Personal Finance: Should You Save and Invest While Still Carrying Unpaid Debts?
In the tight-knit communities of Portland, Oregon, and beyond, this question pops up often. It's akin to suggesting you should start a rigorous workout routine while still indulging in a Krispy Kreme diet—the logic seems to contradict itself.
Understanding Debt: Good and Bad
To break it down, debt can be categorized into two types: good and bad. Good debt, generally associated with mortgages and student loans, typically comes with lower interest rates and is often tied to assets or investments that can appreciate in value, such as property or an advanced education.
On the other hand, bad debt encompasses high-interest loans such as credit cards or payday loans. These can be likened to financial holes that grow in size, and it's crucial to address these promptly.
Tackling Bad Debt First
If you find yourself laden with high-interest credit card debt or payday loans, the immediate steps should be to prioritize debt repayment. The rationale is straightforward: while the returns on investments might be promising, the guaranteed interest on bad debt is likely to eat into any potential gains.
Consider the interest rate on your debt versus the possible returns from your investments. For instance, if you're dealing with a 20% APR on a credit card or payday loan, you need an investment strategy that consistently beats this rate after taxes to make sense. As noted, historically, the SP 500 may offer average returns of 7-10% annually, but these returns are not guaranteed, and the interest payments on bad debt are a certainty.
Guaranteed Returns Through Debt Repayment
By prioritizing the repayment of high-interest bad debt, you're essentially giving yourself a guaranteed return on your efforts. Repaying bad debt is akin to giving yourself a pay raise, removing a significant financial burden. This can have two profound effects: immediate financial relief and the peace of mind that comes from having less pressure on your finances.
Once you've cleared the bad debt, the next step is to start investing. This will allow you to build wealth with peace of mind, knowing that the foundation of your financial health is stable.
Considerations for Good Debt
If you have low-interest good debt, such as a refinanced mortgage or a student loan, and you're disciplined with your finances, you might explore an investment strategy. However, this should be approached with caution. If you're confident that you can generate returns that exceed the interest rates, taking into account the risk and tax implications, it can be a viable option.
Sensible Investment Strategy Steps
To summarize, focus on repaying high-interest bad debt first. Once you're debt-free, you can start investing. This approach ensures that you're not paying interest on debt while potentially earning returns from your investments, creating a more secure financial future.
If you need personalized advice, seeking guidance from a financial counselor can provide clarity and a tailored strategy that matches your unique financial landscape. Keeping your finances smart and disciplined will set you up for financial success.
Stay smart, stay disciplined, and when you're ready, the investment world awaits. Cheers from Portland!