You probably noticed that I’ve only been posting twice a week since Memorial Day.
I decided that I was going to take much of the summer off — having a GREAT time BTW. I also thought you are probably doing the same and that two posts per week were more than enough for now. I’ll go back to three a week after Labor Day.
That said, sometimes an idea or situation pops up and it’s worth inserting into the posts I already have scheduled.
Today’s post is just such an example. It covers an on-going debate that we’ve chatted about in the comments many times but have never had a dedicated post on.
It started with an email from a reader a few days ago with the following question:
I’ve been following your blog for a few months now. Where do you think someone with debt falls on the ESI scale? I’ve done a good job of Earning more income, but not sure what to do with the Saving and Investing part since I have debt.
I have $33k in Auto Loans and $63K in a Student Loan. It’s the only debt I have. Should I focus on the debt or would it be smart to focus on the Savings and Investing, and whatever is left put towards debt? The second way would take longer, but it could work out for the best.
This is the age-old “should I pay down debt or invest?” question that I know will generate lots of conversation. So I simply had to add it to the posts I already had planned.
What I Did with Debt and Investing
Things were a bit different in my day.
The only debt we had was a mortgage and it was at what seems like a loan-shark rate of 8% or 9%. That was a good guaranteed return so we worked at paying it off asap.
In addition, we wanted to be completely debt free as a personal decision/lifestyle, so we may have paid it off even if the interest was lower.
Today’s Situation
But things are a bit different today.
With interest rates so low and the stock market on fire, is it worth paying off debt before investing?
I know there will be passionate thoughts on both sides. I emailed the reader back, asked him if I could let you weigh in with your thoughts, and he said “sure”.
So have at it in the comments below.
My Take
I do want to give some thoughts on the issue but also don’t want to sway the discussion. So let me say this:
If you do well enough with the Earn and Save phases, you don’t need to make an either/or decision here.
Here’s what we did:
- We focused on growing our income at a good pace.
- I added to it by creating a side business (freelance writing).
- We were frugal and controlled our spending, creating a huge gap between what we made and what we spent.
- Thus we had a huge surplus. We were able to fully fund my 401k as well as pay off our mortgage fairly quickly.
- Once the mortgage was gone, we took the extra money and saved in a taxable account (which then grew like crazy).
So in the end, I’d suggest the reader look at opportunities to cut come spending. He’s done well in earning, so why not control spending to have a big gap, fully fund his 401k (at least to get the full match), and THEN consider paying off the debt?
Anyway, I’ll let you take it from here. Let me (and him) know your thoughts below.
This depends on the interest rate he’s paying. My car loan is 1.99% and my student loan is 1.625%. There’s no incentize for me to pay those off because I know I can earn more, even after paying taxes on the gains, by investing the money elsewhere. Yes, it feels GREAT to be debt free, but taking on really cheap debt can be a no-brainer, too.
I agree with this. Doesn’t make much sense to me to pay off low interest rate debt. Way better of in the long run investing that money.
The interest rate on the car loan is 4% and the student loan is 6%
Pay off the student loan as quickly as possible, that is a relatively expensive debt. or is it possible to refinance either/ both at a lower rate?
Maybe I missed this, but what’s the balance on the car and student loan?
The problem with this mentality is that it only works if life goes as planned. What happens if Jon loses his job and can’t make the payments. Or something happens and he becomes disabled. Or maybe he decides he wants to pursue a different career that pays less money but it is really what he feels called to do. Or…. or….. or…. Life doesn’t always proceed as we think and having debt always adds risk.
Pay off the auto loan early but keep the student loan debt, as that is much more flexible to defer if times become tough.
