Paying off debt or investing in stock market, what to pick? Investing should always earn priority over debt clearance?
The honest answer is, it depends.
But my personal preference will always be debt repayment first. Why?
People often face this dilemma because investing can generate better returns.
When we compare interest saved by paying of debt vs returns of stock market, debt repayment looks like a dwarf decision.
But is this the right conclusion?
Wise men will always ask us to remain debt free. This should be our number one priority.
It is essential to invest money, but should it be done at the cost of carrying a debt burden?
At an instant of time, it may happen that one may want to pay off debt and also invest.
But funds are limited. What to do first?
If funds are abundant, then both can be managed.
But in fund crisis, picking between paying off debt or investing in stock market can be a tough decision.
It requires sound financial know-how to take this decision.
In this article we will see what can gain priority between paying off debt or investing in stock market.
#1. Living a debt free (threat free) life
For me, repayment of debt (of any kind) is my number one priority. When there is no debt, person feels more secure.
I know that people who have very secure jobs may not realise the threat of carrying debt burden.
In general, 40% of our salary goes in paying EMI’s of loans? Do you feel this pinch?
No, because majority of us have convinced ourselves that this is how the world is made….not done….
If there is no job, how come I will pay the EMI? Did you ever dreadfully asked yourself this question?
When I asked myself this question, I realised that I am NOT working for myself/my family.
Instead, I was working more for the bank who issued me the loan.
Majority of my monthly paycheck was getting spent, first thing in the month, to pay the EMI.
This is not what is desirable. “WE” should be in control of our money, not our “BANKS”.
When such a large portion of our money flows out to manage our debts, imagine a situation tomorrow, wherein you do not want to continue with your job.
Alternatively, you want to go a vacation for the next 6 months? Is it possible with the present structure of your money flow?
How your money is flowing in and out makes a lot of difference between what you want to do, and what you have to do in life.
When there is no burden, tasks that gain priority are the ones that are important and likeable.
Otherwise, majority of our efforts are directed towards managing emergencies. This is not cool, right?
So the right decision will be to pay off debt and live a more care free life.
#2. Let the debt’s interest rate do the talking
Interest rate is one important factor that can decide the pick between paying off debt or investing in stock market.
The logic is simple, the activity that will save/make more money shall earn preference.
If by paying off debt we are able to save more, it will become priority.
If by investing money one earns higher returns, then investing becomes priority.
The thumb rule says, high interest bearing debt shall be paid off early.
High interest debts like credit card dues, personal loan, car loan etc shall be paid early.
Low interest debts are home loans, corporate loans etc, these can be taken care later.
Credit card dues charge interest in tune of 30% per annum.
No investment can give return of 30% per annum in short term.
In such a situation paying off credit card dues shall gain priority.
Moreover it is also important to understand that by paying off debt, the benefits are immediately realised and it cannot be reversed.
But in case of investing, till one liquidates ones investment (like selling of holding shares), the gains doesn’t get realised.
#3. If you are Warren Buffett, invest. Else pay off your debt first?
Yes it is true, probably Warren Buffett (the greatest investor ever), will prefer to use his funds for investment.
Why? Because he is the greatest investor the world has ever seen.
So, what does it mean?
Warren Buffett is a better investor because he has that skill to generate higher returns.
The rate of returns that his investments yield far exceeds the interest that he pays on his debt.
Hence it is logical for him to use his money for investing. But we are not Buffett.
In today’s terms, a common man pays close to 9.5% per annum on a home loan.
But if the same person invests his money, is he sure to generate returns more than 9.5% per annum.
If at all the person is sure, what is the bases of his surety?
At times the such surety comes more from ignorance than knowledge.
It takes investment knowledge to generate better returns.
If the person has the skill and investment knowledge, probably investing is a better choice.
But if we are dependent on our mutual fund manager to do the talking, paying off debt first should be our choice.
#4. You can do both
It is easier said than done. Doing both, paying off debt and investing, may look ideal. But it is not for all.
People who wants to invest anyhow, can follow this method. Split.
Suppose ones savings is Rs.5,000/month. Using Rs.3,000 (60%) for making prepayments of loan, and balance Rs.2,000 (40%) for investing can be considered.
Some banks does not allow prepayment in such small denominations (like Rs.3,000).
In this case put this amount in recurring deposit (RD). When the deposit becomes big enough (like equivalent to one EMI), break the RD and prepay the loan.
Even for investing, Rs 2,000 is not a big amount. But with this small denomination, one can easily start a SIP in mutual fund.
Each month Rs.2,000 will be automatically invested in equity.
In long term, SIP in an equity fund gives good returns.
Idea is to distribute savings into two parts: Debt Prepayment & SIP Investing.
For common men like us, such approach can prove very effective in managing ones financial health.
Final words on paying off debt or investing in stock market…
For a person like me (defensive investor), having sufficient ‘emergency fund’ is also important.
Give importance to two things, creation of ample ’emergency fund’ and being ‘debt free’.
Apart from these two priorities, keeping ones investment on auto-pilot is also advisable. Means, invest in equity in form of SIP.
SIP in ‘index fund’ and ‘diversified equity funds’ should work well.
It is important for investors to understand their investment psychology.
If a defensive investor is investing only in equity, it is not good.
Depending on one’s psychology one can decide how much funds can be allocated to paying off debt or investing in stock market.
Paying off costlier debts shall be ones number one priority.
For debts like home loan and education loan one can think of delaying.
But credit card debt, car loan, personal loan shall be cleared on priority.
Larger goal MUST be to become debt free as soon as possible.
Paying off debt is always good.
Debt prepayment saves money immediately. Investing money generates returns only in future.