Pay Down Debt or Invest? The Answer is Complex

How is your money best spent: by paying down debt, or by investing? At our financial workshops, some attendees have said they have $10,000 in credit card debt with interest rates of 20% or higher, and several easily liquidated investment accounts earning just 4%. Wouldn’t the best choice be to cash out the investments and pay off the debt?

It might seem like a no-brainer. But when we asked a group of financial education services professionals that question, their answers revealed that it’s not quite that simple. These experts and financial educators fell into three camps: those who said pay off debt, those who said invest, and those who said, “It depends.”

“Pay the debt down!” exclaims Andrew Aran of Regency Wealth Management in New Jersey. “Unless investments are in tax-deferred accounts, there is no logical reason for anyone to carry credit card debt…investments should be made only after there is no debt.” Brian Davis, personal finance blogger at Spark Rental, agrees: “As a general rule of thumb, paying off credit card debt should be the first priority,” Davis says. “Once their only debts are real estate, vehicle, or business debts, they are in a much better position to start investing proactively.”

Paying down debt may itself be viewed as an investment, points out James Juliano of Kairos Capital Advisors, “Except when paying down debt you immediately lock in a guaranteed rate of return equal to your interest payment, often 20% or higher.” Crunch the numbers, recommends Ray Croff of TCFG. “If you have a balance of $10,000 @ 10% interest, with a payment of $222.44 for 60 months you will pay interest in the amount of $3,346.40, which is 33% of your original loan. If you invest $222.44 at an interest rate of 6% for 60 months, you will end up with $15,505. There is a difference of $18,851 between those two situations,” Croff explains. CFP Karen Lee adds a caveat, however: “If your money behavior is one that is used to carrying debt, and you run the risk of running your credit card bills back up once you’ve paid them off…I’d still pay down the higher debt, but would HIGHLY recommend cutting up the CCs and moving forward on a cash only basis.”

Only a couple of experts suggest investing first, and say the choice depends on the experience of the investor. “I prefer investing first and using interest or profit earned to help pay off credit card debt,” says Abhi Golhar of Real Estate Deal Talk. “However, for the inexperienced investor, the prospect of achieving returns of 10-15% in real estate, for example, may prove to be daunting. My suggestion here is, start with something easier like wholesaling real estate.” And CPA Joe Sterf claims it’s all about the interest rates. “If your loans have low interest rates, around 4-5%, you should seriously consider investing any excess money instead of prepaying your loan. The S&P 500 typically averages 8% a year, so even with a conservative return of 6-7%, you would still be better off investing in an index fund than paying down your loan.”

You don’t necessarily have to choose between one or the other, according to The Towles Group’s Frederick Towles. Although many advisors recommend paying off debt first, “This is terrible advice,” Towles says, “Because what happens while focusing on paying down debt and something happens to the person physically where they aren’t able to create income?” Further, cashing out an IRA may be subject to penalties and increase one’s taxable income, indicates Crystal Stranger of 1st Tax Inc. “It is not always so simple,” Stranger warns.

Jay Tea of Just Making Cents expresses his opinion metaphorically: “Think of money allocation like seeds. It doesn’t matter how big the seeds are now. What is the rate at which it grows? A redwood seed is only 3 millimeters big, but can grow several feet a year…If you don’t want that high interest rate (i.e. fast-growing) debt to grow into a mighty tree with deep roots, extinguish it now. However, if your debt is low interest rate and fixed (like today’s mortgage rates), you may want to allocate it into your faster-growing investments. What kind of financial garden do you want to have?”

Thanks to these financial educators and professionals, this article clarifies some of the expert thinking around this complex issue. Everyone should consider their debt payoff versus investment options carefully.

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