Investing in retirement accounts is a very wise decision. People have been investing their resources since the dawn of civilization. Money and investing is one of the Bible’s most referenced topics. “Four things on earth are small, yet they are extremely wise: Ants are creatures of little strength, yet they store up their food in the summer” (Proverbs 30:24-25).
Unfortunately, there is a prerequisite to investing. It’s called being debt-free.
My opinion to stop investing (even if your company offers a match) in order to speed up your Debt Snowball is based on reducing risk and increasing power. As always, reducing risk and increasing power is less about return on investment and more about your behavior over an extended period of time; such as your life.
Is it possible to invest and pay off debt? Or even just invest and not even work towards becoming debt-free? Of course it is! Many people do it, and even advocate for it. But why take that risk?
From a math perspective, I can understand where critics might confuse this with bad advice. After all, you’re foregoing year(s) of compounding interest. Do you have match? Now you are foregoing compounding interest AND free money! Financial wizards would never tell you to eliminate your employer match. But financial wizards only look at your life as if it was a calculator: “Enter this number and this number and it gets you this number”.
The stock market is risky enough. Investing in stocks involves two different types of risks, credit risk and market risk. Credit risk is the risk of loss an investor takes due to the borrower (the company whose stock you own) fails to make a profit or goes out of business and the stock loses value. Market risk is the risk of loss due to downturns in market as a whole.
Credit and Market risk are enough to worry about. That’s why we need diversification. Now envision investing your hard earned money into an environment of credit risk, business risk, AND high personal risk. We can’t control credit and market risk. All we can try to do is diversify enough to reduce this risk to an acceptable level. However, you can control personal risk! We can essentially eliminate personal risk by becoming debt free, increasing our financial margin, AND THEN investing with a vengeance!
All the financial wizards love to talk about diversification, as they should. But we should only diversify things we can’t control. We eliminate the risk we can!
Emergencies will happen. What good is investing into an IRA if you’re forced to withdraw from it before 59 ½ with a 10% penalty plus taxes when an emergency occurs and you don’t have enough financial margin to cover it? What good is an opportunity if your money is tied up in debt repayments and IRA contributions? Even the wealthiest of people have a tough time doing both at the same time.
Your response to a downturn in the market should be “so what?” You are in this for the long haul. You don’t fear a financial crisis. Successful investors are prepared for when – not if – they happen. But when you invest dollars that are better spent elsewhere, we tend to panic. Debt ridden investors don’t have the luxury to be a long-term investor.
Without even knowing it, most investors use a sophisticated approach called Dollar-Cost Averaging (DCA). DCA is a technique of buying a fixed dollar amount of investment on a regular schedule, regardless of the share price. DCA lessens the risk of investing a large amount in a single investment at the wrong time. Successful investing is less about buying at the perfect time and more about consistently not buying at the worse time. Using DCA is an easy, systematic way of consistently investing at good times over the course of one’s investment life (decades).
DCA is only effective when you consistently invest on a regular schedule. Stopping your investing for a couple months because you need new car tires or didn’t realize Christmas was in December defeats the purpose. Paying debts while investing reduces our margin even further; margin we will need to become successful, long-term investors.
A lot of people don’t have enough margins to invest! Investing is just one more financial burden! We need to make A LOT of money to pay off small debts, invest, and keep adequate financial margin. Most of us don’t make that kind of money! Even if we do, our money isn’t being used efficiently! It just doesn’t make mathematical sense to invest while we’re not prepared to handle emergencies. Life has too much risk as it is, there’s no need to add more!
Now that we got the math part out of the way, let’s talk about a more important element – behavior. Stopping your investing (and especially foregoing an employer match) is a HUGE step towards financial fitness! You are willing to sacrifice a little now, for a huge reward in the future.
There is so much to do! So much we read about! So much we listen to! But we reduce our effectiveness with each new thing we add. When it comes to personal finance, it’s best to focus on one thing at a time. Getting out of debt, funding a full emergency fund, saving for a house, and saving for our children’s college tuition are all really good things. They each have their place in our lives. Just not all at once! We would never get anywhere!
Contrary to your finance professor’s opinion, personal finance comes down to simplicity, not leverage. Do you know what you are doing and how you are going to do it? Once that foundation is set, it shouldn’t take you very long to accomplish that specific goal! Then you can move on to your next goal! But let me guess – you have an MBA and sophisticated enough to do it all at once? Not a chance!
Here’s how it works when you do more than one task at a time, regardless of how smart you are: you do a little bit to get out of debt, you do a little bit to plan for emergencies, you do a little bit of saving for a pool, and you do a little bit to build wealth. But in 10 years you look back and realize you didn’t really get anything accomplished. Your still in debt, you still need more money to cover emergencies, you don’t have a functioning pool, and you haven’t accumulated any real wealth!
The best thing you can do for your financial future is get mad and get out of debt really quickly! The more you sulk and act like a three-year-old at Target’s toy section about foregoing investing the longer you forego your investing! But the quicker you act like an adult and dig yourself out of your mess, the quicker you can begin investing and building wealth!
Once debt free, investing becomes more effective. You are able to invest more money, more quickly, with much less risk. You no longer have to make decisions out of desperation. Financial downturns are just something you read about. You have the peace of mind knowing you’re in this for the long haul, handling money as prescribed by the Bible.
“Prepare your work outside and make it ready for yourself in the field; afterwards, then, build your house” (Proverbs 24:27).