Invest or pay off debt? Financial considerations for military families

A common question many people have when beginning to plan for their financial future is how they should prioritize their goals. This is particularly true when it comes to deciding whether to invest or pay off debt. In this article, we’ll outline the key differences between the two strategies, assess the pros and cons of each and explain how certain military benefits and programs can be useful in the pursuit of your financial goals.

Paying Off Debt vs Investing: Key Differences

Investing can improve your financial readiness over time using assets you have already acquired. This makes investing an important part of your financial plan as you work to grow your assets over time. But what is investing, exactly? Investing is the concept that if you purchase an asset now and it increases in value over time, you can sell it later to make a profit. There are hundreds of ways to invest—stocks, bonds, real estate, precious metals, etc.

Debt, on the other hand, is money you owe to someone else, be it a bank, credit card company, or other lender. By giving you the money up front, they collect interest—that’s where debt can come back to haunt you. Over time, you pay back more than you initially borrowed, costing you more in the long run while haunting you with monthly payments that eat into your disposable income.

Different debts serve different purposes and have different downfalls. Credit cards, for example, can be a useful tool to cover emergency costs but come with extremely high interest rates that can rapidly increase your debt balance. A mortgage, on the other hand, usually has a lower interest rate but a much higher balance that stretches on for as long as 30 years, charging you interest the whole time.

So, which should you do first: pay off debt, or invest? As is the answer in many financial topics, that depends on your unique situation. A combination of the rate of return you’d get from investments, the interest rate on your debts, and your overall debt balances play a role in making this decision. But one thing reigns true: you can do both at the same time.

Pros of Paying off Debt First

Given the ways debt can eat away at your income, it is generally a good idea to pay off high interest debt as quickly as possible. This can help you achieve a couple of things: less interest paid over time, fewer monthly payments, and a better credit score that gives you access to lower interest rates for debt you may acquire in the future.

So, what are the best ways to pay off your debts? The answer again depends on both your financial situation and the way you think about debt within your financial plan. Assuming minimum payments are made on every debt they have, some folks choose to allocate extra payments to the debt with the highest interest rate to pay less interest over the life of their debts. Others choose to pay off the smallest debt first to get a psychological ‘win’ to encourage them to move on to the next. Reduced monthly payments means you can ‘snowball’ your payments to attack the next debt even more aggressively. There is no one right answer, but folks that get out from under the thumb of crushing debt can have more freedom to bolster their financial readiness both in the present and future.

Pros for Choosing to Invest First

While paying off debts quickly may sound like an attractive part of your financial plan, investing early in your career can be an important component of building a retirement portfolio. The power of compounding only gets more substantial over time, meaning starting as early as possible is a part of the investing cornerstone that is incorporated into many financial plans.

Think about it: if you could invest $100 per month starting today, in one year you would have $1,200 invested that has been accruing a return to increase that sum. It is worth noting, however, that a positive return is not guaranteed for your assets. While many investments tend to increase in value over long periods of time, there will more than likely be periods where your account balance gets smaller due to a decrease in the value of the assets in your investment portfolio. It is an important part of your financial plan to avoid putting all your eggs in one basket to avoid a combination of debt balances and negative investing trends putting you in a precarious financial position.

How To Pay Off Debt as Military Personnel

Military service comes with access to a few benefits that may help ease the burden of debt. One potentially attractive option for those with multiple debts is a debt consolidation loan. These loans serve to pay off applicable debts and put your debt balance in one place with a lower interest rate to save you both money and stress over time. Rather than debating which debt to pay off first or risk forgetting to make payments, you can have your payments all go to the same place and toward the same goal.

First Command has a host of debt consolidation options for military personnel. Connecting with your financial planner can give you access to these options.

Military Investment Opportunities

Once you have your debt ducks in a row, which investing vehicles are best for you as a military servicemember?

One of the most basic investing methods for both civilians and military servicemembers are tax-advantaged retirement accounts. While folks working for a private company might have access to a 401(k), for example, military servicemembers have the TSP—a military-sponsored, tax-advantaged retirement account that gets both automatic and matching contributions from the government.

You can choose to allocate funds to your TSP every month from your gross income, meaning you only pay taxes on that money when you withdraw it in the future. The government will also match a certain percentage of your contributions on the first five percent of your income with deposits into your account. On top of your funds and matching contributions, you will also receive automatic contributions equal to one percent of your income regardless of how much you contribute.

While other investment vehicles, such as a taxable brokerage account, are always available to you, your TSP is an effective and efficient investment vehicle that can allow you to invest in your future financial readiness while keeping your disposable income relatively high. You can choose from a variety of funds to invest your balance in—the concept with all of them is to grow your account balance by investing in assets that will more than likely increase in value over time.

The Hybrid Approach

At this point you may be wondering how to best structure your financial plan so that you can invest in your future while paying off your debt simultaneously. While each person’s financial situation is unique to them, a general model is to build an emergency fund, contribute to your TSP, and use additional remaining funds to begin tackling your debt balances.

An emergency fund—between three and six months of expenses in savings—is an important component of a financial plan that can help you avoid taking on debt in the future. By contributing what you can to your TSP, you are investing in your future early and allowing the power of compounding returns to benefit your financial readiness. And finally, by tackling debt balances, you are freeing up your income to be used how you want or need for both present and future needs.

Getting Servicemembers Started

Still have questions on the best way for you to tackle your debts and invest in your future? Speaking with a financial advisor is a great place to start. At First Command, we have local financial advisors ready to work with you to help you pursue your financial goals. With complimentary plans for military servicemembers, we can get you started on this journey.

The first step is right in front of you.

First Command does not provide legal or tax advice, and this article does not contain any legal or tax advice. Any recommendations provided to you in this report are strictly for financial planning purposes only. Should you require legal or tax advice, you should consult with your attorney or tax advisor.

TSP funds have very low administrative and investment expenses and, low expenses can have a positive effect on the rate of return of your investment.