So you’ve recently received a windfall from your reclusive, Havisham-esque great aunt. Congratulations! Nothing like an unexpected check from a mysterious relative. Now the question is: what should you do with the cash? Should you use it to pay off your debt? Or is it better to put it toward value stocks?
In this article, we’ll discuss which choice might be best for you. If you’ve got some debt to repay, grab your loan payoff calculator and let’s get to work.
When paying off debt might make sense
Using your money to pay off debt might make sense if the debt you’re carrying is high-interest, like with credit card debt. According to Business Insider, the average credit card APR in 2020 was 16.28%. Paying off debt with an interest rate this high is likely to give you a better return on your cash than most investments you might be considering.
If you decide that you’d like to prioritize paying down your debt, you may want to use the debt avalanche method to help you.
Using the debt avalanche method to pay off debt
With the debt avalanche method, you pay off your debts in order of highest to lowest interest rates. You’ll continue to pay the minimum amounts on all of your debts, but you’ll put any extra money toward the debt with the highest interest rate. Once that’s paid off in full, you’ll put extra money toward the debt with the second-highest interest rate, and so on.
The debt avalanche method can help you save money overall since you’re eliminating your highest-interest debts first.
When investing in value stocks might make sense
Investing in value stocks might make the most sense if you think you’ll be able to earn more than the amount that your debts will cost you in interest.
Let’s say you have a mortgage with an interest rate of 6%. Goldman Sachs data shows that the average stock market return over the past 10 years is 9.2%, with the S&P 500 showing slightly higher results at 13.6%. In this situation, investing your money will likely yield higher results than putting money toward your mortgage.
When a low credit score might be the deciding factor
If you have a low credit score and are looking to take out a loan in the near future, you may want to put your extra cash toward credit card debt instead of stocks. Your credit score is based off a variety of factors, one of which is your credit utilization ratio. This is a comparison of the amount of credit you’re using compared to the total amount of credit you have available.
If you’re carrying high credit card balances, there’s a good chance your credit utilization ratio is high. Credit utilization ratios of 30% or more can hurt your score. Paying off your credit card debt will lower your ratio and thus give your score a boost.
Hopefully this article has helped you decide which option makes the most sense for you. By prioritizing paying off debt if you’re paying high interest rates or investing if you can expect a higher return, you’ll be able to make your new trove of cash truly count.