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Investing Versus Paying Off Debt


Sunday, November 8th, 2009

     One of the biggest decisions people face when beginning to invest is whether or not to pay off debt first. Looming credit card debts, student loans, and mortgages have large appetites that demand attention and eat away at savings accounts and investment possibilities. A sense of obligation or even guilt can dissuade people from opening an investment account and starting their retirement portfolios.

    In order to determine whether it’s more useful to pay off debt or invest, one needs to look at the interest rates associated with either form. For example: if someone has a $2,500.00 loan at a 6% rate, but could invest their money somewhere else and get a 8% rate of return, it would make more sense to invest that money instead of pay off the loan.

     Credit cards are the number one reason why investing is delayed. This type of debt comes with high interest rates and a small minimum balance that needs to be paid every month keeping consumers living paycheck to paycheck and unable to save. In almost every case, paying off the credit card is a better decision than investing and accepting a lower rate of return than the hungry interest rate on the card.

     Mortgages can also be a hindrance for people when investing. In these cases, many people believe that their house counts as an investment itself and so take on a higher payment than necessary, thereby preventing any kind of further diversification. While a house may be a viable part of one’s investments, the recent housing market crash will tell you that other accounts will be needed to maintain a healthy, diverse portfolio.

     Other loans such as car notes or student debt can place a burden on investing. As interest rates on these products are typically lower then what one could expect to receive in mutual funds and other investments, they do not need to be dealt with beforehand. Another reason why investing is usually a better option is that loans can with an amortization schedule, unlike revolving debt such as credit cards. Loans come with a payment schedule so that one knows exactly how long it will be until the debt is paid off. 

   Starting an investment account is an important step in anyone’s financial future, but debt shouldn’t always take center stage. There is a certain psychological benefit in knowing that one has begun to invest the leads to peace of mind. Even in instances where credit card debt exists, it’s not wrong to set up a small monthly deposit account in a mutual fund to get things started. The power of compounding interest and dollar cost averaging makes this a very attractive option. Knowing when to feed investments or pay down debt is the key to successful financial plan.



Article by Daniel Croxton

The views expressed are the subjective opinion of the article's author and not of FinancialAdvisory.com



Tags: credit card debt , debt , debt , pay off debt , student loans