Should I invest my money or pay off my debts?

Category: Financial Planning&Investment

You may have some spare money some surplus income. Either way, you might be thinking about what is best to do with this.

Is it better to invest or repay your debts early? Paying off your debt could mean means reduced stress, and a greater ability to withstand personal emergencies, recessions, and depressions. Investing means building a pot which could provide you with a lump sum or income in the future.

An example of someone choosing to invest is Warren Buffet, a famous investor and one of the world’s richest men. He told CNBC he took out a mortgage on a home he bought in 1971. Despite likely having the cash on hand to purchase the home outright, he estimates he only put down roughly 20% of the cost. He presumably reasoned he could put his money to work elsewhere in his investment portfolio, rather than spend it all at once on a home.

Why it is good to dump your expensive debts

You may have unsecured loans, or cards which have high rates of interest. Interest rates of more than 10% are not uncommon. You should pay off these as soon as you can. These debts will cost more over time than the returns all but the riskiest investments could generate.

The idea here is to pay off whatever debts carry the highest interest rates. You then use any savings from doing so to pay off the next highest one and so on. This is called the avalanche method.

What about low-cost debt?

If the investment returns you are expecting to make may be more than the interest on your debt. In this case, it could make sense to invest. However, it might not be that simple.

Even if the interest rate for your debt is below 3%, there is no guarantee investing will get you higher returns. Investments returns are only expected, they are not guaranteed in any way. Someone investing in our “balanced” portfolio (portfolio 4) might have a 40% chance of getting less than 3% pa over 5 years.

Another thing to consider whether there are any penalties for early repayment.

One certain thing is that your debt, whether it charges you interest or not, is something you will need to pay off. The last thing you should do is to invest anything which could threaten your ability to pay off your debts if it does not go well.

It may be that your mortgage does not let you overpay or puts a limit on any overpayments. In this case, it might make sense to invest any surplus cash. You would need to bear in mind investing comes with risk and you may get back less than you put in.

If debt stresses you out or you have a lot outstanding, you might want to concentrate on paying it off. On the other hand, if you only have a small amount of debt costing you very little in interest, it might make more sense for you to leave it be and invest your money.

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