Should you invest if you have debt? The answer might surprise you. Many people are eager to get started in the stock market, but other financial obligations are holding them back.
You can (and should) start investing even if you have debt
Should you invest if you have debt?
Paying off debt and building wealth doesn’t have to be an either-or decision. You can do both at the same time. You will likely come out further ahead with this strategy rather than focusing on one above the other.
There are circumstances in which investing while you have debt is not a good idea. Namely, when your debt balance is very large or at a high-interest rate. Likewise, the savings side of your budget determines if you can afford to invest at all. Here are the questions you should ask when you ask, should you invest when you have debt?
Is your debt balance greater than $25,000?
Even at low-interest rates, large debt balances are expensive. If your debt balance rivals your annual salary, you want to get it below the threshold of $25,000 before you start dabbling in the stock market.
It might seem crazy to pay only 5% on your student loans when the stock market has historically returned 10%, but remember, those interest rates are working in opposite directions. One is taking away from your wealth and the other is adding to it. I don’t believe in getting completely to debt-free before you start investing. However, you should reduce your balance to something manageable before you jump in.
Is any of your debt high-interest debt, like credit cards?
Most credit cards charge 20% interest, so if you’re carrying a balance, it’s costing you far more than you can hope to earn in the stock market. Even if your total debt balance is under $25,000, if you’re lugging around a balance owing at a double-digit interest rate, you’re better off paying it off before you direct your money elsewhere.
Not sure about your total debts? You can see everything you owe by requesting your free credit report from Borrowell. You can also get your credit score, which can help you lower the interest rate on your balances owing.
Even if it means you have to delay your entry into the stock market by a few months or years, work hard to pay off any debt balances with interest rates greater than 10% before you invest.
Do you already have an emergency fund of at least $3,000?
I’ve never found the advice of having 3 to 6 months of essential expenses saved for emergencies reasonable, and I’ve weathered the unexpected financial catastrophes like divorce and an unplanned pregnancy. That’s not to say you shouldn’t save up that amount; it’s merely to encourage you not to put every other financial goal on the backburner while you do so. However, it’s never ok to have no emergency fund. I generally find for most young people in their 20’s and 30’s without kids or a mortgage, a small emergency fund of $3,000 to $5,000 is more than enough. But under no circumstances should you have less than that.
RELATED: The $20 Emergency Fund
It’s important to have an established emergency fund before you start investing because the money you put in the stock market is for the long-term, and should not be withdrawn if you go over budget one month or get slapped with an unexpected bill. You want to have a healthy-sized emergency fund that ensures you won’t need to dip into your investments if you need extra cash.
Do you have $1,000 to open a brokerage account?
To invest in the stock market, you’ll need to open a brokerage account. This is different than a bank account, and it’s what you need to make trades on the stock market. Most brokerages require a minimum of $1,000 to open an account, but some require as high as $5,000. You need to save up the minimum amount in order to open an account and begin your portfolio. If you don’t have $1,000 to spare, you’re not ready to invest. Focus on saving this amount before you jump into the stock market!
I use Questrade to manage my portfolio. It’s my favorite online brokerage because it offers low-free trades and it’s free to buy ETFs. With most major bank brokerages charging anywhere from $10 to $30 per trade, Questrade is a steal. The less you pay in trading commissions, the faster your portfolio grows.
Can you afford to contribute at least $100 per month to your investments?
The secret to building wealth through investing is consistently contributing to your accounts and letting them grow. Ideally, you should be contributing at least 10% of your net income towards your long-term investments, but if this is unaffordable to you right now, you should start with at least $100 per month. This won’t make you rich, but it is enough to get you into the habit of investing and start to grow your portfolio. If you cannot find an extra $100 in your monthly budget to put into the stock market, you’re not ready to start investing and you need to focus on increasing your income, reducing your debts, or cutting your expenses.
A general budget starting point is to be putting 15% of your net income towards debt repayment and 10% towards long-term savings and investments. In other words, 25% of your net income should be going towards increasing your net worth.
New Investor Checklist:
- No high-interest debt
- Total debt balance is less than $25,000
- Have $3,000 to $5,000 or more in emergency savings
- Have $1,000 saved to open a brokerage account
- Have at least $100 in your monthly budget to contribute to your investments