What to do with cash and debt before investing?

[Gregg Baird]

Hi, I'm new to REI and Bigger Pockets and learning financial literacy, but I'm not sure how to proceed as I get started. I have my first rental house under contract that I'm paying for with money that we pulled out of our personal residence in a refinance. I'm setting up a bank account for that money that is going to be for my real estate assets. We have debt from a car payment and we had to finance a crawl space job. I took the penalty and pulled the balance of my 401k out and am thinking of doing the same with a self directed IRA. My question is should I put the amount of the 401k and IRA toward paying off our debt or should I hold onto it to make another real estate acquisition? I quit my job in March to care for my children as schools closed, and am close to being employed again, so needless to say, those debt payments are quite the burden. I really enjoy the site and forum and thanks in advance for any help you can provide.

[Zach Westerfield]

@Gregg Baird congrats on getting started. When it comes to how and where to use capital and debt, each person's situation is different, as well as each person's risk tolerance is different. The first step is to understand your Risk/Return situation, next establish your long term goals. break these long term goals into shorter term goals, and develop a strategy to use your financial assets, whether that be leverages, cash, equity, etc. 

a few starting points - its important to understand the return as well as tradeoff on each situation you mentioned above. For example, pulling money out of a 401K. first, you are losing the return that money was making, for arguments sake, say 8%. next, you add in the penalty for withdrawal (spread over the term you plan on using the money). Lets say its a 25% penalty. If you use the money and make a 15% return in real estate, it will take approximately 4 years to "pay back" the penalty. 

the same applies to debt. If you have a car loan at 4% and could pay off the balance, you have to consider if you could take the same money and make more than 4%? In general, with the current interest rate environment it doesnt make sense to pay off low interest debt. There are two big caveats to that statement 1. you have the discipline to invest the money, and not spend it. if not, pay off the debt. 2. You can handle the debt payments from a cash flow perspective. If you cant balance your budget each month, pay off the debt first. Once your personal finances are "cash flow positive", then start looking to utilize debt.

Again, all of this is very subjective, and there is no black and white answer. However, hopefully this helps you to start thinking in investing terms.