Expert: Gina Boykin - 10/3/2008

Question
I have a debt of approximately $40,000 or so. I will be receiving approximately $50,000-$60,000 left over after my legal fees. Should I pay off my $40,000 debt or try to invest it so it can grow larger? I am really confused please help me. Thank you in advance. Respectfully. Victor

Answer
Unless your debt is a student loan with a very low rate (2-3 percent), then it makes more sense to pay it off completely.  If you invest your money, especially if it is not tax-advantaged (like a retirement account or municipal bonds), then by the time you pay taxes on your earnings, you will probably end up making less money than you are paying out in interest on your debt.  (It doesn't make sense to earn 8 percent and pay 18 percent interest.)

The great thing about your situation is that you are able to completely pay off your debt and still have money left over to invest.  I would advise that, if you don't already, set aside some of this money in an emergency fund.  That way you won't have to turn back to debt if anything happens (car repair, medical emergency, temporary job loss, etc.)  

The money for your emergency fund should be in a savings account or money market account because it is money you want to be able to access quickly.  Figure out how much you spend each month (on average) and multiply this number by six.  This is how much you should have in an emergency fund.  If you can't do six months, do at least three.  In this current economy though, six is really much better.

If you pay off your debt and set up an emergency fund and you STILL have money left, then put up to $5,000 in a Roth IRA.  This money can grow for retirement tax-free!  You have many options for a Roth - stocks, bonds, mutual funds, options....The choices are endless.  You can set up an account with any of the major brokerage firms Vanguard, Fidelity, and Charles Schwabb are some of the low-cost ("discount") firms.