You are finally making good money. And now?

If you are 30 or 40, does this describe your financial situation?

After years of climbing the corporate ladder, endless long nights as an associate in your company, or completing your residency or scholarship, your career is finally well established. New financial rewards are coming to you from a new job or promotion, hefty bonuses and other rewards that often didn’t seem possible.

For the first time, there is a wave of financial opportunities and you have the resources to consider them. You can buy your first home or move to a larger one; take a vacation in Europe or buy a new car.

You may also decide whether to aggressively pay off debt or save more money for retirement, but which strategy is the right choice?

Most people are naturally against debt. Nobody likes a large credit card balance or seemingly endless payments to cover student loans. But allowing our natural debt aversion to control our decisions isn’t always optimal as part of a long-term financial plan.

Deciphering the best option is largely based on some important factors. How to decide? Here is a process I recommend:

Make sure your financial base is solid

First, understand what I like to call the financial order of operations. Think of this concept as a financial version of Maslow’s Hierarchy of Needs, which describes people’s basic needs as a five-level pyramid with physical needs at the bottom and self-realization at the top.

Before deciding whether to pay off debt or invest near the top of your financial pyramid, make sure your foundation is in order. Start by answering the following questions:

  • Do you have an emergency fund in place? It is recommended that you have enough cash to cover three to six months of expenses, so you won’t need to borrow if your car breaks down or another emergency occurs.
  • Are you paying the required balance on your debts every month not only to avoid penalties but also to reduce the capital? If not, you need to start doing it.
  • Are you taking advantage of your employer’s correspondence in the corporate pension plan? Maximizing your company’s contribution can earn you a significant amount of additional retirement savings over time.

If you haven’t checked all of the above elements, then using excess funds to speed up debt repayment or further investing in your retirement should take a back seat for now. Remember, you cannot build a strong building on a weak foundation.

First of all, pay off the debt with high interest rates

Although the term “high” is purely subjective, a good rule of thumb is to prioritize paying off debts with interest rates above 6% -8%. For example, a credit card with an annual interest rate of 16% should take priority over maximizing 401 (k) contributions. However, debts with interest rates below the threshold indicated above require a small comparative analysis to determine the optimal financial strategy.

So, should you pay more debt or invest?

Compare the benefits of paying off debt versus investing excess money.

For example, if you have $ 5,000 in additional disposable income, does it make sense to pay off student loan debt with an annual interest rate of 9% or invest in a portfolio with an expected return of 6%? By investing all the money and not paying off the debt, you would actually have lost 3%, or $ 150, at the end of the year. In this case, pay off the debt.

However, if there is a car loan with an interest rate of 3%, the script is reversed – you would make $ 150 by investing your excess income.

On the surface, this break-even equation seems to provide the final solution to our question. However, using this logic in our decision making may not create the optimal strategy. One shortcoming of the above equation is that it is nearly impossible to predict the performance of the investment. So, would it be prudent to base our financial decisions solely on mathematical equations that derive their solutions based on unpredictable assumptions? In simpler terms, shouldn’t we avoid making decisions based solely on unpredictable outcomes?

Take other non-financial factors into consideration

Most people don’t like to take unnecessary risks. You may be wondering, “Shouldn’t I always make the best financial decision regardless of my attitude towards risk as it will result in the best outcome?”

The answer: it depends. The best financial plan is the one you can stick with. If having student debt or a car loan prevents you from sleeping at night, it may be a better decision to pay off those obligations rather than invest the excess money in your budget.

Or, if you want to retire early at 50 and need to save as much as possible, it might make more sense to spend more on saving and less on debt repayment to better align with your goals. We all have their own preferences, attitudes, risk tolerance and goals. In fact, what matters most to you is often the right answer.

When deciding whether to invest excess income or use it to expedite debt repayment, consider talking to your financial advisor to come up with a game plan that incorporates the financial and non-financial factors that this decision entails. This will allow you to achieve your goals and at the same time allow you to focus on what matters most.

Wealth Planner, McGill Advisors, a division of CI Brightworth

Andrew Kobylski is an Associate Wealth Adviser with CI Brightworth / McGill Advisors and has been with the company since 2020. Working closely with lawyers, dentists and small business owners, he creates financial plans that align with each client’s values ​​and goals. He graduated summa cum laude in finance from Virginia Tech. He was awarded the CERTIFIED FINANCIAL PLANNER ™ and Certified Investment Management Analyst® designations in 2021.

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