your servicer regularly to stay on top of it.”
If you change your interest rate, monthly payments, or pause payments, it will have a “ripple effect” somewhere, Matthews said. For example, with loan forbearance, interest will continue to accrue, growing your loan balance over time.
The same principle applies for investing.
“Investing starting now is going to have a ripple effect in the future,” Matthews said. “We hope that’s going to create more wealth for you. How is not investing today going to affect you?”
There are many avenues for building wealth while paying down debt. You could take advantage of options like an automated investing app, an online brokerage, financial advising firm, or 401(k) and other employer-sponsored plans.
While the number of choices may seem overwhelming, don’t let that stop you from taking action.
“Don’t overthink it. Just start,” Woodruff-Santos said. “A lot of folks have access to 401(k) through their employer. For a lot of people who are working nine to five, this is the easiest thing to do.”
To get started with your 401(k), find out where in your employer system you can enroll. You may even have access to a 401(k) match, in which your employer matches your contributions up to a certain amount — essentially free money toward your retirement.
Even if you’re just investing in your work’s 401(k), you should think of yourself as an investor, Matthews said.
Though starting to invest can seem discouraging, Matthews said the key to investing is consistency, no matter if you start with $50 or $100 — it adds up over time. Start somewhere and scale up. Many people start out with basic investments like index funds, which are a low-cost, relatively low-risk way to invest in the stock market.
“You want to go for what I call the layup,” Matthews said. “You can shoot from half court if you want, and you might do well. However, go for what’s easy. Go for what’s right in front of you.”
Making withdrawals from IRAs, 401(k)s, or similar employer-sponsored accounts to pay down debt is a risky proposition.
For example, if you leave your job, the money you borrowed from your 401(k) could quickly come due, leaving you in a situation where you might feel stuck in your job. Woodruff-Santos said you have to hedge the risk of needing to pay back the money quickly with the benefit of not depleting cash reserves you might need for emergencies.
“It is exceedingly rare where I would suggest or be OK with withdrawing from any investing account to pay off debt,” Matthews said.
He posed several questions you should consider before taking a loan from your retirement account to pay down debt:
Be sure to consult a financial planner before deciding to take out any loans from retirement accounts to pay off debt.
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