Tuesday, May 26, 2009

Invest or debt reduction?

One of the questions that i hear most often from people that have debt is whether they should invest. Is it not better to pay the debt first and the start investing?

I beg to differ. I think that,while debt reduction is important, you should also invest. Of course it would have been simpler if you had no debt, but hey do you know a lot of people who are debt free?. The key to resolve this issue is a good investment plan and a monthly budget. First you would have to analyze your debt structure so as to determine your investment strategy.

Types of Debt

1. High-interest debt

If the debts have high interest on it then the return on the investment must be more than the interest that you will pay. It is as simple as that. If you have high interest debts like credit card loans then it is better if you pay the loans fast unless you can have a high yielding portfolio. It is very hard for the average investor to build such a portfolio and risky.

2. Low-interest debt

These debts are only a few percentage above the rate of inflation or the repurchase rate. It is still difficult to invest with these types of debts but it is possible to build a portfolio that can have a return of about 10 % to cover the interest of the debts.

3. Tax deductible debts

This the best debt that you can have. You can usually claim a deduction for the interest paid on these loans. As a result you pay only the capital. With such types of debt you can invest in peace as you do not have to build a risky and high yielding portfolio.

So is it not better to pay all debts and then start investing later? That would be a mistake since a lot of debts are long-term debts. As a result you would never start investing. Further investing require discipline, sticking to a budget and to have a plan. I am certain that with a plan and a budget you will spend your money wisely and pay your debts faster or even avoid taking unnecessary debt.

Just like paying debt take time, investing also take time. In fact the earlier you start investing the better your return. I talked about this in this post about compounding. Compounding is simple.

By sticking to your investment plan you can invest small amounts monthly in stocks, bonds or even better in mutual funds and index funds. Investing is a great way to still discipline your spending and help you to live with better debts.

Please read this post about living within your means and how to reduce your debt.
You can also read this post on investing small amount of money.

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