9/14/2012 8:05 PM ET|
Should you pay debt or invest?
Paying down high-interest debt is important, but that doesn't mean you can afford to neglect your retirement savings.
A lot of advice about paying off debt encourages a laser-like focus. Debt is expensive, while investment returns are uncertain. Who wouldn't choose to pay off a credit card charging 22% instead of funding a retirement account that might return 8% (maybe, if you're lucky)?
So, case closed, right? Not so fast.
Too many people making the debt vs. investing analysis are missing the bigger picture. And if they knew exactly what they were missing, they would understand the correct answer is: Do both.
Here's why: Retirement is expensive, and it can last a long time. Most people will have to save a substantial portion of their earnings over their working lifetimes if they want to retire comfortably. If they don't take the opportunities they're given to invest for retirement, they quickly fall behind, never to catch up.
More specifically, here's what you lose when you don't invest for retirement:
A possible company match. Most companies that offer 401k plans also offer some kind of match -- typically half of what you contribute, up to 6% or so. That's free money, honey, and represents an instant 50% return. Even smaller matches can give your account a substantial boost.
A tax break. When you put a dollar into a retirement plan, you get to invest the whole dollar. If you want to put the same dollar toward your debt, however, you'll typically have only 85 cents to work with if you're in the 15% federal tax bracket -- and even less if you're in a higher bracket. Lower-income people could be giving up even more: a tax credit that can equal up to 50% of your contribution.
The power of compounding. It's been called the eighth wonder of the world, for good reason. It can make you rich if you understand how it works.
The best way to illustrate its power is through the example of twins Megan and Morgan. Megan invests $250 a month, or $3,000 a year, in an IRA starting at age 22. Morgan procrastinates. At age 32, Megan stops investing and Morgan starts, putting aside the same $3,000 a year and continuing for the next 30 years.
Overall, Morgan contributes a lot more to her retirement: $90,000, versus Megan's $30,000. But guess who has more money at age 62? It's Megan, the one who got the early start. Exactly how much more depends on the rate of return you use, but assuming a 7% return would leave Megan with $315,522 and Morgan with $283,382.
You may not be able to contribute $3,000 a year yet. You may not have a sister named Morgan. It doesn't matter. The point is that money contributed to your retirement accounts when you're young matters a lot more than money contributed later in life. If you put off investing for retirement, it will get harder and harder to catch up. Many people find they can't. Their expenses grow as they get older, and they can't reclaim the golden opportunity they had in their youth to assure their future comfort.
That doesn't mean it's hopeless if you've already reached midlife without much retirement savings. But you really need to start socking money away and not putting it off any longer, unless you can live on about $1,000 a month (which is the typical Social Security check).
Here's the thing: Saving for retirement is often a "use it or lose it" proposition. You can't get back the company matches or tax breaks you didn't use. You can't make up for lost opportunities to fund Roth IRAs, which probably should be called the ninth wonder of the world. (Roths don't offer an upfront tax deduction, but your contributions can be withdrawn tax-free anytime, and all your earnings are tax-free when withdrawn in retirement.) You certainly can't turn back the clock to get the returns you missed because you failed to make those contributions.
Will your investments show positive returns every year? Probably not. Some years, you'll lose money. But over time, a diversified portfolio of investments should earn the kind of returns you'll need to retire someday.
- Calculator: Do I have too much debt?
Does that mean you can ignore your debts? Hardly. What you need is a smart debt repayment plan that focuses on paying off your most toxic debt, such as credit cards, while you also save for retirement. You don't have to be in a rush to pay off low-rate, potentially tax-deductible debts such as mortgages and federal student loans. Save prepaying those obligations until all your other debts are paid off and you're on track for retirement.
What if you just can't do it? What if you can pay only the minimums on your debt, or less, if you try to save for retirement? Then you're in a deeper hole than you may understand. If you can't cut your expenses or earn more money to free up the necessary funds, then it's time to make two appointments: one with a legitimate credit counselor and another with an experienced bankruptcy attorney, to see what your options might be.
