If you’re a beginning investor eager to grow your wealth, the excitement of building an investment portfolio might have you ready to dive in. However, before you start investing, one crucial step should come first: paying off high-interest debt. High-interest debt, especially from credit cards or personal loans, can be a significant obstacle to financial growth. Here’s why eliminating it should be a priority before putting money into investments — with one important exception: contributing enough to get your 401(k) employer match.
The Impact of High-Interest Debt on Your Finances
High-interest debt is debt with an interest rate typically above 8-10%. Credit cards, for example, often carry interest rates of 15% or higher. In comparison, average annual returns from investing in the stock market hover around 7-10%. This discrepancy means the money you owe on high-interest debt grows faster than the potential gains you’d see from investing. In other words, as your debt accumulates, it cancels out or even outweighs any returns from investment accounts.
Let’s break this down with a simple example.
An Example of High-Interest Debt vs. Investment Growth
Imagine you have $5,000 in credit card debt at a 20% annual interest rate.
- Each year, this debt grows by $1,000 if left unpaid. Now, suppose you also have $5,000 to invest.
- If you invest this amount in the stock market, assuming a 7% return, your investment would grow by only $350 after one year.
In this scenario, the interest on your debt ($1,000) is nearly three times higher than your investment gain ($350). So even though you’re earning money from investments, your debt is growing faster than your investment. Paying off the credit card debt first would put you in a much stronger financial position long-term, freeing up more of your income for investing in the future.
When to Make an Exception: Contributing to Your 401(k) for the Employer Match
There is one smart exception to focusing exclusively on debt payoff: contributing enough to your 401(k) to receive your employer’s match.
Here’s why:
- Immediate Return on Investment: Employer matching contributions are essentially “free money” that instantly increases your contribution. If your employer matches 50% of what you put in, you’re getting an immediate 50% return. This is much higher than the interest rate on most high-interest debts.
- Long-Term Compound Growth: Even if you only contribute a small amount to get the match, that money has years to grow. Over time, the compounding effect can help build a solid retirement foundation.
- Tax Advantages: Contributing to a 401(k) has tax benefits. If you’re contributing pre-tax, it lowers your taxable income for the year, which can help you keep more money in your pocket while you focus on debt repayment.
A Balanced Approach: Debt Repayment and Investing
If you have high-interest debt, prioritize aggressively paying it off but still contribute enough to get the 401(k) match. This balanced approach allows you to benefit from employer contributions and tax savings while working toward a debt-free future.
For beginning investors, the best strategy is to create a solid financial foundation by eliminating high-interest debt. Think of it as clearing the path for your financial future: paying off debt provides a fresh start, allowing you to focus on building investment wealth without the drag of interest payments. Once your high-interest debt is gone, every dollar you invest has the potential to build wealth and increase your financial freedom.
By prioritizing debt payoff before fully diving into investing — but taking advantage of employer-matched 401(k) contributions — you’re setting yourself up for long-term success and maximizing the growth potential of your investment journey.
