Which should I do first – invest for the future or pay down debts?
Would you borrow money on your house or on a credit card to buy into an investment or put in your savings account? Ok, some people would, but it’s not very smart.
Some advisors look at making this decision based on rates of return. For instance, if you can make a larger return on your investment than you will pay in interest on the money borrowed, then the argument is that it would make sense to invest with debt. However, there is a hole in this argument. What guarantee do you have that your investment return will truly actually be larger than your interest paid? It would sure be nice to have an absolutely guaranteed high rate of return with no potential for not reach the mark. (If you do know of one, I’d love to hear about it!)
However, high return investments virtually always involve taking on a high degree of risk –the risk that the return will turn out to be much lower than expected, or even be negative. Also, keep in mind that credit card interest rates are pretty high. Sure, you can find rates in the 7–10% range. I also see ranges in the 10–16% range, or even into the 20% range or higher if you’ve had some payment trouble. Second mortgage rates are generally lower than credit cards, making it a little more likely that that the interest paid could be less than the potential investment return. But do you really want to risk your house on a just a potential return?
Based on this, our recommendation is to use your money to aggressively pay off consumer debts before investing.