Investing Wisely after Debt Payoff
Here is a great question that I received from a reader:
“How do I invest wisely after we pay off our debt?”
Some people would go straight to a financial advisor and ask their advice about investing. As I’ve explained in multiple posts, if you don’t know the basics of how the financial industry works and you’re not interviewing your potential financial advisors with some screening questions, then you may be getting some really bad advice, wasting your time, and losing money to boot.
I am a big fan of getting to know your financial situation to the point where you could have a meaningful, productive conversation with a good financial advisor (if you choose to work with one). A good advisor will genuinely enjoy talking about your life goals and how to use your money as a tool to achieve the life you want. They are NOT simply investment advisors/managers. That’s too narrow of a focus, and it completely ignores the rest of your financial life.
In the meantime, here are some practical steps when it comes to the question of how to invest wisely after paying off debt (ideally, you would be working on both paying off debt AND investing at the same time- you can read about prioritizing paying off debt and investing here). Going through these steps BEFORE you pay off your debt will ease a lot of anxiety, and it will make the transition from paying off debt to savvy investor much smoother.
CELEBRATE YOUR DEBT-FREE STATUS
Paying off debt requires a lot of discipline and sacrifice. Think of all of the large and small purchases that you did without in order to reach your goal. These were not easy decisions. You likely also worked extra shifts or relied on a side hustle to earn extra income so that you could pay off your debt more quickly. Either way, this debt payoff didn’t come without some intentional work and grit.
The idea of suddenly having no debt and freeing up all of that cash flow sounds AMAZING. Once we paid off our student debt, it was a huge relief to get that off our financial to-do list. But it wasn’t long before we asked ourselves “Now what?” It became crystal clear that there were other pressing financial obligations we had to focus on, like saving for retirement, saving for college, as well as dealing with our normal day-to-day expenses.
Before getting overwhelmed, here’s something you can plan for: Celebrate your debt-free status! It can be as simple as having a special night out to planning a celebratory trip. Just plan on something that marks this special occasion- because you deserve to treat yourself for reaching this milestone! Getting the kids involved also drives home the importance of celebrating financial wins!
This will not only give you something to look forward to, but it’s important to get in the habit of giving yourself permission to have some fun with your money (within reason, of course)!
TAKE INVENTORY OF YOUR FINANCIAL HEALTH
So you’ve got your debt-free celebration plans. Next, you need to do an honest assessment of your financial health. Other than paying off your debt, are there other uses for your money? Here’s a quick checklist of other ways you could be using that money to improve your financial health:
- Emergency fund: Is this properly funded?
- Retirement account contributions: Have you been contributing? If so, which accounts are you using? How much are you putting away?
- Disability insurance: Your DVM is your ticket to producing the income that you’re making right now. Are you sufficiently protecting that income?
- Life insurance: Do you have dependents that depend on you financially? Will they be protected in the event of your death?
- HSA: If you have a high deductible health plan (HDHP), have you opened up a health savings account (HSA)?
- College savings: If you have children, are you planning on covering some or all of their postsecondary education?
- Will/Estate Plan: If you have assets, are you ensuring that you have, at the very least, a will set up? For those with children, do you have an estate plan?
- Savings goals: Are you saving for specific goals, like a down payment, a car, a vacation, a practice, or preparing for a new baby?
- Charitable contributions: Have you been meaning to start or increase your charitable contributions once you get your debt paid off?
WHAT ABOUT INVESTING WISELY?
I just wanted to know how to invest wisely!
This is a reminder that you shouldn’t automatically transfer your monthly debt payments into investments without taking inventory of your entire financial situation. If you’re in aggressive debt payoff mode, it’s very easy to ignore all of these other parts of your financial health because you’ve been so laser-focused.
Your monthly debt payments, once they’re no longer earmarked for debt repayment, need to go to your highest financial priorities. You may have thought that your highest priority was investing, but when looking at this list, perhaps you can find other uses for that money before you decide that money should be used for investing purposes only.
FINANCIAL PRIORITIES POST-DEBT PAYOFF
Once you go through this checklist, break out a pencil and paper (or your computer) and write down your financial priorities. List them in order from highest to lowest. Using your current debt payment as a starting point, assign a dollar amount next to each priority until you “use up” your debt payment.
For example, say that you’ve been paying $1,500 a month towards your debt. Now that the debt is paid off, you’ve just received a $1,500 raise per month, or an $18,000 raise for the entire year!
Your three highest priorities are:
- Finish contributing to your emergency fund
- Contribute more to your 401(k)
- Starting a 529 plan for your child
You’ve done some calculations and figure that you should split up your $1,500 like this:
- Emergency fund: $400/month
- 401(k): $800/month
- 529 Plan: $300/month
The beauty of this exercise is that you can completely tailor this to what YOU want. In this example, you will eventually reach your emergency fund number and max out your 401(k). Once you fulfill these priorities, you will re-evaluate your financial situation, make new priorities, and continue to check items off your financial health to-do list.
This is a preliminary exercise that will get you in the mindset of managing your money and telling your money what you want it to do for you. You can always revisit this and refine later.