I’m going to sit on the sidelines and wait for more comments. I have no debt other than my 199K mortgage at 3.75% but am looking at retirement in 11 – 13 years. I’m on track with my financial plan for retiring in 11 years but will have a mortgage payment if I decide to stay in this house. Already live a frugal livestyle with any additional saved money going into a 0.65% savings and Vangaurd 500 Index accounts for Emergency Fund. I have a strict budget but play a game with myself to see how much more unbudgeted money I can save from paycheck to paycheck. Recently decided to rent out my hardly ever used guest bedroom and really torn between putting that money toward increasing my Emergency Fund from 4 months to 6 months or just additional mortgage payments. Looking forward to hearing input from others on the subject matter of saving, investing or paying off debt.
Debbie, the vibe that I get from your query is that you should increase your emergency fund to six months and then you can start paying extra towards your mortgage.
Having a tenant means that you now will have a guaranteed income (mostly) which actually lowers your need for a large emergency fund but I think that the peace of mind of a larger emergency fund is worth a temporary delay in paying down the mortgage.
Thank you so much, Cooper, for your input. Found higher savings account at 1.20% and have a 1 1/2 months worth of emergency fund there. Now approaching two months savings point with the other part of the emergency fund being placed in Vanguard 500 Index to grow at a healthier rate ahead of inflation in the long haul. I agree about the peace of mind for now having near 3 months of emergency savings is a truly peaceful thing.
Agree with Jon’s comment. My rule of thumb is to compare “market” rates of return to what the debt is costing me. If the interest rate on the debt is higher than what I can earn on the money in the market, I’m better off paying down/off the debt with any free cash I might have. My 2 cents 馃檪
I’m a fan of investing over paying off low interest debt. My cut off point on interest rates is 6%.
If you’re the type of person that can’t stand debt, then I don’t fault anyone for paying it off either. There are a lot worse things we can do with our money, but it all comes down to the math and the probability that we can likely do better than 6% over a long period of time compared to most likely low interest student loans and car loans.
Tom @ HIP
I whole heartedly agree here Tom. My wife and I have been plagued with debt since leaving college. Our earnings are very good and going up at a good rate, so on track there. Our debt is slowly going down, my wife and I having student loans, mortgage, car payment, and RV payment. My biggest pet peeve is to pay off the cars and use that to increase my pay in on the highest interest loans. Most of our loans are in the 3.75-6% which to me are close enough to investment earnings to only make reasonable savings investments and focus hard on debt.
Although that being said life happens, and we now have kids, an RV (which we wanted to experience through the duration of our kids growing up) and a New (to us) minivan that we are making payments on.
Its frustrating to have so much debt even though its relatively low interest. Although we have brought on more debt to increase our comforts – having an RV to vacate and decent car to commute in, it helps our peace of mind to continue pounding our careers and earn more. It’s a slow trap to go down the Jones’ road, so we have more recently in the last five years started to really focus on mentally plateauing. We have the house we want to raise the # of kids, we are on plan to keep our cars for 10+ years, we don’t expect to do anything differently with the RV, and we are popping kids out like crazy. AND having a good time doing it…
So we feel like we are at a position to settle, for the next 10-20 years, only adding minor purchases like vacations, a car in the next 5 years or so, and another car maybe 5 after that. But all the while increasing our earnings and our GAP.
Once we get the majority of our debt paid for aside from the mortgage, we would like to spend that extra money on investing in real estate to create multiple income streams down the road.
Thanks for the blog by the way, very informative, and gives me a look into the future that helps us make everyday decisions with purpose!
oweezy9,
How do you guys like the RV? We have been thinking of buying one to enjoy with our kids but have not made a final decision on making the purchase.
Thanks,
I’m a little late on this, but the answer is multi-faceted. Having kids in an RV takes a lot of work to have fun. We have been blessed to have our in-laws go with us on most trips which helps split the load of watching our two very young kids, cook, clean, enjoy ourselves, etc.
We made the decision that if we were going to commit to buying one, we would commit to using it regularly. We probably average 6 trips a year camping, and then I keep it at our deer lease for about 4 or 5 months. So I could say we use the heck out of it.
If we succumbed to how much work it was and did not take full advantage of it, we would probably get rid of it until they are older. Again, having the in laws along most trips gives us some time with them, and an easier load to bare on the road.
