If you’re asking yourself the question as to whether you should invest or pay off debt, you’re probably sitting on a little chunk of change alongside a mediocre amount of debt.
You’ve probably made a little bit of money and aren’t quite sure what to do with it. The prospect of making your money work for you sounds ideal… yet so does the idea of being debt free! But maybe you feel you’re not ready to put it to work… or not ready to send it to the debt collector.
But if you’re asking yourself questions like these, you’re on a good path. So let’s dive in:
Should you invest or pay off debt?
Short Answer: It depends significantly on your situation.
Obviously both investing and paying off debt are good things to do for your life. However, what many people forget is that one involves a notable degree of risk and the latter doesn’t.
At the root, investing is intended to make you money and debt is intended to cost you money.
Many say that “if you can make more money by investing than by the amount your debt is costing, it is worth it.” But realistically, you cannot guarantee a real rate of return on your investment.
Every investment involves a degree of risk, some small, some large. The enterprising investor, as Benjamin Graham liked to say in The Intelligent Investor, cannot be certain about any investment. He can only use the information and knowledge available to him to make a commendable decision on an investment (paraphrased).
On the other hand, every debt compounds by the rate of interest that is determined without influence of other market forces (unless it’s variable). Therefore, every payment you make on your own debt will certainly go to your debt and certainly reduce the amount you owe. No risk involved. The only opportunity cost is that you no longer have that money for other things.
With that said, investing runs the risk of being counterproductive and even destructive if you have debt. The debt will not leave you until it is paid. The longer your debt sits, the more it grows…and if unpaid, the faster it grows.
An investment may indeed make you money, but it can also lose your money and send you back to where you were, empty handed. And if you do make money, the tax man will take his piece when the time comes. Paying off your debt, if it’s student loans or mortgage interest, will give you a break from the tax man.
This does not mean that investing should never be an option, as some investments involve debt (such as Real Estate). In fact, there are many investments that could be worthwhile if done correctly. But, never overlook investing in yourself and paying off your debt.
Here are some no brainers:
You should pay off your debt if:
- it is Credit Card debt;
- it is Student Loan debt (you may be able to write interest off taxes saving you money);
- it’s Consumer debt; and
- interest on it is compounding above 5%
Reasons being that this debt is costly and the odds of beating their compounding costs by investing are quite slim. Your money will probably serve you well cleaning up these closets full of debt as opposed to attempting to invest.
Here is when you should consider investing as opposed to paying off debt:
(With other personal financial conditions in good standing)
- Debt is fixed at a low rate that can be comfortably paid over a long period of time.
- You have a strong amount of surplus income and debt is not costly.
- Mortgage is comfortable and stable.
- You have done due diligence on your potential investment and can be near confident in a solid rate of return.
- You have no consumer debt compounding.
At the end of the day, in most situations, it is better to pay off debt and pay the least amount possible borrowing. This is a certain investment in yourself and a decision that will usually be right. Running the risk of losing your money, especially with a family, is quite dangerous and maybe not the most responsible thing to do. Assess your own situation and see what is best for you. For good planning book on getting out of debt, check out The Total Money Makeover: Classic Edition: A Proven Plan for Financial Fitness
If you’re still unsure, running some simple projections or calculations might help you make the right decision.
If getting in debt is something you struggle with, Check out my last post on How to Stop Overspending!
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Cheers & God Bless!
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