Invest or pay off debt first?

A quick explainer

17 Oct 2021

Having money that we can use to invest after paying our expenses is great! However, it's not always to easy to understand how we should approach our investing when we're still in debt.

In this article, we explore how different strategies of investing or paying off debt can affect our wealth in the long run.

A visual case study

Consider the following example, lets imagine you had the following accounts with your bank: a credit card and a fixed interest account.

  • Credit Card with a 21% interest rate with a balance of -R48 000
  • Fixed Interest Account with a 5% interest rate with a balance of R48 000

Let's imagine we have R4 500 to save every month. We could choose to either invest and ignore our debt, or pay our debt off first. Here's how it plays out.

Scenario 1: Invest only

Our debt accumulates, and we end off with a total of R0 (investment balance + debt balance) in our bank after 3 years

Scenario 2: Pay off debt first, then invest

We stop our debt from accumulating, then invest and end off with R0 after 3 years

What does this mean?

In the example above, we see that paying off our debt saves us a total of R0 over the three year period.

In a more practical sense, this suggests that we should review the interest rate that comes with debt such as credit cards.

Credit card interest rates are usually high and fixed. The example above shows a scenario where paying your debt off first could save you some money.

What's the catch?

While the interest rate on your credit might be guaranteed, the returns on your investments might not. For example if you're invested in the stock market for example, some stocks might grow over 50% in value in the space of a year.

This certainly makes it tricky to know what to do. My personal rule of thumb is that if I am certain that the interest rate on my credit card is higher than the returns I would receive on another account, then I will focus on paying off my credit card over contributing to that account.

What to do next

If you're looking for advice on how to navigate your own personal situation, contact a financial adviser. If you feel like you cannot afford one, it never hurts to do some research!

If you have a credit card, it also won't hurt to see if you can negotiate a lower rate with your bank, or investigate if they offer a different credit solution that offers you a lower interest rate.

Here's a good article by Investopedia on why you might want to consider investing first, or doing both.

My favourite podcast on the topic of investing is The Honest Money Podcast by Warren Ingram. I hope it helps you as much as it's helped me.

Thanks for reading! I provide insights specific to your account in a more digestible format in my app Simfolio. Download it below.

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