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Certain personal finance experts will tell you this financial plan: Conquer debt first, build an emergency fund, and then invest.
I think that’s wrong.
Of course it’s easier to focus on one step instead of a multi-pronged attack, but waiting years, possibly even a decade or more, to start investing limits your capacity to build future long-term wealth.
You can’t — and shouldn’t — wait until you’re debt-free to begin building wealth. You can have more than one financial goal at the same time, such as working towards being debt free and investing for retirement. Here’s how.
Not All Investing Is Created Equal
First, a brief reminder. Often, when we talk about investing people jump directly into “taxable investing” aka investing in the stock market. But putting money into your retirement account is investing, too. The confusion might lie in the fact that we say “save for retirement” instead of the more accurate “invest for retirement.”
You should be investing for retirement, even when paying off debt. The reason is simple:
Time + compound interest = your greatest asset.
The feeling of aggressively paying off debt is tantalizing. It feels actionable and freeing. You have a definitive end goal. I understand, because my husband and I aggressively paid off $51,000 in student loans in 17 months. But we didn’t ignore all our other financial goals for the sake of this one. We continued to invest into our retirement plans.
When it comes to investing, time and compound interest are your two greatest assets. It’s hard to catch up later. The market is cyclical and doesn’t always go up steadily. There will be dips, but, starting early and contributing consistently will help you ride out those waves and benefit from the long-term growth of the market.
What Investing Looks Like at 25 and 35
Here are two examples that explain the importance of investing early.
Let’s say you’re 25 years old. You begin putting $400 a month into your 401(k), a combination of your monthly contribution plus your employer match. (That means the full $400 isn’t coming from your paycheck; some is from your employer.) In 40 years, at age 65, you’ll have $958,248.54.
Now let’s say you wait until you’re 35 to make a monthly contribution, plus get an employer match. Even if you contributed $800 in an attempt to catch up on the last decade, at age 65, you’ll end up with $906,823.55. That’s $51,424.99 less than if you started investing earlier with smaller monthly contributions.
Even doubling down, you couldn’t catch up to your 25-year-old self.
This isn’t meant to demoralize anyone who is starting later. You can run the same analysis about starting at 35 compared to 45, or 45 compared to 55. The point is that getting starting, even with a smaller amount, is what matters. Your money is able to do some of the work for you, and it takes a lot less cash to amass a nice nest egg.
You shouldn’t anticipate that your future self will have the flexibility to contribute significant amounts to retirement or other investing goals.
Life Gets More (Not Less) Complicated
Another reason you should start investing early, even with a modest amount, is because life tends to get more, not less, complicated as we age.
There’s a common idea that once you achieve a certain financial milestone — such as paying off debt — or hit a certain age or career goal, you’ll magically be able to fund all your other money goals. Sure, maybe sometimes it works out that way. But typically, life gets more complicated and expensive, not the other way around.
The explanation isn’t simply lifestyle inflation, but rather costly decisions like adopting a dog, getting married, starting a family, buying a house, experiencing a health scare — all of which can make it harder to prioritize investing for retirement or any other financial goals.
What Happens When You Delay Building Wealth
Bear with me, because I’m about to dump a lot of numbers. But the point is to illustrate the difference in waiting to build wealth or starting today.
Meet Ramona and LuAnn
They have similar financial profiles. Both are 25 years old with an income of $45,000, which is approximately $3,000 monthly net after taxes.
Ramona and LuAnn each have:
- $35,000 in student loans at 4.66% APR
- $7,000 auto loan at 3.11% APR
They pay $365 per month in student loans and $126 towards the auto loan for a total of $491 minimum going towards debt.
Ramona Focuses on Strict Debt Repayment
Ramona decides to live sparsely and puts $1,000 a month towards her debts. She uses the debt snowball strategy in order to aggressively pay them off.
If Ramona starts her pay-off journey in September 2020, she will be debt free in June 2024, just shy of four years. She’ll pay $3,874 in interest on her original balance of $42,000 in debt.