NOW FOR THE INVESTING QUESTION
When it comes to investing, figure out your “why.” What is it that you’re investing for? Why is this important to you? Do you have a number that you’re shooting for? This gives you much more clarity when it comes to what to invest in, and how to invest.
Rather than saying something vague, like “I want to save for retirement,” you should have a more specific goal, like “I want to have $2 million saved for retirement by age 65.”
WHAT DO I INVEST IN?
Remember that there are multiple ways one can invest. You can invest in three major categories:
- Stock Market
- Real Estate
Each of these categories work in very different ways and require different skill sets and knowledge in order to be successful.
When people think of investing, they usually think of investing in the stock market, since this is how people typically plan for retirement and college.
If you decide to invest in real estate or a business (like practice ownership), then be prepared to put a lot of time and effort into learning about these topics in depth in order to increase your chances of being successful.
For the purposes of this question, let’s say the reader wants to focus on investing in the stock market for retirement.
HOW DO I INVEST WISELY IN THE STOCK MARKET?
Luckily, investing in the stock market for the long term is becoming easier, thanks to the power of index investing, the availability of roboadvisors that can help manage investments for a low fee, and the many wonderful books/websites/blogs/podcasts/videos that have a treasure trove of information at your fingertips (provided that you find the good ones!).
Wisdom comes from avoiding past mistakes. So a good way to think about investing wisely is that you avoid the many common mistakes that people have made in the past. They include:
- Not understanding the basics of the stock market
- Being unaware that volatility and stock market cycles are normal and expected
- Not investing soon enough
- Trying to time the market
- Trying to beat the market
- Making emotional decisions
- Having the wrong asset allocation
- Not knowing which accounts to invest in
- Not being properly diversified or having a balanced portfolio
- Paying too much in fees
- Not sticking with a plan
Too often, we get intimidated by the technical side and all the jargon, so it’s natural to keep putting it off because we feel like we don’t have enough knowledge to get started. But let me assure you- learning the basics of stock market investing is not hard. You can pretty easily build a simple portfolio or let a roboadvisor do the investing for you.
But as you can see in the list, there are many BEHAVIORAL mistakes that people make when it comes to investing. Even seasoned, successful investors wrestle with making good behavioral decisions.
Let’s say you hired someone, either a financial advisor or a roboadvisor, to design a beautiful portfolio with graphs and numbers galore. This portfolio is designed with your risk tolerance and investment goals in mind. You’re getting great returns, and everyone is happy.
But then the stock market starts tanking. You can’t stomach investing more money as the value of your portfolio decreases. You panic, ditch the plan, and decide to sell. You decide to keep this money in cash, never to invest again. This has cost you dearly since you’re now missing out on all the future gains that occur when the markets eventually recover and surpass previous highs.
So get educated on the basics first so that you can set reasonable expectations and hopefully avoid making behavioral mistakes. Yes, there is a little bit of a learning curve, but as long as you make a commitment to learn the basics AND you focus on keeping the behavioral side of investing in check, you will be light years ahead in terms of being a wise investor.
The journey to debt payoff can be very long. Finally getting to the point where it’s gone is a huge relief! But as you can see, figuring out what you’re going to do AFTER the fact is going to require that you become very intentional about your money.
What happens when people don’t have a plan? When people have extra cash lying around without a plan, it can be a dangerous place. Without a sense of direction and purpose, you can easily find yourself using your money inefficiently, living paycheck to paycheck if you don’t keep lifestyle inflation in check, or worse, going into debt again.
A very easy way someone could do this is by deciding to upgrade their big expenses, like housing and transportation. Now, that extra cash flow is simply gone, tied to assets that are illiquid. In the case of a car, it’s a depreciating asset. And home ownership is not just the mortgage– there are many other costs that people don’t take into account, and there’s no guarantee that the value of the home will appreciate over time.
Now they’ve created a situation where they have less options with whatever money they do have leftover, and they could very well find themselves in debt again. The cycle continues.
Don’t put yourself in this situation. Celebrate your debt free status, take inventory of your financial health, list your financial priorities, THEN get a solid investing plan in place for putting those extra dollars to work for YOU.
Have you paid off debt and started focusing on investing? What has helped you make this transition? Comment below!
Great advice, as always! I wish we had been more intentional about investing. I noticed my bank account growing each year as my expenses were less than my income, but I had no idea what to do with it. My family had experience in real estate, so I bought a couple of rentals at the bottom of the market. That turned out fairly well, but it would have been wiser to pursue more options and be more deliberate about it. Now that we know, we still have those rentals, we have a municipal bond fund, and a fair amount in index stock funds through Vanguard (taxable and Roth IRAs) and Fidelity (403b and 457). We also had no idea what we would DO with the money we were accumulating. Not knowing any better, we thought, “Build a million dollar dream house?” Then we discovered Mr. Money Mustache and Financial Independence/Retire Early, which is a MUCH better plan than the dream house. 🙂
Wondering what to do with your money is a good problem to have! I agree that FIRE sounds much better than the dream home!
Great advice and blue print to organizing goals. I think you could do this while paying off debt too like you said.
Thanks- it can get hard to prioritize when debt is also in the picture. The key is to make sure you’re making progress!