Do I payoff my debt¹ or invest?
This question emphasizes the personal in personal finance. There is the spreadsheet answer and then there is the personal-to-you answer.
Generally, the spreadsheet answer says if your debt interest rates is 3–4% then you can grow wealth in the long run by investing those excess proceeds. The market (measured by the S&P 500) has returned ~8% annualized since 1957 and ~6% since 2000. Remember this is annualized and the power of this strategy is the compound growth several years down the road!²
Life isn’t always about the spreadsheet.
This does not work for everyone’s personal situations. Let’s say you’re in a commission-driven job and not confident in your cash flow situation. If you have several months of no sales, then you might not be able to service that debt, you get stressed at work and home, and it creates a poor spiral of events. Or, you like sleeping at night knowing you own your home and no one can take it away from you. What is that feeling worth to you? Could be more than a portfolio growing…remember it’s what makes you personally feel the best.
There is the caveat to investing your excess-to-debt proceeds — it doesn’t always work out. The market won’t kindly return 8% annualized every year. From 2000–2009, the market’s annualized returned was -0.95% and is referred to as the “lost decade” of equity returns. The decade started with the dot-com bubble popping³ and then topped that off with the Great Financial Crisis of 2008. Clearly investing instead of paying off debt would not have worked out.
What you need to ask yourself:
Does my situation allow me to safely invest excess proceeds?
Do I want to take the risk in the market to potentially earn more?
How do I feel about not paying debt down rapidly?
Remember you are doing this for yourself! Other people will make different decisions than you and that’s fine. Sometimes it’s fine to make things personal and to go your own route:
Feel free to reach out with questions.
Disclaimer — none of this is financial advice. Please work with a trusted advisor to see what works for you.
Notes:
- In this case, I mean good debt — generally there is an underlying asset that will generally hold it’s value; so, homes, cars, and even student loans (underlying asset is your increased personal capital and higher future income). If you have credit card debt, then stop, drop, and pay that off.
- The power of investing kicks in when you start earning 8% on the 8% you earned the year before. Rinse and repeat for years at a time. That’s how you build wealth!
- The NASDAQ (aka tech stocks) fell 75% during this time. Ouch.
Sources: https://www.dimensional.com/us-en/insights/a-tale-of-two-decades
