Should I Pay Down Debt or Invest to Achieve Financial Freedom?

This is a guest post by Millionaire Mob, a blog focused on investing in dividend growth stocks and travel hacking. We have helped thousands of people with bettering their financial future through passive income and dividend investing. 

Paying down debt should be a top priority for every person striving to achieve financial freedom. But what should you do about investing? Should I invest in addition to prepaying my debt? Well, here we will provide you a guide on how to strategize both investing and paying down debt to achieve your financial freedom goals.

The Case for Paying Down Debt to Achieve Financial Freedom

There are two methods that I like to use when thinking about paying down debt: the snowball method or the avalanche method. I like to repay debt with the highest interest rate first. This is the most economically sound way to repay debt and saves you money over time!

I like to calculate a weighted average cost of debt for my liabilities. What is the blended interest rate of all my debts added up? You can do so by taking a simple table of your debts.

Here is a simple example of how I would create a table to understand my personal cost of debt:

Debt Debt Amount Interest Rate Weighting (Debt Amount Divided by Total Debt) Interest Rate x Weighting
Student Loan 1 $10,000 6.0% 40% 2.4%
Student Loan 2 $15,000 4.5% 60% 2.7%
Total $25,000 100% 5.1%

In the above example, my blended personal cost of debt is 5.1%. To lower that blended cost of debt, I would focus on repaying ‘Student Loan 1’, which is the higher interest rate debt. As I repay this debt, I should lower my overall cost of debt over time.

The Case for Investing to Achieve Financial Freedom

I only like investing when my blended cost of debt is lower than 4.5%. I like to use that as a threshold because the long-term total return for the stock market is about 6%. Your money is better used placed in an asset that can generate a return greater than your cost of money. For example, for every dollar that I invest in stocks I earn 1.5% over my cost of debt, which is 4.5%. If I paid down the debt instead, I would be losing out on an incremental 1.5% of return.

Keep in mind the stock market is volatile. It does not return 6% every year. Some years the return on the stock market is greater than +10% and others it can be -10%, or more so you must be able to understand that you are invested for the long haul. We don’t invest to get rich quickly. This is a long-term goal. Good investing is boring.

Building your asset base is just as important as removing your liabilities. Remember that. Besides our retirement accounts, we like to invest in Dividend Kings and dividend growth stocks to help build our asset base. We take all of our dividend income and continue to reinvest it into dividend paying stocks. This allows for us to use compound interest to the highest advantage.

Conclusion for Achieving Financial Freedom

If you have high interest debt such as debt above 6%. You must focus on paying that off immediately. If you have high interest credit card debt (greater than 15%), you must change your lifestyle immediately to focus on repaying this debt as soon as possible. Drop everything and start earning additional income to repay this debt. Credit card debt can be very detrimental to your overall financial freedom goals. This can set you back years and possibly decades!

As far as investing, allocate as much as you can to your retirement accounts that you are able to still service your debt payments or even prepay high interest debt. Once you hit a blended cost of debt below 4.5%, I believe it is prudent to build a number of different forms of investment income streams.

Author Bio: Millionaire Mob is a blog focused on everything online income including: Travel Photography, Travel Rewards, Passive Income, Dividend Growth Investing and Personal Finance advice. I hope to provide the best advice to help you learn and grow along the way. Join the mob of financial freedom experts and escalate your life. Follow us on Twitter or Instagram!