Decide Whether to Invest or Pay off Debt

Whether it's a mortgage, personal loans, credit cards or all of the above, more and more people are drowning under the burden of their debt, and for those with enough income to keep their heads above water, the only logical choice may seem to be Repay Your Debts as quickly as possible. But wait —is that always the best financial game plan? While it certainly feels good to be debt free, in some extremely rare situations you may be better off simply maintaining your debts (i.e. paying the minimum payments on your loan) and investing your spare cash. Fortunately, there are some basic principles you can use to help you determine whether to invest or pay down debt.

Steps

Learning the Difference Between "Good" Debt and "Bad" Debt

1. Make a list that includes all of your liabilities. Gather your financial statements and make a list that includes all of your debts. The list should include the following:
   • The name of the company that you borrowed the money from.
   • The outstanding balance on the loan.
   • The monthly minimum payment.
   • The expected date when the loan will be fully paid off.
2. Create a list of everything that you bought with borrowed money. You probably used most of your debts to make purchases. Write down a list of everything that was paid for with a loan. If you can't remember everything you bought with your credit card, simply write down "Credit Card Purchases."
3. Combine the two lists. Create a master list that connects your debts to your purchases.
   • For example, if one of your debts is a Visa credit card, list the purchases you made with that credit card under its heading.
   • If you bought a house with a mortgage, list the house under the mortgage heading.
   • Anything you labeled as "Credit Card Purchases" from the step above is considered bad debt. Very rarely do people use a credit card to buy something that increases in value over time.
4. Separate your good debt from your bad debt. All of your debts will fall into one of two categories: good debt or bad debt. That's based on the following criteria:
   • If the purchase involves something that typically increases in value over time, then it's good debt. Examples of good debt include: your home, your college education, renovations, and fine art.
   • You accumulate bad debt when you use credit cards or other debt to establish or maintain a lifestyle you could not otherwise afford. Purchases that you no longer remember or use, such as entertainment, travel, or basic living expenses, are examples of bad debt and living beyond your means. Going into debt to purchase a new car is considered bad debt, since its value quickly depreciates and the interest rates may be very high.

Deciding Whether to Invest or Pay off Debt

1. Eliminate all of your bad debt before you invest. The reason that you should eliminate your bad debt before you start investing is simple: you have a double expense associated with bad debt.
   • The purchases made with bad debt include items that go down in value over time, so you're losing money as those items depreciate in value.
   • The purchases made with bad debt may have a high interest rate associated with them, so you're losing money by paying an interest expense. In the case of credit card debt, that expense can be quite high. However, just because something is interest-free it does not make it good debt. An interest-free loan on an expense or depreciating asset could be bad debt.
   • If you invest while you still have bad debt, you're taking a risk with money that could add to the losses you're already experiencing.
2. Consider investing once you only have good debt. If all the debt you have is good debt, you can invest because you'll typically see an appreciation in value of the things you purchased with the debt.
   • If you purchased a house with a mortgage, that house will usually increase in value over the long term (though this is not guaranteed). That increase in value will offset, to some degree, the interest that you're paying for the mortgage.
   • If you still have college loans, you invested in your professional career. Your salary should increase over time as you gain more experience and/or get promoted.
3. Consider the risks of investing. Even if you are free of your bad debt, remember that there is always a risk involved with making an investment, and you will need to weight the potential risks and rewards of investing. For instance, consider that good debt doesn't always give the returns you hope for — the real estate market has proven to not be as steady as was once thought, and more and more college graduates are finding that their degrees aren't guaranteeing a good job. You need to examine the cost of good debt versus the expected return on investment.
   • For example, it might be better to pay off a good debt with a high interest rate if your potential investment return is less than the interest on the debt.
4. Avoid incurring more bad debt once you've started investing. If you have to, liquidate some of your investments to purchase items that go down in value. However, avoid incurring more bad debt with losses that will offset the gains from your investments.
   • A car, for instance, may be a necessity where you live, or for your lifestyle. But going into debt to buy the newest, shiniest car is considered a bad debt — they are expensive, quickly depreciate, and the interest you pay is a waste of money. To avoid this, either pay cash for a reliable used car, or take out a loan with little or no interest and buy an inexpensive car you can pay off fairly quickly.
5. Look at the big picture. Debt can be scary and stressful, and, for the most part, it is best to get out of debt completely as soon as possible. However, paying off certain debts is not always the best decision in the long-term. Don't become so obsessed with paying off debt that you don't look at the big picture.
   • Sometimes it is worth it to keep your mortgage for the tax benefits. Paying in full for a second home by taking money out of your retirement plan, for instance, may seem ideal since you will have no debt. But, in fact, you must pay taxes to take money out of your retirement plan — it may actually be better to have a mortgage on the house and get a tax break.
   • Plan carefully for retirement. Most people are retiring with some debt. This is okay, as long as you have carefully planned your finances post-retirement to be able to pay those debts. Experts recommend you have a spending plan for your retirement which includes being able to pay off your debts. This may mean you have to work a few years longer than you'd like, but you'll be saving yourself stress and financial hardship in the long run.

Tips

• If you are married, be sure you and your spouse agree about the course of action you propose. When in doubt, pay debt first, and work out a compromise. Perhaps the more cautious partner will favor beginning to invest when your debt is lowered beyond a certain point.
• Being debt free allows you to invest more aggressively and be more generous with charitable giving.
• Find others who are enthusiastic about reducing the debts in their life, and meet with them on a regular basis. Develop accountability partners who can help you make decisions about major purchases and walk with you through life as you climb out of debt.
• Consult a professional. Many accountants and professional advisors are available to help you come up with a plan that allows you to save for the future while also paying down current debts.

Warnings

• Investments carry risk, and choosing to use your money to invest rather than pay off debts more quickly is inherently risky. The amount of risk depends on the investment, of course, so you need to consider each investment opportunity carefully. Remember also, however, that neglecting your retirement savings (even if doing so to pay off debts early) is also risky.
• Most of those internet calculators assume your investments will go well, and don't take into account the risk involved. If the Avoid Investment Trading System Scams doesn't go well, you may find yourself miserably paying off the debts while having little or nothing to show for your "savings".
• This article is intended as a general guide only and is not intended to replace professional financial or legal advice.
• Never borrow money with the sole purpose of investing it. Most investments (if not all) do not have a "guaranteed" return rate. All loans will require you to pay interest on them. It's too easy to be caught between a low-paying investment and a higher interest loans.

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Sources and Citations

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