Would you ever borrow money to invest? That is, would you take out a loan such that you could put more money in the stock market or other investments? Think carefully. You might already be doing it without even realizing it.
And I’m not just talking about people who use leverage to amplify the returns from their rental properties. I’m also talking about people who have mortgages, car loans, credit card debt, etc. but are still stashing money in an investment portfolio. In effect, they’re investing with borrowed money.
To be fair, these investments are often held in tax-advantaged retirement accounts, and mortgage loans likewise offer tax advantages (not to mention historically low rates), so perhaps this makes sense.
It’s also important to keep in mind that contributions to retirement accounts are subject to annual limits, and that many employers match 401(k) contributions. Thus, there are additional factors to consider when deciding whether to invest or pay down debt.
My point? Only that you should occasionally take a step back and look at the big picture. You might find that you’ve been fooling yourself and making investment decisions that you wouldn’t otherwise make.
I’ve kept this in mind as I’ve reached a point of being able to invest outside of retirement accounts.. For a long time I have striven to pay off debt because it was a guaranteed ROI. Now that rates are so low, I have a small loan at 3.75% and the rest is lower. I did have some small amount of money in Lending Club that I thought I could lose. It has done well with a NAR of 12.22% I was waiting for another investment bonus to come up but those don’t seem to be happening in 2012.
I think John has the right idea. When I pay a debt, I get a guaranteed, pre-tax (matters if the interest is tax deductible) return equal to the loan’s effective interest rate. It’s the ‘guaranteed’ part that gets my attention. This is a personal judgment thing, but I’d probably choose to pay debt that’s at even 3% (post-tax) before I’d put the cash in stocks, for example. In a near zero interest rate world for savers, 3% guaranteed strikes me as appealing. And this is just dollar & cents–hard to quantify the intangible benefits of paying down debt like freedom, flexibility, and less risk, but for me they sure feel real!
Paying off debt early is investing, and as others have said: it is investing with a guaranteed ROR. Nickle rightly points out how tax advantaged funds and employer matching distorts what a sane person would normally do (pay off debt and not invest in stocks).
Without company matching and tax benefits, I wouldn’t own any investments, not until the mortgage was paid off…
Personally, I would not want to make an investment using borrowed money. If you use borrowed money, then it just means that you don’t have enough yet to make an investment, wait till you’re really ready financially.
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