Liz Weston is the Web's most-read personal-finance writer. She is the author of several books, most recently "The 10 Commandments of Money: Survive and Thrive in the New Economy" (find it on Bing). Weston's award-winning columns appear every Monday and Thursday, exclusively on MSN Money. Join the conversation and send in your financial questions on Liz Weston's Facebook fan page.
MORE ON MSN MONEY
VIDEO ON MSN MONEY
The World gets wiser. And wise people never do business with Al-Qaeda.
The real Al-Qaeda, works on Wall Street (robbing 99% of investors)
I hope that' the entire Wall Street will starve to death! :D =)) =)) lol fucckkers!
GET A REAL JOB YOU LAZY COCKROACHES!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!
HaHaHaHaHaHaHaHa!!!!!! Best laugh I have had in a while. Learned all this in College did we? Text book says 7% compounding, but, but, but isn't that real life??? My college professor said it was!! No Obamabernankenway! Today if you get .7% interest you are lucky. Did you catch that little tiny decimal point before the seven?? Compound that and see where you end up!! Pay off the 22% interest credit cards and only use them when you can pay off the balance every month. Reality check time. Today it really does not matter what you do anymore. With the government spending trillions more than what is comming in and the federal reserve's QE3 printing presses running at 500% capacity for the forseeable future, our credit rating as a country being downgraded, everyone's nest eggs will be worthless soon. Buy a farm at least you can grow something and eat it.
Too much testosterone in Republican genes..Their conservatism doesn't save anyone a dime. Least of all the Middle Class these predators are alway stiffing. Take a good look at every Republican president since Hoover...Each suffered at least one half of their term with a recession. Conservatism anyone? Take a good look at how often they come up with very convenient surplus created by cut backs on services the Middle Class have bought and paid for decades ago. Is that what government is supposed to be? A source of wealth for 1%, Wall Street and the Corporate Welfare state? Or are the tax dollars we invest in our government ours and to be dispersed to the advantage of the the whole country and not 1% who think investing is a bloodline of the Holy Grail?
When you've had enough of the GOP saving to create a surplus, maybe you'll confront them about their duty to the people of this country....In their view, Numero Uno is the 1% with all the moolah they steal from everyone else. Know a single fund manager earning less than 6 figures? A CEO of an HMO? A General Manager of Big Energy? You bet not.
As for the hotchas who deem themselves so above those who believe in real financial stability and not high risk investment hope for a fast cash deal financial stability, they'll be the first to run to goverment for help when their 401Ks and other high risk investments tank when, not if, the next crash comes.
Ah yes....The desperation of the wealthheads at its finest. So now they want you to hang onto a lifetime of debt. Now here's a thought. How desperate are the investors to encourage you to invest? So desperate they live in mortal terror of the next Wall Street Crash they know is coming. Why? Speculators who are out of control.
In the months leading up to the first crash in 1929, speculators ignored all warning signs. Dead cat bounce 3 times that caused the Great Depression. and who was it that lost the most back then? Those who had outstanding loans, mortgages and other debts. Wiped completely out. See why the "Invest, Baby, Invest" crowd wants your hard earned money?
Second question. If you owe outstanding debts that equals more than your annual income, how won't you end up in the gutter when the nutjob speculators play their high risk gambling with your investment funds?
So...a little pragmatism here from a liberal...play it safe. Pay off as much of your debts as possible before the next crash...which if the Fed and other experts have it right will be sometime in the 1st Fiscal quarter 2013 thanks to the gamers on Wall Street all rushing for that last shred of empirical profitorium. That way, you are insulated from attack by the Wall Street thieves because your debts are all paid and you still have what remains of currency that is still viable. Listen to a wealthhead and see if his wealth grows and your never will.
Funny. The example of Morgan and Megan conveniently addresses only one side of the issue, and conveniently assumes a real return on investment. What if Megan, while socking away that $3K per year is simultaneously NOT paying down her debt as fast as she can, thus incurring interest on her outstanding debt that triples the amount of the return she is making on her investment, rendering her "savings" illusory; while Morgan not only gets all paid off but then has the cash flow to really enjoy life while she's young enough to enjoy it? Furthermore, "the power of compounding" only works when return on investment is positive. The way the game is rigged these days -- dominated by greedy and ethically-challenged members of the C-suite, enabling and lying internal and external accountants, unmotivated and underresourced regulators and sycophantic "analysts" -- a positive return is more like a pipe dream. Talk to some folks who followed Liz's advice before 2008 and see where they stood in 2009. And a company match? Perhaps Liz missed the memo that a lot of companies have ended that nice little perk as currently unaffordable.
