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I live debt free, and invest, but I'm starting to feel like the fool after repeatedly footing the bill for everyone running up and away from their debt obligations...
I'm tempted to join the party, max out a bunch of credit cards and walk away from them... let you guys cover the cost ;p
Build a little emergency fund nest egg first, if you don't have it, then pay off your debts, then invest.
I've made some fantastic investments in my lifetime -- huge payoffs. They were so like clockwork that I thought I could always do it. I made investments rather than pay off debts. Big mistake when the investments went south.
You have no guarantee that you will make money with your investments. Once you are debt free, you will be in a better position to take chances with your money.
I faced this same dilemma in the past. I personally opted to pay off my debts before investing. I had a small credit card balance at 11%, my husband had some student loans at around 4%, and we had a car payment at around 8%. So we paid off the credit card first, then the car, then the student loan. We could have opted to hold off on the student loan, at that low interest rate, but by that time, the balance was so low, we just wrote a check and paid it off.
Personally, 5% or under $2000 was my breakpoint. If a loan was costing more than 5%, or if the balance was under $2000, it got paid off, highest interest first. If it is under 5% and over $2000, it would have been much lower priority. The exception being my house. My interest rate is 5.75% (and yes, I tried to refi, and the final numbers didn't make sense to do so, so I'm just leaving it there). So it is over 5%, but it didn't get priority over the student loans, because it would take so long to pay off. I still will be paying it off early, but maxing investments and having an adequate emergency fund takes priority over that.
So anyway, we paid off the last of our non-mortgage debts a few years ago, and started investing at that time. I got a much later start than some (about age 31). But everyone I talk to complains about how much of their portfolio they lost, and I haven't really lost any. I haven't gained any yet either, but I'm holding steady at about a 0% net gain/loss. And in the meantime, I paid off some debt, which saved on interest paid out. I think I came out far ahead of where I would have been paying interest and losing out on the value of my investments. Instead of a lose/lose, I came out with a win/wash.
Between my company and me, 11% of my salary goes into my 401k (maxed out on what they match).
But besides that, how do you know whether to pay off bills or invest the money?
I got a $6,400 balance on a car loan and owe $23,000 in student loans. both at 5-7% interest rates.
Should I be using my excess funds to pay off my loans or should I invest it?
The key is risk adjusted basis. 5-7% return on zero risk is a great investment in this environment. Right now junk bonds are in that range and they are certainly not even close on a risk adjusted basis. The only down side is they are not as liquid for emergences or opportunities so I would not put all your low risk surplus there but certainly should be part of it.
I never met an older wealthy person who thought it was a good idea to not pay off debt...
I have. And the strategy could make sense. If you can mortgage your home for 3.25% over 30 years and make twice that amount in bonds it makes sense.
That being said, I paid off all my debt back in 2009 when interest rates on CDs and MMFs plumeted. I would only compare paying off debt to an investment with a guaranteed return. As such, I would pay off the 5-7% debt first.
That being said, I paid off all my debt back in 2009 when interest rates on CDs and MMFs plumeted. I would only compare paying off debt to an investment with a guaranteed return. As such, I would pay off the 5-7% debt first.
This brings up a great point. I never understood how some people look at the interest rate on debt as an opportunity. Most debts are a sunk cost. Better to get them paid off, regardless of the low interest rate they may have. Just my opinion.
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