Should You Invest While You’re In Debt?

by Ron Haynes


The decision to begin investing while you still have debt hanging over your head isn’t a black or white proposition. A lot depends on what type of investments you’d like to make and what type of debt remains on your personal books. Is it high interest debt, low interest debt, or tax deductible debt?

If you are in debt but you want to begin investing anyway, it’s best to seek out investments with a greater return than you incur from your debt. For example, if you have a car loan at 7%, you’ll generally want to find an investment vehicle that returns greater than 7%. Otherwise, investing while you’re in debt can feel like taking taking two steps forward and three steps backward.

What type of debt plagues you?

  • High interest debt
  • Low interest debt
  • Tax-deductible debt

High interest debt

The term “high interest” is relative, but I would consider anything higher than 12 percent to be “high.” The primary contributor to your high interest debt is your credit card. If you’re carrying ANY balance on a high interest credit card, paying it down should be a much higher priority than investing. Consider moving any high interest debt to a zero percent balance transfer card found on my Credit Cards page because finding an investment that will return a greater rate than your credit card is next to impossible.

Low interest debt

This type of debt may stem from a car loan, a line of credit, or a personal loan from your bank or credit union. This type of debt is generally “prime plus” meaning that the interest rate adds a set amount to the prevailing prime rate. While it’s easier to overcome debt at 12% than at 24%, it is still difficult in today’s market. Difficult, but not impossible.

Tax deductible debt

If there IS a “good” debt, I would classify tax deductible debt that way. Tax deductible debt could include mortgages, student loans, business loans, or any other loan where the sting of the interest is lessened by the ointment of tax deductions. Since tax deductible debt is usually low interest as well, it’s much easier to build your investment portfolio while paying it down.

If you have low interest debt and/or tax deductible debt, continue reading but if you’re saddled with high interest debt – STOP. Pay it off first. After you’ve built an emergency fund, focus your energies and resources on paying off your high interest debt. Investing can come later.

Why invest while you’re in debt?

When you’re working to pay off any type of debt, you’re robbed of the capital – not just in money lost, but of compounding time lost. For any investment to pay off, the key is TIME. You need to give your money as much time as possible to compound and grow. That’s why it could be important to start investing now. Your investment amounts may be small, but with the added component of time, they will have the chance to grow to larger amounts than the greater amounts you invest later in life. Small amounts invested sooner generally outperform larger amounts invested later.

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An investment plan while in debt

Example:

  • Funds available to invest AND put towards debt reduction: $1,000
  • Debt payments (low interest and tax deductible debt only): $800
  • Available for investment: $200

A typical portfolio has a range of investments, some low risk, some moderate risk, and a few high risk. While you’re in debt, you could consider the amounts you’re putting toward debt reduction your low or moderate risk investments. The majority of your “returns” will be in debt reduction and lower interest paid out rather than in the 3% to 6% you could get from bonds or other low risk investments. The balance of your available funds can then be invested in higher risk, higher return equities and investments. If you are a very low risk investor, then the majority of your investing activities will be focused on debt reduction with just a minimal amount going toward higher risk securities.

Even those of us with a higher risk tolerance may have to spend more than we like on debt reduction and force us to use a more conservative approach. In my example above, a high risk tolerance investor would put the $200 into stocks while a low risk tolerance investor might put only $100 into stocks and $100 into bonds.

You CAN invest while in debt

Paying down debt can be monotonous, boring, and even demoralizing. We tend to think: I need to pay off this debt so that I can live a normal financial life – saving, investing, and enjoying the benefits of having money. Debt puts our lives on hold. But by having even a small portfolio that we fund on a regular basis, we can escape the dreariness of debt elimination.

As long as you’re not paying on high interest debt, I believe you should contribute to an investment portfolio. If you want to grow your money, it’s critical to begin investing as soon as possible.

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About the author

Ron Haynes has written 1001 articles on The Wisdom Journal.


The founder and editor of The Wisdom Journal in 2007, Ron has worked in banking, distribution, retail, and upper management for companies ranging in size from small startups to multi-billion dollar corporations. He graduated Suma Cum Laude from a top MBA program and currently is a Human Resources and Management consultant, helping companies know how employees will behave in varying situations and what motivates them to action, assisting firms in identifying top talent, and coaching managers and employees on how to better communicate and make the workplace MUCH more enjoyable. If you'd like help in these areas, contact Ron using the contact form at the top of this page or at 870-761-7881.


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{ 6 comments }

Sun

Even with low interest rates, investments are not guaranteed while you’re tangible savings from payin debt is. I wouldn’t invest with debt. A sure thing vs risk is a no brainer

Ron

Nothing is guaranteed. If risk aversion is your #1 goal then sure, wait until your mortgage is paid off, your student loans are paid off, and your business loan is paid off. You’ll get your investment plan cranked up at age 60 … or later.

I personally think it’s short-sighted to avoid investing in your IRA, 401(k), or any other retirement plan while you have any debt whatsoever. But since personal finance IS personal, it’s best to know and understand your options. Getting even a small investment plan started was, for me, a way to be in more control of my own finances. Plus I have a 15 year head start on those who think they have to be 100% debt free before they begin investing.

Sun

I don’t have a mortgage and I can restart again at age forty after the medical calamity. You’re right it is personal so investing may make sense for some with a 15 year mortgage. I would still pay off my student loans if I had any. My wife and I both worked our way through school and don’t have loans to repay.

Don

When I’m personally asked this question, I like to respond saying that paying off your debt is one sure way to get a return on your investment.

Using your high interest example. Getting a 12+% return in the market is not easy to do, but paying down your debt that charges you 12% guarantees you that return.

Ron

True. Where it gets murky is when you have debt in the 0 to 6 percent range.

JoeTaxpayer

Ron, the one point I’d highlight in the discussion is the matched 401(k).
In my opinion, this deposit should be prioritized above any debt repayment, with the very next priority going to doing anything and everything to pay off or lower the rate of the high interest debt you cite.
Objection 1 – “the stock market is a gamble” – Perhaps, but a 401(k) is required to have a low risk fund, typically a money market or short term bong fund. You discussed the mix approach above.
Objection 2 – “it’s more motivating to see the debt paid off faster” – Something got you into this mess, so clearly, something’s not working. Instead of latching on to something you thing will feel good (Why didn’t that debt make you feel bad in the first place?) why not try the method that going to improve your bottom line the most? $100 paid to the 12% card will improve your bottom line $100. But $100 sent to the 401(k) immediately makes you $220 richer (assuming a 10% marginal bracket to stay conservative).

Something has to change, of course. If that debt is left floating indefinitely, after so many years even the 401(k) match benefit is negated. This takes years to happen, 6-8 depending on your calculations. So long as the budget can handle the high debt payoff in a reasonable time, even 3-4 years, grabbing that match is key.

My wife and I are in our 50′s, and our 401(k) balances come with bragging rights. The interesting thing is the statement shows over 25% of our balances came from the match. The match alone is sufficient to pay off the mortgage after taxes are paid on it. No regrets on how we handled this.

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