Smart.Happy.Money 2: Should I pay off debt or invest?
One of the most common questions people ask me is whether should they pay off
debt or invest? Well, the answer is the same as many answers to financial questions, and that is……. it depends. Actually, the answer is probably a little bit of both.
Let’s look at an example. Michelle has an extra $500per month to her spending needs. She has a loan to pay down but would also like to build an investment portfolio.
What to do with the $500?
Let’s assume that Michelle is happy to invest in the stock market and that her interest rate in her loan is 5.5%. It’s a simple question. Will an investment in the market make more than 5.5%
If she pays the $500 on the loan, then she is effectively earning the interest she would otherwise have paid, 5.5% on that $500. If she invests, then her returns will be volatile but over time will most likely be higher than 5.5%. Does this mean that she should invest? No, she also needs to consider how much risk she wants to take. The loan saving is definite. The market return could be higher or lower.
Usually, with my clients we come to some sort of compromise. How about we pay $200 off the loan and lock in that gain, then invest $300 per month into a diversified portfolio? Is that the best of both worlds?
Many areas of finance do not have absolute answers. What we search for is the best way to proceed to reach a client's goals, and that is what you should consider too. What are your goals? Some people just hate debt and need to be out of it, in this case, put it all on the loan. Some people are fine with debt as long as it’s manageable, they may prefer an aggresive investment portfolio.
Either way, get some advice and run the numbers. You will make the right choice!
Ben Graham-Nellor is an advisor, coach, blogger and speaker who has worked in the financial services industry for over 15 years.
BGN Financial Management Pty Ltd is a Corporate Authorised Representative 468796 of Professional Investment Services Pty Ltd AFSL 234951 ABN 11 074 608 558 www.centrepointalliance.com.au
The information in this communication has been prepared on a general advice basis only. The advice has been prepared without taking account of your specific objectives, financial situation or needs. Accordingly, you should, before acting on the advice, consider the appropriateness of the advice having regard to your objectives, financial situation and needs. In cases where the advice relates to the acquisition, or possible acquisition, of a particular financial product, you should obtain a Product Disclosure Statement (or other relevant information statement) and consider such document before you make any decision about whether or not to acquire the product. For these reasons, it is imperative that you seek advice from your financial adviser before making any investment decisions.