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How to Invest When You Have Debt

How to Invest When You Have Debt


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Are you looking on how to invest, if you have debt? Debt does not preclude you from investing; in fact many people go into debt in order to invest. There is a way to leverage debt to invest in assets that actually makes more financial sense. If you want to invest even though you are in debt there are certain considerations to take into account when making these decisions. Look at the factors discussed below to help you decide how to invest and which investments make financial sense.

Pay Debt vs Investing

The first major consideration in deciding on investing is the comparison of paying down your current debts or whether investing would be better for your financial health. Since there are different types of debt, a wise investor considers each one before making investment decisions. The first category is high interest debt which includes credit cards and loans with interest rates higher than 10%. If you have any of these debts with balances over $1000, it is generally better to pay down these debts before investing. The reason is that investments rarely make over 10%, so you would be in a better position by paying down these high interest debts first. Consolidating these high interest debts into low-interest debt is a great way to open up cash flow for investing.

If you have low-interest debt such as a car loan, a line of credit or a very good rate personal loan with interest rates from 3 to 9%, you may want to invest any extra money instead of paying these down. However, you should only invest if the investment rate of return is greater than the interest you are paying. A 2.5% investment certificate at a bank compared to paying down a car loan with an 8% interest rate would be unwise. Yet, if you could earn 9% in mutual funds or stocks compared with a 1.5% car loan, the investment is a better option.

Lastly, tax-deductible debt is one category where investing is almost always the better option. If you can claim tax deductions for a home mortgage or interest, business loans, investment loans for retirement or other similar vehicles, the investment route is almost always a better option.

Considering the Compound Value

Many people consider paying off their home mortgage to free up cash flow as a good idea to reduce debt. Yet, if you take 10 years to pay off your mortgage instead of investing the same amount of money into investments, it is almost always a bad idea. The ability for your investments to compound over time gives investments a very powerful exponential growth curve. Whereas paying down a low interest mortgage, because of the size of the loan which provides a long-term pay-off horizon, robs you of the ability to get compound growth in your investments.

A Decision of Risk

Lastly, deciding whether to invest or pay down debt is a very personal choice because of the inherent risk involved in investing in non-principal guaranteed investment instruments. When you pay down debt, there is no risk. However, if you take the same money and invest it in the stock market or mutual funds there is risk that you may actually lose money. Each person needs to decide on their risk tolerance level. It is this risk tolerance that may ultimately help you make a decision on whether to invest or pay down debt.

You can invest in spite of debt, but the true question is whether you personally should.

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