221 | Should I Pay Off Debt or Invest?

Is it better to focus on paying off debt or investing? Are there times when it doesn’t make sense to pay down your debt quickly? Can investing hurt your finances?

In this episode, we talk about how to determine whether you should pay off your debt or invest, including some questions to ask yourself in making your decision.

• • lawyers who are overinvesting

  • why investing is important

  • how compound interest can be positive and negative

  • my experience with the debt vs. investing decision

  • my clients’ experience with the debt vs. investing decision
  • questions to consider when deciding whether to pay off debt or invest

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You’re listening to Wealthyesq. We are a community of lawyers who believe that true wealth is having control of our time. I’m Rho Thomas, and as a busy wife, mom and former Biglaw associate, I know all too well the tension between the culture of the legal profession and pretty much everything else you want to do in life. That’s why each week, I’m bringing you the information and tools you need to improve your money mindset and manage your money to create true wealth. Because ultimately, it’s not about the money. It’s about the freedom and flexibility the money affords.

Hey friend. Welcome back to the show. I hope you’re doing well and having an amazing day so far. Today we are talking about investing versus paying off debt. Now let me start this by saying I am not an investment expert. I’m not licensed to give investment advice anything like that. I am just sharing what I’ve seen in my personal experience and what I’ve seen working with so many lawyers over the years so that you have some guidance on how to think about this decision as you’re making it for yourself. With that caveat, we are going to talk about investing versus paying down debt. One thing that I have seen more than a few times is lawyers who are over investing. And what I mean by that is they are investing to the point that they either aren’t able to handle their day to day expenses, so they’re spending more than they make, or they’re not able to make progress on their debt or their savings, so they’re stuck in the same place month after month. They can’t get ahead. A huge part of it is that they have a lot of money going out in minimum payments. So they’ve got a bunch of money going out in minimum payments. And then on top of that, they have a bunch of money going out to investments. Now, investing is great. It is something that we all need to do, because you’re not able to get to the point of retiring just by saving. If you want to stop working one day, then you need to invest so that your money can work for you and earn more money. That happens through compound interest. However, compound interest works both ways. So it works for you when you’re investing and your money is earning interest, and that interest is earning interest, but it works against you when you’re paying off debt, and your debt is accruing interest, and those debt balances keep growing. And what happened with me and what happened a lot of my clients, is they are aggressively investing, typically, in their retirement accounts, but then they also have credit card debt or student loans or personal loans, and the money that they’re investing is money that they can’t use to pay off that debt. So to give you an example, when my husband and I were first starting our debt journey, we were maxing out our retirement accounts, and we were able to, like, manage our monthly payments and everything, but we only had about $150 less debt payments, and we started out with over $670,000 of debt. So $150 extra was not really doing anything for us. When we were looking at how we could put more money toward that debt, one of the things we decided to do was decrease how much we were saving for retirement. So we dropped down our retirement contributions to the amount needed for my husband to get his employer match, it was something like 3% so like, if you put in 3% they put in 3% or something like that firm didn’t offer a match, but we did the same in my account, because we knew that it was going to take us a long time to pay all that debt off, and so we didn’t want to completely stop my contributions for that long. When we dropped our retirement contributions down, we ended up having another $1,500 a month. That we were actually seeing in our checking account, and we were able to use all that money to work making extra payments on our debt because we weren’t used to having it in the first place. So that is an example of how aggressive investing can lead to staying stuck in the same place, because we weren’t able to make those larger payments on our debt at first. And even if our interest rates have been low, with 678 some odd $1,000 of debt, that’s still a lot of interest and plus, our student loan interest rates actually weren’t low. The majority of our student loans were at 6.89% so they were quite high, and the majority of that debt, about 500,000 of it was student loans. I am seeing much more reasonable student loan rates now, and I’ve talked to people on LinkedIn who had like, 2% or 3% interest rates on their loans, and so they chose not to pay them off aggressively and instead focus more on investing. That makes perfect sense. We might have chosen to do the same if we had interest rates like that, but in our situation, it was kind of a wash, because on average, you can experience in the stock market to return about 8% and so that’s not that much different from the 6.8 and 7.9% that we were paying on our student loans. So it wasn’t like the slam dunk for investments as it would have been if our student loans were at 2% or 3% so that was our situation. But on top of student loans, many of my clients are also dealing with significant credit card debt, with personal loans, things like that, and those will have like 15% 20% 30 interest rates. And in that case, you’re definitely not doing better investing and earning 8% right? If your investments are returning 8% on average, and on high end, maybe you get 10% but your debt is accruing 1520, 30% interest, you’re basically losing