I Have some extra money! Yay! What do I do next?

People are always wondering, should I pay down my debt or invest? What is the best use of my extra money? If I received some sort of windfall, what should I do with it?

This sounds like it should have a simple answer, but it is never that simple. It requires you to take a look at your specific circumstances and do a little math. It also depends on your financial goals and what strategy you are using to achieve them. 

Let’s look at a few different scenarios and philosophies:

Cash Flow is KING 

One way to choose where to put your money is to determine what will keep the most money in your pocket every month. Remember, cash flow is king. 

If paying down a debt saves you $200 a month but investing that same amount earns you $100 then pay down the debt. If the opposite is true, then invest. Pretty simple. You are only as rich as your free cash flow. We need money to live. We cannot take control of our financial futures and implement a plan if we don’t have any money. It is simple math. So, thinking about cash flow is a nice, easy evaluation strategy to make the “invest vs. debt” choice. 

Since cash flow is king, creating more cash flow to invest can come from reducing your expenses. So paying off a debt creates more free cash flow. If you are committed to investing what you gain every month from reducing your debt burden, then I am OK with that. 

Some guys will tell you to choose the debt or investment with the highest interest rate. 

That make sense too, yet I feel that when evaluating returns, you need to make sure you are moving forward and not standing still.

I often think of the old saying : 

Spending money is easy, getting money is hard. 

This makes me always want to invest. Why? Because it is hard. There never seems to be a right time to invest, as debt and expenses are always going to try to take priority over investing. Investing often takes a backseat to debt because debt is more immediate, and investing seems like a luxury. We need to reverse this idea and reinforce the mantra “Pay yourself first”.

My thinking often goes like this:

“If I invest my money, I am now earning more money, which makes me more powerful”

“If I am earning more money, this makes me more able to service my debt”

“The debt loses its power over me if I am earning more money”

“Earning more money empowers me to better deal with my money problems” 

Yet on the other hand, having less debt makes the most of the money I already have. Which is right?

Financial Freedom

Then of course there is the concept of financial freedom. In the end. I am looking for freedom. That comes from me not having to trade my time for money. I philosophically want to be the master of my own time and therefore my life. Working to make someone else rich seems like a waste of my life. I want to work hard, and earn money by providing value to the world, and in exchange, I earn the rewards. I want to work if I choose. I want to have the ability to come and go as I please. This dream can ONLY be achieved through EARNING income. I need a way to earn money that I am in control of. Having no debt doesn’t buy me that. Only having passive income does that. I could have a business, but if I am working 80 hours a week to keep it running I am a slave to my business and really do not have the freedom that I am looking for. Time is the most precious asset you can own and in order to maximize my time freedom, I need to earn passive income.

Brian Tracy wrote an amazing book “Eat that Frog” that basically says “If you eat a live frog first thing in the morning, it will probably be the worst thing you have to do all day” which usually applies to time management in the context of productivity. If we apply this philosophy to the macro scale we should take this approach to our quest for financial freedom. 

Building up a portfolio of passive income producing investments is really hard. Why not focus on that FIRST? Always choose investing. It is the road to financial freedom. 

Opportunity Cost

We always need to factor in how much we can earn by putting our money to work. because of inflation, debt actually becomes less of a burden over time.

Let’s have some fun and do a little math. 

eg. 

Lets say you have a loan of $10000 at 6% interest for the next ten years

Payment every month: $111.02

Total interest: $3,322.46

You suddenly are given $10000 as a gift. (Lets ignore taxes for the Moment)

Should you pay off your loan or invest?

Let’s look at an apples to apples comparison:

If you have an investment that pays 6% as well then we can compare the pros and cons. 

Initial investment: $10,000

6% compounded over 10 years = $7,908.48 profit<- you have made almost $8000 in the ten years! 

So you can save yourself $3,322 in interest or earn yourself $7,908 in returns.  

TAXES

If I earn another $100 a month I really only have an extra $50 as I have to pay taxes on that money. But if I SAVE $100 a month by reducing my debt or expenses, then I have the whole $100. My return is way better. I am farther ahead by spending less than by earning more. This is great in the short term.

Now if you consider that your investment will continue to earn more and more every month for as long as you choose to hold the investment, It starts to appear as if investing wins every time. 

Now, depending in the tax rate, you may give up to 50% of that investment income to the government so your ROI is a lot less than you initially think. Always factor in the TAX implications when you are deciding. You can end up in a bit of a pickle unless you do it correctly. There are ways to legally and ethically reduce your tax burden by speaking with a tax professional and getting advice specific to your region and your earning situation. 

I Like Investing

I like to invest any extra money I have as I believe that the more money you have, the better prepared you are to deal with life. People always believe that winning the lottery would be the best thing to happen to them. How often do people pray to have all of their debt removed?  

Create your own “lottery”  windfall by building up your income producing assets and growing your sources of passive income. You could even have the income from the investment help pay down the loan. Now you are getting TWO benefits for the price of one! You can invest AND pay down your debt at the same time!

So it pays to do the math first. Always look at the TOTAL absolute amounts you will see over the term of the loan and the term of the investment. Factor in taxes and you will know which to do. There is no “Always do this” rule that says Always invest or always pay down debt. Debt feels horrible. Passive income feels awesome. You have to decide which feeling you are more inclined to pursue.