Ask a Fool: Should I Pay Off Debt or Invest?

By Matthew Frankel, CFP

| Photographs By Antonio_Diaz

QUESTION: I recently came into some money that I don’t need to cover my living expenses right now. Would I be better off paying down some debt I have, or investing the money in stocks?

ANSWER: It depends what type of debt you’re talking about.

If the APR or interest rate you’re paying on a particular type of debt is greater than the long-term returns you can realistically expect to get from your investments, then paying down debt is a good idea. On the other hand, you’re better off investing instead of paying down low-interest debt, at least from a mathematical perspective.

Here’s what I’m talking about. Over the long run, the annualized return of the overall stock market is around 9%-10%. So although there’s no way to know for sure what the market will do, it’s fair to expect this level of return from your portfolio if you stay invested for a period of a couple decades or longer.

If you have credit card debt at say, 20% interest, it’s a good idea to go ahead and pay it off instead of investing. Most great investors don’t consistently achieve returns like this.

On the other hand, if the debt you’re referring to is a mortgage at 4% interest, or an auto loan at a similarly low APR, it’s tough to justify paying it down early.

Of course, this is purely from a long-term expectation perspective that I say you’d be better off investing. If you simply don’t want to be in debt anymore, that’s another story.

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Tags - Debt, Investing


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