Should I pay off my debt or invest? A parent's guide

Paying off debt or investing depends on your priorities, financial situation, and financial goals. Many parents wrestle with this decision, and it can be like solving a puzzle. There are numerous factors to consider depending on your unique circumstances. 

How do debt and investing affect your finances?

First, let's explain the key differences between debt repayment and investing. Debt is simply money you owe for paying for something on credit. If you don't pay the debt, it will continue to grow with recurring interest charged to your balance. 

When you invest, you set aside money for the future, typically in investment vehicles such as stocks, bonds, or mutual funds. The idea is for the value of your money to grow over time.

Government bonds are low-risk, and there are four main types: 

• Agency

• Municipal

• Corporate

• International 

What are common types of debt?

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Debt can impact your financial wellness. It comes in many forms, such as mortgage loans, home equity loans, auto loans, student loans, personal loans, and credit cards. Debt can be secured or unsecured, and categorized as revolving or installment accounts. 

Secured debt: Secured debt is backed or guaranteed by an asset used as collateral, such as a car loan or mortgage loan. A lender can reclaim ownership of property if you fail to make payments on a secured loan. Interest rates on secured loans are typically lower because collateral minimizes the lender's risk.

Unsecured debt: Unsecured debt requires no collateral asset and relies only on your ability to repay the loan. You are bound by a contractual agreement with the lender to repay the loan, and if you default, the lender can reclaim the unpaid balance in a court of law.

Revolving debt: With revolving debt, once you pay down your balance, you can reuse it. You get a maximum line of credit to use up to that limit. Your available credit fluctuates based on how much you use. You must make at least the minimum monthly payment, and the remaining balance will transfer to the next month, incurring interest.

Installment loans: These loans are close-ended, lump-sum amounts that you repay in regular, fixed monthly payments for a set time.

What are some different types of investments?

The world of investing is complex. There are various types of investment vehicles — or accounts and products to invest in. Determining which type best fits your investment portfolio can be hard. Numerous types of investments can be grouped into three basic categories: equity, fixed income, and cash (or cash equivalents). 

Equity: An equity investment gives you an ownership stake in a company via stocks, preferred shares, or stock-holding funds like mutual funds and exchange-traded funds (ETFs). 

Fixed income: Investors loan money to businesses or government entities through corporate and government bonds in fixed-income investments. 

Cash: Cash and cash equivalents can include checking accounts, savings accounts, money market accounts, and certificates of deposit. These types of accounts typically make it easy for you to withdraw your money.

Here are some of the most common types of securities investments and the risks associated with each.

Stocks: Buying stock gets you ownership in a publicly traded company, such as Microsoft, Apple, or Google. Buying company stock can be risky because the price increases or decreases. You'll be better positioned to sell it for a profit when the price goes up. On the other hand, if the stock price goes down, you could lose money.

Bonds: These investments are debt instruments that investors buy. Local governments issue municipal bonds, and companies issue corporate bonds. The U.S. Treasury issues bills, notes, and Treasury bonds. As a bond investor, you usually receive interest payments on your loan, and after your bond matures, you receive the principal.

Compared to stocks, the rate of return on bonds is typically low due to their lower risk. However, additional risk is possible if the company you buy the bond from folds or the government defaults. It's safer to invest in Treasury bills, notes, and bonds.

Mutual funds: You invest in mutual funds with a pool of other investors. Your money is invested across a wide number of companies. Mutual funds are either actively or passively managed. 

Fund managers actively manage a mutual fund by attempting to beat a specific market index and selecting investments that will outperform that index. A passively managed fund, or index fund, tracks a major stock market index such as the S&P 500 or Dow Jones Industrial Average. 

Mutual funds typically invest in a broad range of securities, such as derivatives, equities, currencies, bonds, and commodities.

ETFs: This collection of funds is similar to mutual funds. ETFs often track a particular market index, and ETF shares are bought and sold on the stock markets. ETF prices fluctuate throughout each trading day, and you can make money from collecting a return on your investment. New investors find ETFs attractive because of their diversification and minimal risk, especially if they track a broad index. Selling an investment for a profit may increase your tax liability. If you sell at a loss, your tax liability may be reduced.

What are the pros and cons of paying off debt vs. investing?

There are several arguments for paying off debt instead of investing. For instance, if your debt interest rates are high, paying off your debt first might make more sense. This is particularly true if you have credit card debt. 

Why should you pay off debt first?

You don’t want to pay more interest than you’d potentially earn in interest. Paying off high-interest debt as soon as possible should be the goal, whether on mortgage or auto loans.

Depending on your credit score, you may want to pay off your debt first, particularly if you plan to borrow money in the future for a car or mortgage loan. The lower your credit score, the higher you can expect to pay in interest. You might even be unable to get a loan. Low credit scores can affect your insurance premiums, ability to rent an apartment or buy a car, or ability to get a job.

Choosing between paying off debt or investing is critical to your financial future. Begin by comparing the interest rates on your debt payments with your expected rate of return on your investments. Choose the option that yields the higher percentage. 

Even financial experts cannot precisely forecast return rates, so don't base your decision on a single factor. However, the average S&P 500 rate of return from 2002 to 2022 is 8.14%

Pay off debt or invest?

Should you pay off debt and invest at the same time? There’s no universal agreement, but it’s generally one or the other based on your financial situation or preference. Some financial advisors say that savings should be a priority, while others recommend paying off high-interest debt should come first.

When it comes to paying off debt or investing, you don't have to choose one over the other. Depending on your financial situation, you could do both. Consider your savings first. For example, if you have an emergency fund in place, and have additional savings, you could use some of that money to pay down debt.

Learn more about financial well-being with the Greenlight app

You can learn more about paying off debt, investing, and other financial management strategies on the Greenlight® app. You can educate your children with Greenlight financial content to help prepare them for a successful financial future. Download the Greenlight investing app to help your kids and teens learn how to save, invest, and much more.