Vail Daily column: What’s smarter — paying off debts or investing?
February 9, 2017
If you're starting out in your career, you will need to be prepared to face some financial challenges along the way — but here's one that's not unpleasant: choosing what to do with disposable income. When this happens, what should you do with the money? Your decisions could make a difference in your ability to achieve important financial goals.
Under what circumstances might you receive this money? You could receive a year-end bonus or a sizable tax refund. However the money comes to you, don't let it slip through your fingers. Instead, consider these two moves: investing the money or using it to pay off debts.
Which of these choices should you pick? There's no correct answer, as everyone's situation is different. But here are a few general considerations:
Good versus Bad debt
• Distinguish between good and bad debt. Not all types of debt are created equal. Your mortgage, for example, is probably a good form of debt. You're using the loan for a valid purpose — living in your house — and you likely get a hefty tax deduction for the interest you pay. On the other hand, nondeductible consumer debt that carries a high interest rate might be considered bad debt — and this is the debt you might want to reduce or eliminate when you receive extra money. By doing so, you can free up money to save and invest for retirement or other goals.
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• Compare making extra mortgage payments to investing. Many of us receive psychological benefits by making extra house payments. Yet, when you do have extra money, putting it toward your house may not be the best move. Your mortgage can be considered a good type of debt; therefore, you may not need to rush to pay it off. And from an investment standpoint, your home is somewhat "illiquid" — it's not always easy to take money out. If you put your extra money into traditional investments, then you may increase your growth potential and gain an income stream through interest payments and dividends.
• Consider tax advantages of investing. Apart from your mortgage, your other debts likely won't provide you with tax benefits. But you can receive tax advantages by putting money into certain types of investment vehicles, such as a traditional or Roth IRA. When you invest in a traditional IRA, your contributions may be deductible, and your money grows on a tax-deferred basis. (Keep in mind that taxes will be due upon withdrawals, and any withdrawals you make before you reach 59 1/2 may be subject to a 10 percent IRS penalty.) Roth IRA contributions are not deductible, but your earnings are distributed tax-free, provided you don't take withdrawals until you reach 59 1/2 and you've had your account for at least five years.
Of course, it's not always an either-or situation; you may be able to tackle some debts and still invest for the future. In any case, use this money wisely — you weren't necessarily counting on it, but you can make it count for you.
This article was written by Edward Jones for use by your local Edward Jones financial adviser. Edward Jones and its associates and financial advisers do not provide tax or legal advice. Chuck Smallwood, Bret Hooper, Tina DeWitt, Charlie Wick, Chris Murray and Kevin Brubeck are financial advisers with Edward Jones Investments. They can be reached in Edwards at 970-926-1728 or in Eagle at 970-328-4959 or 970-328-0361.