Should You Invest When You Are in Debt?

Jeremy Biberdorf |

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This is a complicated topic – and one that allows for some wiggle-room.

If you want a short answer to the question, “Should I invest if I have debt?”, here it is: Don’t invest if you have high-interest debt. “High-interest debt” includes all debt with an APR of 10% or above. That’s a general measurement, but it’s the one used by most. For most people, it’s not a good idea to start to invest until big debts – like those you have with your credit card, are paid off. For all the rest of you, the following considerations need to be made.

In addition to High-Interest Debt, there is Low-Interest and Tax-Deductible Debt. Low-Interest debts include personal loans from a bank, car loans, and other debts beneath that 10% APR watermark. Tax-Deductible debts include things like mortgages, student loans, investment loans, and the like. The interest payments you make for these loans are tax-deductible, and usually quite low in the first place.

A helpful metaphor for people deciding whether or not to invest with debt is the lifeboat. If you are in a lifeboat that is taking on water at a rate of 10% per hour, you will have to bail out water at a rate of greater than 10% per hour. That’s exactly the same way your debt works. It can be difficult to develop a portfolio that performs at 11% a year, to beat your low-interest debt payments. Imagine the difficulty in trying to outperform the 24% you’re losing every year from your credit card payment!

Assuming you’ve eliminated your most expensive debt, compound interest is a good reason to start investing, even if you have smaller debts. Even though initial investments may not amount to very much, they’ll have much longer to mature than investments you make when you’re older. One of the best approaches is to look at the risk you are willing to tolerate in your investments. Investing in bonds, for example, may only yield 4-5% every year. If that’s what you want to invest in, you’d do much better to use that money to pay off your low-interest or tax-deductible debts. However, if you’re willing to invest in higher-risk investments, like stocks and ETFs, then this is a good way to build a portfolio while paying off smaller debts.

You may have debt payments which restrict your ability to contribute to investments beyond a certain point. This is something you’ll just have to live with, but it could serve as a motivation to make extra money and pay off these debts early. Whether you should invest at all while paying off debts comes down to you and your thinking. If you feel discouraged because your debt is forcing you to live a certain kind of financial life, you may build your own morale by building a portfolio, even if this technically isn’t the most efficient way to use your money. But I would advise you to make it all about the numbers – at least as much as possible. Do what works for you, and I hope you create a lot of wealth along the way. 

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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