My friend messaged me the attached question on "investing when in debt" based on one of your insta posts. What is the best advice to give them?
Yeah, I would definitely pay off the non-mortgage debt first. Here’s some reasons:
- Guaranteed vs potential: Even if the interest rate on the debt is lower than the potential gain from investing, you are DEFINITELY on the hook for paying the interest, whereas gains from investing are only POTENTIAL gains and will include a lot of volatility. That opens you up to risk. i.e. imagine borrowing $1 million at 5% then dumping it all in the market. Hopefully that makes your stomach turn, because you could realize how you can go broke if the bad thing happens. That’s the risk that you can avoid by paying off the debt first.
- Borrowing mentality: Paying interest to borrow money to spend money you don’t have to buy something that goes down in value in value is a quadruple whopper good way to stay broke. If you choose to keep that debt around, it represents a borrowing mentality that is likely to continue in the future. If you get out of debt and decide never to borrow money again, you’ll avoid that debt trap and be much more wealthy.
- Simplicity: Why do you need the bank in your life? Get rid of those debt payments, then throw those debt payments into investing. Simplicity favors the individual investor (complexity favors the bank or the financial institution) and is one of PFC’s principles.
- Leveraging depreciating asset: I know a lot of millionaires, but I don’t know any who got there by borrowing money to buy things that plummet in value and investing the difference. That’s just not how to build wealth. That’s how to stay broke.
So yeah. Keep it simple. Pay off the debt. Never borrow money again. Then pay invest those payments.
Here’s a look at the PFC Phases of Investing that includes the “why” for each step. That might help him organize a plan as well.