LuAnn Focuses on Investing and Debt Repayment
LuAnn decides to put three percent of her income towards the company 401(k) plan, which is a matched plan. LuAnn contributes $112.50 a month and so does the company, so she has $225 going towards her retirement each month.
She also puts $700 a month towards her debt ($300 a month less than Ramona) using the debt snowball strategy.
According to this plan, LuAnn is debt free in May of 2026, almost two years after Ramona, and pays $5,779 in interest — nearly $2,000 more than Ramona.
Who Ends Up With More Money?
Ramona seems like the clear winner, right? After all, she paid about $2,000 less in interest towards her debt and was debt free two years earlier.
Not so fast. LuAnn’s contributions to her retirement plan while paying off debt netted her approximately $19,000 in six years — assuming a 7-percent return.
Even if you subtract the $5,779 she paid in interest by not paying off debt more aggressively, LuAnn is still ahead by $13,221.
And that’s how quickly money can grow when it’s invested.
What About High-Interest Credit Card Debt?
One could argue that Ramona and LuAnn were dealing with fairly low interest rate debt and the retirement contributions got higher returns than the interest they were accruing, so it would make sense to invest. But what about a crusher like credit cards, where the market returns are usually much lower than the interest rate?
Let’s take a look.
If LuAnn had additional credit card debt, let’s say $5,000 at 18% APR with a minimum monthly payment of $150 per month, it would have taken an extra year to become debt free. She would also pay $8,458 in interest.
But if she had continued to invest into her retirement account, she would have approximately $23,000 in her 401(k) by April 2027. Taking into account the interest paid, she would still be up $14,544.
If she didn’t make her monthly retirement contribution of $112.50 and instead put it toward her debt repayment plan (the one with credit card debt), she would only shave a year and $1,657 off the interest she paid.
LuAnn is the clear winner in all scenarios. LuAnn came out significantly ahead by contributing enough to get the full match on her 401(k) while also paying down debt, even when some of that debt was high interest rate debt.
But What If I Don’t Have an Emergency Fund?
It’s tempting to want to shore up cash.
While you should have a 3-6 month emergency fund before investing in any non-retirement accounts, it’s best to not wait on investing into a 401(k) or IRA. You don’t want to wait the years it might take to build a six-month emergency fund.
My recommendation: invest at least 1% of your salary while you work on building up at least one month’s worth of bare minimum expenses in your emergency fund. After you hit that one month minimum, push towards contributing enough to get the full employer match, so you can double your money. It’s quite literally the best return on your money available.
No employer match? Aim to contribute at least 5% per paycheck while you’re still building that emergency savings fund. Modest but consistent contributions while building your emergency fund will still add up. If 5% is too much to start, just increase your contribution by half a percent every six months. That slow increase will barely be felt in your monthly budget.
Shifting Your Own Focus
It’s tempting to stay focused on debt payoff. It’s actionable and you can quickly see the result, especially if you’re hyper aggressive with your payments. Plus, debt is so enmeshed with morality in the United States that it feels like a principled decision to pursue debt freedom.
While becoming debt free can be a high priority, the pursuit shouldn’t come at the expense of your financial future.
The simplest way you can build wealth for the future is to start early and be consistent, even with a small sum. Sometimes it doesn’t feel significant to invest modest amounts, like $20, because heck, it’s hard to even go out to dinner for less than 20 dollars, so how much can that really do when it comes to investing? Truthfully, a lot more than you think.
Starting today, say you invest $20 per month and do that consistently for 40 years. Assuming a seven percent return, you’d have $48,211.92 in 40 years. If you simply saved that money, you’d have $9,600 in 40 years (480 months x $20). Investing a modest sum consistently gets you an extra $39,000. It really does matter.
Delaying your start date for years because you’re focused on debt can have serious long-term repercussions. The rest of your life isn’t “all or nothing” and your money doesn’t have to be either.