Council Post: Weighing Your Options To Invest Or Pay Down Debt

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Tyler Lang, CFA, is the founder and CEO of Journey Advisory Group. obey Tyler on LinkedIn,

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Federal Reserve Board Chairman Jerome Powell recently gave a solemn address in Jackson Hole, Wyoming, warning that interest rates could drop continue To extend “for a while”. He cited the need to control the record-high levels of inflation through sustained interest rate hikes and gave no reason for relief in the near future. He said that, although this hardening of debt would be a pain for many households and businesses, these rate hikes are necessary and less harmful to the economy than persistently high inflation. As a result, the Dow Jones Industrial Average reacted quickly by dropping 1,000 points.

So, as an honest money holder, what should you do to protect your hard-earned resources? Head for the hills and head to Timbuktu? Maybe not. Most countries are facing an economic crisis worse than the US. During this unfortunate time of high inflation and rapidly rising interest rates, you must find a way to save and grow your wealth rather than losing it to forces beyond your control. .

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If, after paying record-high prices for gas, groceries, and housing each month, you’re lucky enough to have money left over, what can you do to help protect your valuable assets? Two viable options exist: invest or pay off debt. Ideally, the best solution would be to do both at once. However, with limited funds, this is not always possible. So, which one is the better option? The answer, as all economists often say, is “it depends.”

The simple solution is to compare the interest rate you pay on your loan with the return you expect to earn on your investment. The option with the highest percentage should theoretically be the best place to put your money. The caveat here is that, while debt repayments have a known percentage value that can be realized, the investment’s earnings rate is not guaranteed. In other words, the “refund” you earn on every dollar of debt you pay off is a guaranteed amount through additional interest you avoid. Those who tend to be risk averse may find greater satisfaction in taking a known interest rate and paying off their debt.

However, there is much more to consider. Even in times of inflation and high interest rates, a properly balanced and diversified investment portfolio can provide good earning potential. Probabilities can be assigned to the expected return of an investment in order to more closely assess the expected rate of return. It provides greater assurance of the earning viability of the investment. Also, stocks with low correlation to each other or the economy provide a way to diversify a portfolio, which is always recommended in uncertain times.

Other factors to consider include the importance of your personal income situation or balance sheet, your time horizon, your risk profile and taxability. Your personal balance sheet and time frame are interrelated and are the key to the decisions you make regarding investments and loans. Whether you’re hoping to buy a new home in the next few years, planning for your kids’ college education in the interim, or preparing for retirement in the long term, it affects your decision-making process.

If you have a conservative risk profile, you may be more likely to pay off debt instead of speculating on investment opportunities. On the other hand, for those more comfortable with risk, investing now offers the potential for sufficient wealth for retirement through the compounding of interest that comes with investing. Six percent is considered a rough rule of thumb for debt reduction versus investment. In other words, paying off the loan may be more profitable if the rate is higher than 6%. If the interest on the loan is less than 6%, an investment is often recommended based on an analysis of past market performance.

Finally, an examination of taxability is important for both debt reduction and investment. Consider after-tax return on investment and which route to take when evaluating whether a loan is tax-friendly.

Whether you decide to pay off debt or invest, here are some hard-and-fast ideas to consider during uncertain times:

  • Keep a reserve of three to six months to cover medical emergencies, job insecurity etc.
  • Keep making minimum payments on all loans to avoid late fees and low credit scores.
  • Pay off the credit card balance with the highest interest rates first.
  • Take advantage of employer matching programs. This is free money.
  • Most importantly, don’t wait to invest your money for your work.

Your financial advisor can help you consider all of the above factors to create a unique action plan designed specifically for you. Opportunities exist to secure your future and it can be important to start now.

The information provided here is not investment, tax or financial advice. You should consult a licensed professional for advice related to your specific situation.

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