Good luck with your decision!
I think a lot of it depends on the person too. If you’re the type of person that blows through his money, it might be wise to pay off the debt so you aren’t ever tempted to spend the money. If you’re otherwise good with money then I think my cut off point is 5 or 6%.
We went the path of paying off the debt. We have been totally debt free for about 7 years. What we have noticed is that in that time our income has significantly increased mainly due to our ability and freedom to take a couple of risks that we probably would not have taken if we had the debt. It just feels different when you are not paying others, but paying yourself instead.
Thank you for your input for that is an excellent point.
I truly agree with Tex. Interest rate savings when comparing the market rate of return vs. debt rate on average is ” noise” for the most part in big scheme of things. There is huge mental release knowing that when you don’t owe anyone money and you have a massive increase in free cash flow.
I will say that it’s not an all or nothing proposition because diversification is the key but I would lean heavily on accelerating mortgage and car payments, maintaining student loans and eliminating any credit card debt (except monthly revolver debt that is paid in full each month). That accelerated debt reduction split with your free cash flow could be done at a 70/30 split, this way you can feel that you are making progress in both arenas. Lastly before doing anything of the above work on maxing out the 401k first.
Honestly, I say do both. Tackle the car loan first while still investing and learning to control your spending. Check out the app Daily Budget and use it for 60 days. You’ll see real quick which variable expenses can be cut. Take the leftover and keep paying down that car. Then start on the school loan. But it’s important to have that emergency fund and like ESI says, at least get the match out of your 401K.
Good post! I think it’s a debt by debt decision. Not all debt is the same and should be treated differently. High interest rates should definitely be paid off. As well as debt that is preventing you from managing your monthly bills. Beyond that, sometimes it’s better to invest and get that return over time.
I hate to continue the “it depends” trend, but I’d like to know, in addition to the rate on the debt, what the overall balance sheet looks like (I’m as interested in assets as I am income). I suspect the assets are a little thin, which would further lower the priority of paying off any “good” (perhaps the student loan) and/or cheap debt.
But I also have to tap the brakes and ask: $33K in car loans? That’s a big number. What are the cars involved? Could there be an opportunity to “S” more by spending less?
I was thinking the same on car loans. I’ve only ever had one, on my first car and it was 6-8% or something and I paid it off within a year (not $33K!). Always save first and pay cash for cars – even if loan rates are low – you can typically negotiate much better deals. With anything – I think “Save then Buy” beats “Buy then Pay” – when you look at what you put into savings to generate the cash for a $25K car purchase while making interest/returns on the savings you might have put $20K into that car, but if you buy it on credit, it’ll cost more out the door + paying interest you can have 30K+ in that vehicle – and it’s the same vehicle. The trick is getting on the other side of the coin in this – by continuing to drive a beater right out of college vs. running out and buying a car you think you can now “afford”. Self discipline and not “Keeping up with the Jones’es” is the key to this wealth thing IMO.
I agree on the car loans too. $33K on a depreciating asset. That flies in the face of investing and paying off debt. Sell those cars and buy a reliable used car for cash. I am guessing the car payment is approximately $700 a month plus insurance on the new car. Get rid of the car debt. Fully fund 401K and use the remaining money to invest. I am OK with some debt around the student loans, but do not let it linger because if something happens to you, that debt continues without you.
My wife and I paid off our house and started maxing out both 401Ks for the investments and tax benefits. We still have debt on some rental properties that we are attacking, but we treat that as a business case.
Also, be sure to have Emergency Fund and Replacement Fund well funded.
Hi Folks,
A bit of sideline here: I cringe when I hear that someone’s car loan is *only* 1.99% (or even 0% !) Cash is king, and my experience has been that rates posted at car dealerships are very fictitious. If you are fortunate enough to have cash on hand, you will find that you are in a very good position to negotiate the price further if you outright pay cash for a car. And when you do the math, you realize that the ‘low interest rates’ that the dealer was offering you was factored into the inflated price of the car. If a dealer tells you that can’t give you any discounts for cash, try to walk away — they will not let you get to the door.
