Tuesday, June 2, 2009

Credit card debt - The investor's worst nightmare

A few days ago I wrote a post on whether it is possible to invest and to have debt at the same time. I wrote that someone who is on a credit card debt should preferably pay back the debt first.
You can read the post here.

So I have decided to make a few calculations in order to convince you of the above. Suppose that two persons spend $3000 on a credit card. Bob decides to pay it back by monthly payments of $ 100. while Tom decides to pay it back by monthly payments of $75. Suppose the credit card company charged at an interest rate of 20 % per year.

Below is table on how the two of the paid the balance on the credit card.

So what are the information that we can deduce from the table.

For just 25 dollars more per month Bob reduces the time needed to pay the debt by two years and also reduces his interest payment by half compared to Tom.

What is more shocking is the fact the return of the credit card company is roughly 60 % for Tom and that falls to roughly 30 % for Bob.

In order for any investment to pay off with such interest rate payments you would need to have return on your portfolio that is greater than 20 %. I must say that unless you are a very good investor that is not possible for the average person. Unless you invest in a credit card company.

Having a credit card is a definite drag on the investor. If you are unlucky enough to have a credit card balance. try to pay it in the shortest possible time because as i said it in my earlier post the earlier you start investing the better, and you cannot invest with a credit card balance. It is as simple as that.

Please read my post on how to reduce debt and how to live within your means.

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