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I’ve got £3k to spare. Should I pay down my debts or invest in shares instead?

Whether you have a lump sum such as £3k, £5k, or £10k, it makes sense to put it to work. So what should be your priority, paying down your debts, or investing in the stock market?

Deciding between those two options isn’t always easy and the answer may depend on your personal circumstances. However, here’s a simple tip. If you owe money on expensive short-term credit, there’s only one thing you should do. Pay that debt down!

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Whether you’re paying an APR of 20% on a credit card, 30% on a store card, or some mind-boggling interest rate on a payday loan, that is your number-one priority, because no investment on earth can honestly guarantee to deliver such a return. Always check if there are any penalties for early repayment, though.

Don’t forget to invest

I think the stock market is a terrific way to invest for your future. It’s what I do when I have money to spare, but I don’t expect to generate that kind of return. And, please, don’t get distracted by flash-in-the-pan investments like Bitcoin. Pay that debt down.

Alternatively, consider shifting the debt to an interest-free balance transfer card, charging 0% for two years or more, and whittle it down without racking up further interest charges.

It’s a different matter if you owe money on a mortgage. Here, instead of 20% or 30%, you may only be paying 2% or 3%. If you’re paying much more than that, then shop around to see if you can get a cheaper mortgage, because you could save thousands by doing that.

You need to plan ahead

Then, as a general rule, I’d look to invest my £3k (or whatever) in the stock market, to build wealth for the longer run, and retirement in particular. This assumes you can afford your monthly mortgage repayments and are on course to pay off the debt before you retire.

I would recommend investing in a Stocks and Shares ISA, because that way you can take all your capital gains and dividend income absolutely free of tax, for life, making your money work even harder. You could invest in a simple fund tracking the FTSE 100 or FTSE 250, or a collection of UK blue-chip stocks.

The top 350 stocks on the FTSE currently offer a yield of 4.27% a year, which is more than most new mortgages charge, plus you get the scope for capital growth when share prices increase.

Stock markets may be volatile in the short run, but over a typical 25-year mortgage term, history shows they should rise faster than almost any rival asset class. The average long-term return is around 7% a year, more than your mortgage charges.

The longer you invest in the stock market, the better. That way your money will have more time to compound and grow in value. So don’t wait it until your mortgage is paid off. You need to start sooner than that.

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Harvey Jones has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.