In my case, I *did* have the cash on hand to buy a car, but instead opted to invest in high-dividend paying solid stocks. I used a low-interest secured line of credit bank loan (not a dealership loan) to negotiate a “cash” price for the car, and have been watching my dividend stock outpace the interest on my loan. Sure – there’s risk, if interest rates climb quickly and/or if a stock bubble pops, but I’m comfortable with how things are playing out and have the option to cash out the stocks to pay off the loan if I start losing sleep.
I believe this ‘cash is king’ mentality in car purchases might be evolving as well – I’ve recently purchased 2 cars and did extensive research and negotiated with various dealerships. They consistently offered a cash purchase price and a lower, discounted financed price. I pushed hard in offering cash (and ultimately, could take out the loan and pay it off the next day – so did not matter to me) – they would not budge. They are offering lower purchase price on a car, knowing they will get additional kick-back on the interest payments. Just something to think about based on my recent experiences. Now I am in the same boat as the OP, where I have financed cars at 2%, and weighing pros/cons of paying those off!
I’d suggest to pay off the debt. I don’t like bills.
The math would say it depends on the interest rate of the debt. But there’s more to the question. What’s your risk tolerance? Is your debt causing you undue stress? Tough question to ask generally. I favored debt repayment over savings early on and view it as a mistake now. But it still might have been the right psychological decision.
The math argument around the interest rate is logical, but this person has almost $100K of debt. A job loss or other life event could be financially devastating unless they’ve got a large emergency fund. Something to consider especially if you have a family. I’d cut down the lifestyle down to nothing and wipe out a large portion of the debt before ramping up the investing.
I know that with low interest debt it makes more sense to gamble on the possibility of making more money through investing as opposed to paying off the debt. That being said, I am also fully aware that finance is personal and that focusing on one or the other has it’s pros and cons. With a higher than average income, I would say to do both. Eliminating debt will give a guaranteed rate of return and is an awesome feeling on a personal level, but there is likely more money to be made by investing. I would try to accelerate debt repayment AND invest any surplus.
Having had debt in the past myself, I understand how discouraging it can be to ONLY focus on debt elimination. For me, investing money concurrently with debt repayment made me feel like I was doing everything right. But again, personal finance is emotional. As long as you’re doing one or the other, or even both, you will come out ahead in the long run.
Just think how much more you can save & invest when you have NO debt. You will be free of that 96K, and can invest & save what ever you want. If it were me advising, I would encourage you to pay more on the car (since that’s the lower amount) and then put that amount towards the student loan — and be free from debt. That opens up all kinds of possibilities. Yes you do need to be funding your 401K simultaneously as well, but getting rid of the debt will open your world to so much more.
Doing both is a nice thought. Practical for high earners (like docs…). I just wonder for the young college kid who is earning 30k what they should do first. For this person I would say get rid of the 33K auto debt. There is no reason that they should have auto debt that is half their school debt. Downgrade the car and pay off that debt. That will knock out a third of the debt immediately with minimal work. Then all that will be left is the student debt.
Depending on the interest rate (if it is <3.5%), I would probably invest. If the rate is higher than that then consider paying off school debt.
I recently read a blog on low interest loan vs paying cash for car. No question that a 0% loan makes financial sense … but the argument against a loan is by paying cash, you may buy a less expensive car vs “creep” if using a loan.
I think of accelerated mortgage repayment like investing in bonds. Lower, guaranteed return. Because I’m doing that, I then invest more stock heavy. So if your risk allocation is an 80/20 stocks/bonds, maybe do 90/10 or 95/5 instead since you also have your mortgage paydown as your conservation investment.
I agree with what everyone has stated but I would add that you also have to think about debt to net worth %. If you have a very high debt to net worth % then I would pay down some debt even if it was cheap money. If your % is low then I would invest 100% of the time.
Great discussion and great advise all over. I’m in agreement with most comments and will not rehash the same advise.
