Let’s tackle the classic question: ‘REPAY DEBT OR INVEST?’
In case you haven’t heard this question before, here’s the background: One school of thought believes repaying your debt should be your top priority, no matter what. This camp believes debt psychologically cage you and restrict you in life. Another school of thought advocates one shouldn’t miss out on the returns you would gain if the interest rate earned from investing is higher than the interest rate paid on debt.
It is glaring to see that these two camps are arguing between risks and rewards. Both camps, however, agree that if you have a credit card debt with an interest rate of 20 percent or more, you should pay it off immediately. The anti-debt camp believes that by doing this, you will stop losing money on interest. The pro-invest camp, on the other hand, believes you won’t find a reasonable investment that pays more than 20 percent.
So, repay debt or invest? Which of these two camps is right? Let me pause here and remind you that personal finance decision is personal to every individual. I will, therefore, leave you to choose which camp to go for. You should base your decision on the option that makes financial sense to you. Here are four things to consider before making your choice. My focus here is on expensive debts…
1. Personal finance is like a watering can:
when you invest, you’re essentially filling up your watering can to grow your wealth. But if you have expensive debts, it’s like having a hole in the bottom of the can so the water leaks out faster than you can fill it up. Paying off your debt before you invest seems like a smart option here - it will eliminate drains on your finances.
2. Retirement Investment and retirement match:
If the company you work for offers an employer match for retirement investment plan or workplace pension, then you should take advantage of this ASAP and contribute just enough to get the full match. Investing here is a smart option. A retirement match is a guaranteed 50 percent (or more) return on each penny you contribute. You can’t beat that rate; this is simply free money you mustn’t pass up!
3. Interest Rate:
The higher the interest rate on your debt, the harder it is to justify holding that loan. Expensive debts cost more than investing in the long term. Paying off your debt is a smart option here. The average return of the stock market investment since inception (1817) has been 8%. Therefore, despite the peaks, the valleys, over the long term, 8% has stayed consistent. So do the maths. If you have a debt with an interest rate in the double figures, compound interest will definitely work against you!
4. Inflation:
Inflation occurs when there is a general increase in the price of goods and services and a fall in purchasing power. If you hold debt, inflation is your best friend. Inflation allows borrowers to pay lenders back with money that is worth less than it was when it was originally borrowed, which benefits borrowers. In this instance, hanging on to your debt could be a smart move. However, if deflation dare strike, you will be worse off!
So which camp is better? From my perspective, both camps carry an element of risk. The power is in your hand to choose the risk you prefer and can tolerate. I like to use the “sleep at night” analogy as a measure of risk tolerance, meaning an ideal risk level is a level that allows you to sleep at night and not worry about either your debt repayment or your investing moves.
About Nike
Oyenike Adetoye (aka Nike) is an impactful speaker, author and personal finance expert. A Chartered Management Accountant by profession. Nike is the founder and CEO of LifTED Finance, a private financial firm that educates, coaches and supports people on their journey through financial fitness and wealth management.