The question to invest is a very personal one.
The answer won’t always be obvious, and the reasoning will be different for each person. But here’s some simple math that can help you decide if investing in the stock market through an IRA or your 401(k) makes more financial sense than paying off an outstanding loan.
Invest or pay off debt?
Let’s say you recently came into $10,000. Congrats!
You have $10,000 remaining on a loan at 4% APR that will be due in 10 years. Taking into account interest, over the next 10 years, the loan will ultimately cost you $12,149. If you pay off the loan today, you are, in essence, avoiding a cost of $2,149.
But let’s say, as an alternative, you invest that $10,000 today in an S&P 500 Index Fund.
Assuming a good-but-not-great 9% rate of return for the market, in 10 years, your $10,000 would be worth $23,673. That’s a gain of $13,673 on your principal investment.
While the loan payoff is effectively a gain of $2,149, the S&P 500 investment will gain you $13,673. That’s $11,673 more than the gain of the loan payoff, or more than 5 times as much of a return on your investment (ROI).
Your results may vary
That said, there are plenty of situations where it might be more beneficial to pay off the loan. Maybe your loan rate is higher. Or maybe you have less time to invest the money.
There are also situations that you can’t predict. Historically, the market has returned 9%, but you could always invest your money before a bear market.
Hopefully, you now feel comfortable enough with the math to change the inputs for your specific situation to determine which choice might be best for you.
— Answer provided by business intelligence Fool Sarah Will