We are debt free except for our home, and investment properties. However, I looked at debt as part of an investment portfolio, so instead of buying bonds or having a money market account, send that “Cash” part of the investment portfolio to your debt. You are guaranteed whatever the loan rate is … so the higher the rate the better it is to pay it off.
I’m with pretty much everyone else here. I’d focus on growing that gap (lower the spending/expenses) and having more money to do both.
Our debt includes a mortgage on our primary residence (3.5%) and an investment property (4.5%). We are focused on the investing side for now (401k, IRAs, HSA, and real estate). Once we buy a couple more properties, we will work on paying down the mortgage on our primary residence (or sell it and pay cash for a smaller house) while still investing in index funds.
I don’t have many expenses to cut. My monthly expenses total about $2900, but my income is around $4900. So I can use the extra $2000 to pay off debt, or invest. It’s really $1500 because I save $500 just for other things I want to do. I don’t want to be so consumed with getting out of debt I forget I have a life, but $1500 is still a good amount to put towards debt. If that’s what I choose
Wow 33k in auto debt! I hope that is for two cars!
For me the tolerance is 3 to 4%.. but the amount is very low. A 300K mortgage @ 4% is way scarier than 33K @ 4%. I would focus on retirement and throw anything extra at debt. Unless that 33k is for just one car, in which case I agree with others about getting rid of the car. I just assumed that was two cars!
Follow a simple rule. Save 20%. Half to retirement and half to paying down debt. Once debt is paid down, It all goes to retirement. Include your home in the calculation.
The problem I am sitting with in South Africa is that our bond payments have between 7-8% interest and vehicle repayments can go up to 14%. The problem is, if I wait before I start investing and let that money build up, I have less time to capitalize on gains. If I wait too long to pay off my debts, I keep on throwing money away. It’s quite a conundrum.
Personally, I focus on servicing my debt month after month, and push more money towards investments.
Agreed. Can’t leave money on the table. So the company match, should always be taken. And if you can tackle both, that’d be ideal. I’m very big on hustling, at least in the early phase of your career. Because it dictates the trajectory. 80 hour workweeks should be common place. Not everyone would agree, but this is the way I see it. At least for the 1st decade of your career, to really have a firm footing (not just from a career standpoint, but more importantly from a financial standpoint).
Me I am a bit of a conservative. When I bought my 2nd house (a large foreclosure) I put 50% down in 2005 and paid an extra $100/$200 month. In 2012 I no longer wanted this upkeep of 4000sf 6 bedroom almost 1/2 acre place. Fair amount of expenses. So I sold it and now keep zero debt. I moved into a high-rise where if I need even a light-bulb I put in a maintenance request. I pay about the same, maybe a bit less, but with 3000sf less. But I have a pool, gym, and my electricity last month was $28 (typically $35-$70) so I save a lot here in Texas just with that. Insurance is less, no maintenance cost which you can imagine. I used the funds to invest in 2012 and the rest is history. I keep about 28% in cash, sometimes a bit more, but no more than 35% (usually just over $1M) as I keep waiting for the pullback. Despite being conservative from that aspect my wealth is up $600k in the last 16 months. I dislike debt, but also know that it is a valuable tool if used wisely. My former home probably would be worth $100k or $150k more if were still there, but I think I made the right decision for me as a person as well as financially. My brother in law even brought this up. I said, well how much money do you think I have made in the last 5 years investing those funds and not having all those extra expenses? He just nodded his head.
My thoughts on this debt or no debt would be if it is under 3%, maximize investments. This may turn shortly (who knows when), in which case you should maximize paying off the debt. Debt is good as I said if used wisely, but can handcuff you from opportunities and as we are all trying to reach our goal of retirement (which to me is I get to choose what I do, work or not). Of course that is very high level, for someone younger who is taking on more risk to get a higher return, maybe the if debt is 4% to 4.5% or lower then you maximize investments before paying off debt. The point is to maximize your return, and paying off 4% is not maximizing your return if you can use the same funds and make 7.5% or 12%. If making 5% and in a taxable account may be best to pay off debt. So many variables, but it simply comes down to maximizing your return. Work on that piece and you should be good to go for the long haul. Just know that it may change from time to time.
