Should I invest or pay off debt?
In my practice, I get this question often from people between the ages of 25 and 50 when they get into higher paying positions, receive inheritances, win settlements or discover that they owe less in taxes than they thought. Admittedly, that last one is rare!
The question of debt versus savings is not rare at all though. It’s a legitimate question without a one-size-fits-all answer that has more to do with an individual’s goals and objectives than a single article or even book could cover.
But as you’re looking to answer that question yourself, or else you probably wouldn’t be reading this, I’m going to break down for you some things to think about when figuring out what might be best for you.
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Here’s the concept:
Before we go any further, there’s one thing you, dear reader, need to agree to for you to be able to grab all the golden nuggets in the paragraphs below. Of the 7.5 Billion people on the planet, 5 billion can’t answer basic questions about how money works.
My hope here is to share some basic principles with you, so you have a starting point against which to measure the advice you hear from your friends, family or people in the streets… so to speak.
Knowing what can threaten your wealth, can help you guard against it.
The wealth formula shows us that aside from daily expenses, the known threats to building wealth are taxes and inflation. One key indicator: How interest rates are affecting your money.
The most valuable known factor for building wealth is time.
The question is how are you leveraging time against the threats working against you?
+/- INTEREST RATE
Now, let’s take it into the real world:
Now here’s what that means for you. And what you need to know to answer the question of investing or paying off debt.
You’re 36, and you recently got a substantial raise at work just after you finally paid off all but 2 of your remaining student loans. You have known that you should be saving for the future, but between grinding out at work and investing in looking “the part” with the right car and apparel, student loan payments, starting a family and a whole bunch of unforeseen projects at the house, you’ve never really felt like you could start saving.
Now, you’re wondering if this is your moment to finally start saving for the future. You also consider that between your student loan payment, your car payment and a few credit cards you used to fix your furnace, repair the foundation at your house, and fix a leak in your kid’s bathroom over the last 18 months, you’re now paying close to $1350/month in debt payments not including your house.
You imagine what your debt-free life would be like if it made your monthly after-tax income boost $1,950 instead of just $600. But as you’re working the math, your buddy at work comes in talking about how he’s figured out how to make a few hundred a week on some online trading app. Now you’re conflicted.
Before you get all twisted up about being 36, consider the relationship you have with interest rates and how they’re affecting you.
First, you have $22,452 compounding at 9% on your vehicle, you have about $8300 compounding at 23.99% on your credit cards and you have $7,436 compounding at roughly 6%. If you had to remember all those figures, in order to catch the point, this would be a terrible article. It’s not, so here’s the point.
If you can invest your $600 each month in a way that pays you consistently more than the interest rates that are working against you in the form of debt, then you invest. So, can you?
Generally speaking, if you don’t already have assets totaling in the hundreds of thousands or millions, it’s not likely you can afford that type of risk exposure. If you aren’t investing with one of the 4% of professional money managers that routinely outperforms the market, also not likely. I say not likely because it’s possible in shorts spurts, but the likelihood of anyone being able to consistently earn more than these debt interest rates are costing you within a market cycle or even the years it would take you to pay off the debts is… unlikely.
If investing against your debt comes with such an unlikely success rate, what’s the success rate of paying off debt in a way that gives you a bigger pile of income to throw into savings vehicles?
The answer to that question is 100% if…. 1.) you sit down with a pro and build a clear strategy for doing so, and 2.) You follow the strategy. On another day, I may give you tips on building a strategy, or I may talk about how time affects the game plan, or when to consider inflation in this context. Let us know what you’d like to learn next!
Licensed Financial Professional Serving your Dayton Community