If you have extra money lying around, should you use it to pay down your debts or should you invest that money for the future? There is no straightforward answer that is applicable for everyone, but here are three layers of decisions that can help to find the answer.
The first layer to look at is the interest rate. We all know about the powerful effect of compounding. When it comes to debt, the power of compounding works against your favor. Your outstanding liability continues to balloon at a constant pace and compounds on itself. Therefore, the first question that you need to ask is if the return of your investments can beat this rate of interest.
But that is not enough, markets can move up and markets can come down. You may have thought that your investments would give you a certain return. But the market might disappoint and give you much less than you expect, and you might not achieve your desired objectives.
This is why you need to look at the second decision layer which is to identify the range of outcomes from investing and understand how comfortable and confident you are to reasonably grow your investments more than your liabilities grow. This is why it is also very important to continue to service all your existing EMIs and loan payments in full so that you prevent your debt from spiraling out of control. The decision of investment versus paying down debt should be restricted only to spare cash that you have accumulated beyond that.
Third, this is not a binary decision. It is not the case that you have to choose between investing or paying down debt – you could easily split up your funds and do both! Many people feel a lot of stress from paying dues for their loans and clearing of the debt can be a huge relief to them. On the other hand, depending on your financial situation, you might have other financial goals that are of a higher priority which you need to start setting money aside for.
Once you have considered all this, you will be able to make a much more informed decision about paying down debt versus investing your money.