Should I invest or pay off debt? That has to be at the top of the most common questions I have received over the years. And the answer is a solid—it depends! But only on one thing:
If you do not have an emergency fund saved and stashed in a safe place—and I’m talking about at least $1,000—you should save madly while you keep paying the minimums required on your burgeoning debt. Once you have an emergency fund in place, the answer to that question is clear:
Dear Mary: I have $13,000 in credit-card debt. I have designed a plan in which I would pay the amount of interest charged to me on my last statement plus $930 each month. The way I figure it, by doing this I will have this debt paid off in 15 months. I am going to have to dip into my investment account to come up with that additional amount each month, but I can do that. I could also just pay off the whole amount from my investment account (it is not a tax-advantaged retirement account), but I don’t prefer to do it that way. My investment account is at about $209,000 and I really don’t want to go under the $200,000 mark in that account. What is your suggestion? Anonymous
Dear Anon: You don’t say the interest rate you are paying on that debt, so I am going to assume it’s the current average rate of 17.55 APR. You don’t say how your funds are invested, so I will assume you are invested in the stock market (some equity stock, some bonds).
Here are the facts:
- You owe the $13,000 regardless of anything that happens in your life or the world. And you owe it at a huge rate of 17.55 percent interest. That works out to $190 interest per month. It’s a sure thing.
- Your money in the investment account is at risk. It could grow, it could shrink. You could lose it all overnight. That’s the nature of an investment. It is not a sure thing.
Here is the principle I recommend that you follow: There is no better investment than a repaid debt because it comes with a guaranteed return. It is always the wise thing to invest in your debt (but only to the point that you are not raiding your basic emergency fund to do so). Pay off that $13,000 debt now.
By investing in this debt you will, in effect, be earning 17.55 percent on that $13,000 rather than paying it to the credit-card company. Let me explain how that works:
If you keep paying on the debt, next month when you pay that credit-card payment you will be paying $190 to the bank in interest. But if you pay it off in full this month, next month you do not have to pay that $190. You get to keep it. That money is now yours and is the 17.55 percent interest you are “earning” on the $13,000 you chose to invest in your debt.
Your investment account ebbs and flows due to current market conditions. Many believe the U.S. stock market is going to go through a major correction in the coming months or years (read: crash), which we’re being told could see a 30-percent drop or more. Will that happen? Your guess is as good as mine.
If the worst happens (your investment account suffers a mighty blow) you will still owe $13,000 on your credit-card account. The wise decision would be to pay that off now and reap the benefit of not having to pay 17.55 percent interest (or whatever your exact rate is) going forward.
Invest in your debt. It’s a sure thing with a solid return.