Invest or pay your debt first?By Randell Tiongson on June 27th, 2016
Question: Hi Sir Randell! I’m sorry to take up a few minutes of your time, but I’d like to ask you a question since based from research, you are one of the best personal finance experts in the country, and my concern is very much related to your expertise. My question is: Should I pay my debt first or should I invest, and then use the returns on the investments to pay the debt? I have friends who have been telling me to invest “today rather than tomorrow” but is that smart considering I have debts?—Lia via Facebook
Answer: Hi Lia! I’m always happy to help! My dream is for every Filipino to become financially free, and that starts with education—teaching the basics of personal finance.
However, education is only the first step. Execution is what is important.
The advice I give here will be useless if there’s no follow through, so I deeply suggest that after you read the column, you practice what you read.
Moving on to your question, so should you pay your debts first before you invest?There are numerous aspects to consider, but one of the more significant factors is the interest rate.
Interest rate and ROI
What is the interest rate offered by your credit card company? What is your possible return on investment (ROI)?
If the interest rate on your credit card debt is 3.5% monthly, or 42% annually, and your ROI by buying a “hot stock pick” is 100%, the answer seems like a no-brainer. Invest first and use the 100% ROI to pay the debt.
However, you have to remember the interest on credit cards is guaranteed, while returns on investments are not. You can gain 100%, but you can lose your money as well.
You’ll definitely be accruing interest payments by not paying your full credit card balance. In this case, it would be advisable to pay your debt first and invest later.
Can’t you do both? Invest and pay debt?
Yes, you can if:
You have a surplus of money coming in.
If your bonus or 13th month pay is only a few weeks away, you can use the money to pay both your credit card debt and open an investment account. If you have a credit card debt of P10,000 and are expected to receive your 13th month pay of P20,000, you can use 50% to fully pay your debt and the other 50% to open an investment account.
Your debt amount is small.
If your debt is P10,000 and you are earning much more than that, you have the room to pay your debt and invest at the same time (provided you already have an emergency fund).
Lia, I hope the guidelines here have given you more clarity when it comes to making a decision.
So should a person pay his or her debts first and then invest later? Or he or she can do both?
As you can see from the points above, it really varies and depends on a person’s situation and circumstance. Just remember that if you decide to pay your debts, invest, or balance doing both, you’re taking yourself one step closer to financial freedom.
As always wisdom is needed.