Living debt free is the way to go, and paying down early whatever existing debt you have is the only sure-thing investment in today's environment.
I have always been a good saver but learned to be a good investor later in life. It took me a long time to invest in stocks because I did not know anything about them and because my father always told me you could lose everything if you invested in the stock market. The first stock I purchased was because of a recommendation from a co-worker. I did not know anything about the security other than it paid a good dividend. At first the stock did well and then it tanked and I lost my money. The lesson I learned was to do my own research. I found out I was pretty good at picking out securities and have been making my own investment choices for years.
I learned you have to be patient, you have to diversify, and you really must do your homework before investing your hard earned money. When I first started investing you really had to work at it to research a company. Everything changed once the computer age and the Internet was born. It still takes time to do the research but what once took weeks may take an hour or two. I agree with a lot of things that were said in this article. If your company offers a 401K plan and can invest in a lot of different funds or securities and your company will match a portion of what you put in you should take advantage of it.
The other important things I learned it try and not to have a lot of debt. I learned that as a teenager. If you cannot afford it do not buy it. I can thank my parents for teaching me that lesson. I learned to manage my money at an early age and later on to invest it. My one regret is that I did not invest in the stock market when I was in my twenties. I was almost forty when I bought my first stock. I am now in my later fifties and I have a nice nest egg. If I would have invested in the stock market when I was in my twenties I would be much better off than I am know. The power of compounding is also important.
I wasn't aware that Republicans had been paying off any debt, ever. Come to think about it, Republicans have never been serious about cutting costs, except when a Democrat gets elected.
Maybe you should crawl back under that rock you came out of to blame anyone other than yourself.
Liz, you missed the target, and again created for many, a false sense of financial priorities. A revolving savings account is #1 savings goal, then an emergency savings account #2 saving goals must be in place. Then you can take a balanced approach to paying down the debts and contributing to the retirement accounts.
What sense does it make to save for retirement when an emergecy happens and you have no financial resources to cover the emergency except borrowing from your retirement accounts...........bad idea and poor financial counseling and planning.....
Savings (Revolving then Emergency) first, then a balanced approach to investing (Retirement accounts) and debt..........
You failed to understand and accknowledge most don't understand the difference between savings account and investment accounts......nor do you Liz.......Retirement accounts are investment, savings accounts are used for emergencies and vacations and new cars.........
I've trained and counseled thousand in financial education and also teach financial counselors how this stuff works also.........
Obamanomics - maximize your debt load then let somebody else pay it off for you. It's the way of the American liberal.
This answer will be different for everyone. I am fortunate, I make a good living, and am in a higher tax bracket, so my marginal federal income tax rate is 28%. I get a good current tax break on my contributions. Also, deductions for 401k contributions are above the AGI line on your federal income tax return - deductions above the AGI line are few, and many other below-the-AGI-line deductions can be limited if your AGI is above certain IRS limits. Additionally, my employer has a 401k plan that is better than most - 4% match AND a 4% safe harbor contribution, so if I put 4% of my own in, I'm getting 12% of my pay once the employer throws in those contributions. That's a no-brainer. You could think of employer matching as just additional return on your contributions; that is how I look at it. I do agree that in general, mortgage debt is the ONLY debt that could remotely be considered "good" debt ( and I'm using "good" loosely). If you have a cheap mortgage and your employer has a good 401k plan, you should probably be saving at least the minimum required to get all of the employer-matching.
Copyright © 2013 Microsoft. All rights reserved.
Fundamental company data and historical chart data provided by Morningstar Inc. Real-time index quotes and delayed quotes supplied by Morningstar Inc. Quotes delayed by up to 15 minutes, except where indicated otherwise. Fund summary, fund performance and dividend data provided by Morningstar Inc. Analyst recommendations provided by Zacks Investment Research. StockScouter data provided by Verus Analytics. IPO data provided by Hoover's Inc. Index membership data provided by Morningstar Inc.