Why You Should Pay Down Debt and Not Invest

September 01, 2020
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You might be surprised to hear a financial advisor tell you that but it is some of the most frequent advice I give. In almost all cases on consumer debt, I advise paying it off before investing. There are a few exceptions such as mortgages or business debt. 

 

Most individuals take on debt while investing using a very rational thought process - If I can borrow at 5% (for example) and stocks historically have earned 9%, I should invest. That is a completely true statement and yet very misleading. When you borrow at 5%, you are guaranteed to lose 5% per year in interest. When you invest in stocks, you are anything but guaranteed to earn 9%. In simple terms, you have not factored in risk to your equation.

 

An easy exercise to help you think about the risk is to consider whether you would borrow to invest if you didn’t have the debt to start with. The answer is almost always “no”.

 

Example - If you have a $20,000 car loan at 5% it is much easier to decide to continue investing than if you had a car paid for and went to the bank to get a personal loan at 5% so you could invest the $20,000. It is the same math both ways but now you feel the risk.

 

One final point I will make is only anecdotal from working with many families over the years. In general families who don't carry debt make better financial decisions because they don't have the subtle stress that debt puts on them. They quit the job they hate to try something new or retire. They risk their steady paycheck to start a business that doubles their income. They don't panic and sell when the market is down. 

 

However, you should consider your own spending behavior. One reason that debt does work for some is that it forces them to cut expenses in order to afford the payment. Be honest with yourself about whether this is true for you, and if so, would you actually save that money if you didn't have the debt payment?

 

 

Disclaimer: Alex Voorhees and Reston Wealth Management do not provide legal, accounting or tax advice. This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified investment, tax or legal advisor. The opinions voiced in this article are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) or strategies may be appropriate for you, consult your financial advisor prior to investing. No strategy assures success or protects against loss. You should consider the investment objectives, risks, charges and expenses of any investment carefully before investing.