Whether you’ve received a raise at work, eliminated a monthly payment, or generated a new stream of income, a common financial planning question is how you should manage additional cash flow. Should you invest it or focus on paying down debt? There are generally two sides to this decision you should consider: the financial side and the emotional side. Let’s discuss how these factors will affect what you do with those extra dollars.
The Financial Side
From a financial perspective, running the numbers may be the most objective way to choose if you’ll invest or pay down significant debt. This method involves a straightforward analysis of your debt’s interest rate compared to the rate of return on your investments. As a simple example, imagine you’re paying a 3 percent interest rate on your mortgage, but are earning a 7 percent return on your investment. In this case, you’re essentially making 4 percent more than you’re paying in interest on your debt, so investing appears to be the most efficient use of your extra cash flow.
This example doesn’t include the tax costs or benefits associated with the debt or investment, such as deductible interest expenses or tax-deferred savings accounts. However, you can frame this calculation for any debt or investment you’re evaluating as a way to inform your decision.
The Emotional Side
While our emotions are highly complex and difficult to evaluate, they’re generally always a factor in how we view, spend, and save money. Perhaps you have significant debt that has been looming over your head for a long time. From student loan debt to an expensive monthly car payment, you can’t put a price tag on the feeling of relief you’ll have when you reach your goal and make that final payment.
Reducing your monthly payments and creating more financial breathing room will certainly decrease stress, and it can have longer-term effects on your money mindset. With more cash flow each month, you’ll have more flexibility and empowerment with what you can achieve financially—and that’s a great feeling.
Conclusion
Whether you’re committed to paying down your debt or investing your extra dollars, deciding what you do with your money will always walk the line between the analytical and emotional. At CCMI, we understand many factors go into your lifetime of financial planning. That’s why we strive to build lasting relationships with our clients through comprehensive, tax-efficient planning that focuses on their short- and long-term goals. If you need help making an informed decision about additional income or other financial situations, contact us today and we can help you evaluate your options.
CCMI provides personalized fee-only financial planning and investment management services to business owners, professionals, individuals and families in San Diego and throughout the country. CCMI has a team of CERTIFIED FINANCIAL PLANNERTM professionals who act as fiduciaries, which means our clients’ interests always come first.
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