money when you invest. Like, if we are purely looking at the math, if you are accruing 1520, and 30% interest, but you’re only earning 8% interest, you are losing money. So for a lot of my clients, they will decide to pull back on investing so that they have more money to pay off these high interest debts. Doing that also frees up money for them in their monthly budget, because then they don’t have to pay those minimum payments anymore. Because sometimes people are investing so aggressively that they don’t have the money to cover all their expenses. For example, I have talked before about a couple I worked with who were contributing so heavily to retirement that it was causing them to go into debt because they didn’t have enough for all their expenses, and then because they had the credit card debt limits and all of that, then they had all these minimum payments that were causing their expenses to be even higher, and it was further and further into debt with this cycle. So they decided to pause their retirement contributions completely so they could use all that money to pay off the debt, to free up that money that was going to minimum payments so they could get their cash flow and their budget on track. And you know, to be clear, the money that they had already put into their accounts would continue to work for them, would continue to earn interest. But then once they got rid of that debt and they got rid of monthly payments, then they could go back to investing, but this time, they have more control over their money. They have more wiggle room in their budget, because they don’t have 1000s of dollars going out and minimum payments. The same with us, the money that we had already invested, the smaller amount that we were investing, continued to work for us. I even though we decrease the amount that we’re contributing, to put more focus on paying down our debt. So I want you to think about what’s going on with your finances. Are you in a situation where you feel like you can’t cut anything else? Are you in a situation where you’re upside down every month, where you’re spending more than you make? How much is going into investment accounts, like your retirement accounts or other types of accounts? Would that money be better used to pay down debt, especially if you have high interest debt, like credit cards and personal loans and stuff like that, by slowing down or pausing, yes, you can take that money and accelerate your path out of debt. And I think a lot of times we feel resistant to doing that, because it feels like we’re already behind with investing. We were in school for all this time. Now we’re finally making money, and so we think we need to be investing. That’s the conventional wisdom that we hear, right? But by taking a slightly different approach, you can set yourself up to be investing well, to feel comfortable while you do it, and not be getting yourself into a hole or stagnating with your finances. When I talk to my clients about this, I talk about it a lot of times in terms of running a race. To this point you think you’ve been going full speed. You have been investing super heavily, investing like super aggressively, but the debt that you have has been a drag on that, and it’s been slowing you down. So we’re going to pause. We’re going to build you a car so you can go faster, and so even though it feels like you’re taking a step back or you’re falling behind, what you’re actually doing is slowing down to get your position to propel yourself forward. Because once you don’t have the debt dragging you down, you don’t have hundreds or 1000s of dollars a month that you have to pay out to these different banks and creditors and whoever else, when you go back to investing at the level that you’re currently at, you’ll be able to do so more comfortably. Your monthly budget won’t feel so tight because you’ve eliminated a huge chunk of your current monthly expenses. So that’s the way that I think about debt versus investing. And again, there are different things that go into it, like how much debt you have debts at how much your minimum payments are, how that’s impacting your day to day expenses, your spending. For us, the minimum payments on our debt was more than our mortgage, and so we wanted to not have that anymore. It was $3,500 a month at the highest. So getting rid of that opened up a lot of opportunities for us and allowed us to do more personally that we wouldn’t have been able to do. For example, I was able to drop down to 50% at my job during the pandemic, and ultimately, I also do that job to go full time in my business. And if we were still paying $3,500 a month in loan payments, that probably wouldn’t have been feasible, or it wouldn’t have been as comfortable to do so. So you want to think about those kinds of things, like run the numbers and see, does it make sense for me to be putting as much as I’m putting toward investing when I’ve got minimum payments? If I didn’t have all these minimum payments, what? Would my life be like? What would my finances look like? How much am I paying in interest? Where am I earning in my accounts? Are interest rates on my debt way above the eight to 10% that I could expect to earn on my investments? Does it make sense to pause or slow down investing, to be able to get rid of those high interest debts, or to be able to get rid of those minimum payments? Those are the kinds of questions I want you to ask yourself. So that is how I think about the debt versus investing conversation. I hope that is helpful for you as you think about it for your own finances. All right, so that is it for this week’s episode. Please take a second and share this with us too. Help me share this information, spread this information so more lawyers can experience the freedom of having control of their money. I greatly appreciate your support as we close out, friend, I pray that you take the information you learn here, apply it in your life and open up to the realization that wealth is available to you. As you do that consistently, week after week, you’ll continue to take steps to regain control of your time, build wealth and live the life of freedom and choice, you deserve. Talk to you later.