What is a better use of my money, pay off debt or invest?
This is a common question that most of us have and wrestle with daily.
Heart Says Go, Head Says No
Putting our money into a sexy investment and making gazillion dollars seem like a the best way to go. But that’s your emotions speaking. Those same emotions are to blame for gambling. That drive, so many people have, to spend their last dollar on a lottery ticket, hoping they would hit it big. Yet, we all know, the probability of it is nearly zero. In fact, it is so low, that you have a better chance of being hit by lightning on a sunny day.
Let’s leave our emotions aside. Emotions are better left for dates and birthdays. For money, let’s take a look at this problem from the math and logic perspective.
Before we get started, I want to drive home a point that there is a stark difference between a productive debt that is helping you leverage your returns and the destructive debt that you have used to purchase consumer goods that go down in value consistently.
It is my professional and educated opinion that your productive debts should never be paid off, for as long as inflation is the major force in our economic lives. So, here I focus on the destructive debt only, also known as “bad debt” by the followers of Robert Kiyosaki.
How To Decide
Take the debt you have at the rate you are charged and compare it to the investment return you are hoping to gain to see which would make more sense.
Let’s assume you have $5,000 in credit card debt that you are paying 20% interest.
The question you should ask yourself is whether you can find an investment that will give you a consistent 20% return or more. Then, and only then, would it make more sense to invest as oppose to pay off your debt. It would make sense to invest, in the example above, if the return on investment (ROI) is significantly higher than 20%. It would have to satisfy the positive ROI on both short- and long-term basis and in a, more or less, guaranteed form.
Why do I say that?
If I pay off my $5,000 debt at 20% interest, I have guaranteed myself a return of 20% on my investment. Because a dollar not spent is the same (actually better due to taxes) as a dollar earned.
If we consider that one person’s expenses are another person’s earnings, then your expense for managing your debt is an earning to the lending company. Yes?
By paying off my debt, I am keeping my expenses for myself and isn’t that a form of earning?
Of course, it is. And a safer one, too.
Paying off your debt is a safer form of investment. Because you keep the money that would be going out in a form of an expense for yourself. With investment there is no guarantee. So paying off your destructive debts is always the best choice, when you have to make one.
Interested to learn more how to eliminate your destructive debt? Curious to learn how to create constructive debt and invest better? Check out our on demand courses.