QUESTION: I have recently received an unexpected sum of $10,000. Is it better to use the money to pay down debt or invest it? Any thoughts would be welcome.
ANSWER: I love unexpected money! How wonderful for you. I commend you for wanting to do something with the money and not just let it slip through your fingers, which is easy to do. Your dilemma of whether to pay down debt or invest the money is a tough choice, and there is no right answer since everyone’s situation is different. But here are some things to think about.
First, not all debt is equal. You should distinguish between good and bad debt. For example, your mortgage is usually a good form of debt. It provides shelter and also tax deductions.
On the other hand, nondeductible consumer debt with a high interest rate, such as credit card debt, is bad debt.
Unexpected money would be well spent in lowering or eliminating this kind of debt. Making extra mortgage payments can feel good, but may not be the wisest use of extra money.
Investing the money in stocks and bonds, or some other investment vehicle, provides growth potential and may yield an income stream through interest and dividends. There can also be tax advantages to investing. For example, investing in a traditional or Roth IRA has pluses.
In addition to saving for retirement, contributions to a traditional IRA may be tax deductible depending on your income, and your money grows tax deferred. (You will have to pay taxes upon withdrawal, and if you withdraw before age 59-1/2, you may be subject to a 10 percent penalty.)
If you invest in a Roth IRA, your contributions are not tax deductible, but your money grows tax-free and your withdrawals are also tax-free (as long as you do not withdraw money before age 59-1/2 and you have your account at least five years).
Pay down debt or invest. You have a wonderful dilemma before you. And it may not even be an either/or kind of decision that you have to make. You may be able to accomplish both goals: Pay down some debt and invest the rest.
Linda Goodspeed is a longtime real estate writer and author of “In and Out of Darkness.”
Email her at email@example.com.