Seeing that the stack market is doing well I would do a little of both but work to pay the debt off sooner that what is scheduled. You will get decent returns in the market for a while but eventually in the future there will be a down turn. When the market is poor, your returns are poor, that is when you aggressively pay down the debt but also don’t neglect your emergency fund because you may need it in a economic down turn. It is a balancng act toward multiple goals of not needing a job to pay your bill which controls you but you control you debt and feel safe.
Why not buy shares when the market is discounted and pay down debt when the market is over valued? JD
Debt vs investing formula is as follows:
If the returns are fairly stable such as in real estate then the more debt the better if interest rate is below rate of return. Never pay down that debt. If the returns are quite volatile like in the stock market its a bit tougher. Then keep the lowest interest debt but not stuff that is anywhere close to the average return in the market.
However the bigger issue here is what appears to be an over sight on choices that accumulated the debt. Can’t speak to the student loans. May have been a good choice but nothing can be done to change it now. However a 33K auto debt with a $4900 monthly income? That is out of balance. Save the $2000 for 8 months and then sell that car and buy a different one for half as much. Paying down debt or investing the difference is not the decision that will make or break your wealth. Not maximizing the gap between income and spending is what kills your wealth.
I invest heavily in real estate. My Net Worth is strongly into 7 figures. 8 months ago I left corportate to focus on my real estate business full time. 2 months ago my 15 year old car with 220K miles on it bit the dust. I replaced it with an awesome 2013 SUV with 60K miles for under 20K. Could have easily bought a new one for 40K. Could easily afford a new one for 40K. Some day I will buy a new one for 40K (probably 60K by then). But I am still in the save and expand phase. So the extra 20K goes a lot farther in my real estate business than it does depreciating in my garage.
Wanna build wealth? Get rid of that car!!! It’s a money eater.
I should’ve said that $4900 is after tax. If I do my before tax income, It’s about $6370 per month
I already figured it was after tax.
Why such an attachment to the expensive car? It is the most common comment you are getting.
Just bad decisions. The first car I bought was brand new, so I was immediately upside down. I needed a bigger car, so I traded that car in for another new one. I figured I was now paying too much for a car I didn’t want, so I traded in that car for the one I have now. I figured this would be the last car I get until the wheels fall off on this one. It has everything I want and the note is only $490. It’s not good, but not terrible either to where it’s killing me
Fair enough. I made a car mistake earlier in life as well. Expensive education, but it sticks.
Interesting debate, but I am firmly in the pay off the debt camp. Discussions on return versus the interest rate of the debt tend to conveniently forget the risk element. Life happens, so why not be prepared by paying off your debt and having an emergency fund. If you later do not enjoy being debt free, it is really easy to go borrow some money again.
A view from the UK. I only use debt to finance a couple of rental properties which makes sense over here as (until recently) you could offset the interest payments against your rental income for tax purposes. The government is now phasing out this benefit over the next few years for most ‘buy-to-let’ investment properties. However, the good news is that furnished holiday rentals can still benefit from this tax relief. This is really good news for me as my main property is a 6-bed holiday home that nets around 拢30,000 p/a in income 馃檪
A view from South Africa: I was in a similar situation a year and a half ago and I chose the “pay off all non-mortgage related debt first” specifically car and student loans. Although the market can potentially give better return, the associated risk wasn’t worth it for me. In addition, the psychology of being debt free was good for my emotional and spiritual life. Fast forward 18 months later, the only debt I’m left with is my mortgage. With a better cash flow position, I have started splitting the “additional cash” between investing and paying off my mortgage. Being debt free will give you OPTIONS most of which you can not put a price tag to
Even if you make enough to do both, as ESIMoney suggests, you still have to make decisions in terms of prioritizing what you pay down first and how much. What first, what second, etc.
