Stop Investing To Get Out of Debt
| November 13, 2009 | Posted by Roshawn Watson under Uncategorized |
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Savings rates have increased dramatically over the course of this last year, and so has investing. At least 26% of consumers believe their more frugal ways will be permanent. We have gone through the financial grinder and emerged more frugal. Unfortunately, many of us are also in debt. It is difficult enough to encourage people to save anything, so the thouoght of stopping investments in order to get out of debt seems like a bad idea, especially given the turmultuous economic environment. However, it is still the right choice for many individuals. When is it advisable to suspend retirement investing to get out of debt?
Do You Want To Be In Debt Forever?
Do you want to be in debt forever? It is a legitimate question. Since our incomes are not infinite, we will undoubtedly have to make some decisions regarding spending. It would be nice if we could pay our bills, fund our retirements, pay off our debts, contribute to college education funds for our children, and have a ton of fun with our money simultaneously, but it is not feasible for most people. We accordingly need to financially prioritize our spending, and one of the first priorities is getting rid of consumer debt. Otherwise, the debt will linger on. When I look at my old student loans records, Sallie Mae was all too happy to extend my repayment period to 300 months! With a term that long, I would not make much financial traction and would have paid them tens of thousands in interest. I’m glad to have that monkey off my back. By eliminating your consumer debt, you are removing one of the biggest constraints to your cash flow. It is one of the fastest ways to finally to build wealth because your dollars will go farther. Don’t take my word for it. According to the 400 richest Americans (Forbes 400), 75% believe “the best way to build wealth is to become and stay debt-free.”
Do the Math
Additionally, the math often works out better for those who pay off their consumer debts. In most cases, the interest rates on your debts are likely higher than the return on your retirement. Historically, the stock market averages around 12% per year. If your the interest rates on your credit card is 17%, you save yourself 5% per year by paying off the credit card first. Also consider the price of all of the debt. If you have an average car payment of $480 (per Edmunds.com) and a second car payment of $200, an average student loan payment of $250, a credit card payment of $200, and miscellaneous (furniture, stereos, or personal loans) debt of $120, you are paying over $1000 monthly towards consumer debts. If you were to invest this instead, you would have over $1.3 million in 25 years, assuming a conservative 10% average return. Thus, the sooner you get out of debt so that you can do some real investing, the sooner you build some real wealth.
Debt Equals Risk
Most people are mired in credit card debt, have student loans, and car notes. In fact, 61% of Americans live paycheck to paycheck just to make ends meet. Most people are just one or two paychecks away from financial ruin. All it takes is one misstep, and your low interest credit cards can go sky-high thanks to universal default clauses. I have unfortunately heard of credit cards charging as high as 79.9% interest. By keeping debt in your life longer for the sake of investing, people are risking repos, late fees, high interest, and worse. Consider how vulnerable to a job loss if you have a lot of payments. I have heard 100% of the cars that were repoed had a car note on them. If you mathematically adjust for risk, the answer is clearly to get rid of the debt in most cases.
The Caveat
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Copyright 2012, Roshawn Watson, Pharm.D., Ph.D. All Rights Reserved.
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