Invest, Save, or Pay Down Debt?

Your 5 step checklist to being ready to invest

Here’s what you need to know.

You want more money, and you’ve heard that investing is a good way to grow your money and to build your retirement nest egg. Before you start investing, in the stock market or any other risky investment, make sure you have your financial house in order—we’ll look at what that means in terms of debt, savings, and monthly cash flow. Best practice is to deal with high-interest debt first.

Debt

Whether or not you can start investing when you have debt depends on what type of debt you have. If you have high-interest debt, meaning any debt with an interest rate over 6-8%, you need to focus all your efforts on paying that off first. This may include credit card or medical debt, personal loans, and payday loans.

If you have credit card debt, you should not be investing in the stock market; the best thing is to pay that off ASAP because the interest rates on credit card debt usually range from 18-30%. Additionally, do what you can to avoid taking on any more debt so that you can focus on paying off high-interest debt.

If you have other types of debt, such as a monthly car payment, mortgage, or lower interest rate student loans, and you can comfortably make those payments each month, then they don’t need to hinder you from investing. Typically the interest rates on those are in the 2-6% range and therefore, they are comfortable long-term debts you can pay off by making regular monthly payments. In fact, making the regular monthly payments on your debt can build your credit score.

Savings

When it comes to savings, experts typically recommend building up a “rainy day” fund or enough money to cover 3-9 months of living expenses. That means you need to figure out how much you spend every month across all categories: rent/mortgage, groceries, insurance, daily expenses, car and transportation, fun and splurges, education, health care, and anything else you spend money on each month. Then multiply that number by 3 to get your baseline savings number.

Having 3-9 months of living expenses saved provides a level of security and comfort because if you got injured or lost your job, you would still have enough to live on for those months without bringing in any more income. It also means that if some other unexpected expense came up, such as your car had an expensive repair bill or your A/C stopped working or you had a medical procedure, then you’d be able to pull from your savings to cover that.

With 6 months of savings accumulated in a High-Interest Savings Account (HYSA), you’re likely in a good position to look at investing.

(Pin this graphic for easy reference or to come back to this page in the future.)

Did you know… When you put your money in a savings account, the bank lends that money out to businesses or individuals in the form of loans and mortgages. The big banks are the biggest lenders to fossil fuel companies. Whereas local credit unions and climate-friendly banks tend to invest in community development or environmental protection, respectively. If you care what’s being done with your savings, download our guide to environmentally-conscious banks.

Other

If you’re still not sure that you’re ready, but want to get started and you work for an employer with at least 50 employees, you have a couple of options.

Hopefully your company offers a 401K plan — this means you can have money taken from your paycheck and put into an investment account meant only for retirement. Many companies will match some percentage of your contribution, which is basically free money! Another reason to do 401K besides the company match, is that type of account is tax-advantaged, so you can avoid taxes either when you put the money in or when you take it out (more on that another time). Also, most 401K providers will automatically invest your money in a fund (a basket of stocks), usually a target-date retirement fund, so you don’t need to know how or what to do. While I highly recommend anyone who is eligible to go ahead and start a 401K, you shouldn’t neglect high-interest debt to contribute to this account. There are steep penalties for pulling the money out early, so you want to be sure whatever you’re contributing to your 401K, you’re comfortable leaving there until retirement age.

The next option, also through your employer is an HSA (Health Savings Account). Since health insurance is mandatory in the US, your employer (if it’s of a certain size) must offer you some kind of health coverage. Many companies offer High Deductible Health Plans (HDHP), which come with an HSA account. In this circumstance, you typically pay very little in health insurance premiums but a lot more for health services (so make sure you know what your typical medical needs are), and most of what you’re paying for monthly health coverage goes into the Health Savings Account. Here’s where it gets pretty awesome: an HSA is triple tax-advantaged, meaning when you put in money you don’t pay any tax, you can grow the money in the account without paying tax, and when you use the money in the account to pay for qualified medical bills, you still pay no tax. Now, in order to grow the money in the HSA account, you need to login to the provider’s portal and enable or request investing. Then you need to actually invest in stocks or funds, being careful not to invest what you’re going to need in the short-term to pay for medical bills.

Ready

When you are ready to invest your disposable income, having paid off high-interest debt, built up at least 3 months of savings, taken advantage of investment options through your employer, and still have income leftover each month, it’s time to get started. A great place to start is with index funds, which typically have low fees and track the market, so you’re getting market returns and you get to keep more of your money’s growth because is less is going to fees.

If this is something that matters to you, an even better option is to look for responsible or sustainable index funds or ESG index funds. These types of funds may focus more on companies that tend to take better care of the environment, their employees, and their communities (or at least have less of a negative impact). Because these companies tend have an eye towards reducing harm towards people and planet, there may also be less risk by investing in them. Furthermore, the last few years, they have tended to outperform the market generally.

Do you feel ready to start investing? Leave a comment below.