This is both a personal and a mathematical question. Personally, how comfortable are you carrying debt vs. flowing funds towards investments? Mathematically, these personal decisions depend on the interest rates involved. For me, any debt (on an after tax basis) at four percent or below should take a back seat to investing. Anything above, just go ahead and crush it. That figure will vary form person to person.
More specifically, I suggest the ordering should be:
–get the company 401k match (often a 100 percent immediate return on your money);
–pay off any debt above 4 percent;
–max out Roth (assuming you are young and not in stratospheric tax bracket);
–max out 401k;
–max out back-door Roth IRA options;
–pay off any debt at 4 percent or under;
–max out any other investment opportunities (this one could also come second to last).
But as I noted above, this is very much a personal decision. Many people would want to just crush the debt no matter the interest rate. For me, knowing I get a guaranteed 4 percent (or higher) paying down debt would trump the possibility of making higher returns. Full disclosure: I’ve never carried any debt ever so I focused on investments from the get go. Never owned real estate either!
It seems to me that for many people, owning their finances is a drag. Investing in opportunities that will yield more than paying off debt take time and effort and many will not fully follow through.
So, my recommendation to anyone, regardless of situation, is to pay off your debts first. It will take less effort, will give you some guaranteed return in terms of cost avoidance, and it will give you a sense of accomplishment. After paying off the debt, the cashflow situation will be such that your approach to decision making will be different. How many out there fear making a tough decision at work (for fear of losing the job) because they have to make that next monthly payment?
Having no idea what the market will do in the next year or two take this with a grain of salt. We are headed into the 9th year of a bull market. I would much rather pay of debt today then jump into the market for the first time. I don’t fool myself that I can time the market but it feels pretty over heated right now.
In general I live debt free, just a mortgage and its a 2.6% and tax deductible, I don’t rush to pay it off.
I have found Sam’s recommendations useful.
http://www.financialsamurai.com/pay-down-debt-or-invest-implement-fs-dair/
For those South Africans who have commented, multiply the debt interest rate by 2.94 (or 3 if you are not an engineer 馃檪 ) to get a South African equivalent.
We have never had consumer based debt. The only debt that we have is a small student loan and a low balance on our mortgage. Our Debt to income ratio was around 5% the last I checked. We balanced paying down those two debts and trying to max out all of our investment accounts.
Some of my thoughts here, because others haven’t touched on them:
-Debt tends to be a long term liability and difficult to dispense of. Whereas investments in a stock fund would tend to be liquid and is current.
-The cost of capital (debt) will change with the interest rate and is effected by inflation. The stock market has a variable and unpredictable rate of return.
-Debt is an obligation which raises the cost of living expenses. Investment return tends to boost income. They act on your financial situation in very different ways.
-Modeling my own finances, paying down debt appears to stabilize my net worth. Investing in assets like property or stocks tends increase the volatility of my NW.
-We can always go into more debt in the future if it is paid down now. There is optionality in debt reduction.
-Debt doesn’t compound. Investments do, and that’s good.
My conclusion:
It’s best to have a ratio approach i.e.: appportion money saved for 50% debt reduction and 50% investment. Move around this band as one asses the situation.
Really love your work and the information Esimoney! I am in a similar situation to yours….made good money, saved loads, and recently severed hoping to do my own thing now.
Fast stats – I have over $1.4M in retirement funds, $1.8M in investments/cash, and $720k in home equity (and I owe $700k on a 3% mortgage). I live in an expensive state and want to be able to stay here in the short term (5-7 years for my kids).
My question is should I refi my mortage to an interest only at about the same rate? My thinking is that I can do better than the 3% cost of money if I invest that principle payment (around 1,200/m).
Appreciate any insight!
If it helps anyone, the math answer might be absolutely correct in achieving more return on investment than losing to interest on debt. However, the psychological power of having no debt whatsoever became overwhelmingly correct for us. Only you can answer what works for you.