Debt vs. Investment: An Anecdotal Examination

In this economy it’s often very hard to know which financial decisions are smart and which ones are less so.  There are fears over inflation, interest rate hikes, more economic downturns, currency instability, and the availability of credit just to name a few.  Without a proper plan or road map it’s nearly impossible to remain afloat financially, especially if you have a large amount of high interest debt.  Now, more than ever, people are being turned on to investing.  These people are beginning to see the benefit of saving more money for their future.  These same people often make some very fundamental errors when it comes to deciding when and how much to invest.  These investors would be much better off taking inventory of their debt and working to pay that debt down.

I have a friend who just put $5000 into the stock market expecting a modest 7% return on his money per year.  This rate of return may not be hard to achieve, considering the DOW’s climb from its March lows.  The likelihood of the stock market duplicating another rally is probably quite low right now since there is so much uncertainty, but 7% is not out of the question.  This friend also confided that he has about $8000 in credit card and other debts, averaging around 25% APR.  This is no small percentage, even at 7% APR, the balance doubles every 7 years or so.  So you can imagine what is minimum payments must be.  My friend is sadly mistaken if he thinks his path to financial stability is to assume a debt that doubles every year and a half in exchange for a consistent investment gain of 7%.  Even in the long run, it would have benefited him more to pay down his credit card bills before he invested his money.  Sure there is an opportunity cost for not investing in the market right now, but the interest he will have to pay in his credit card debt alone will eclipse the $5000 mark in just a couple of years or less.

This is a fairly common situation for many Americans who are excited about investing.  They invest money that they should have used to pay down their debts first.  Without debt a person is free to realize investment gains as well as take advantage of some really amazing investment opportunities.  With debt, investing is just keeping the cycle of debt going longer, and giving consumers a false sense that they are climbing out of the hole they have already dug for themselves with their high interest debt.

So the debt versus investment question is an easy one to answer from this standpoint.  It’s better to be broke with no debts than have a $5,000 stock portfolio and owe $8,000 with an APR of 25%.  The stock market will always be there after you pay down your debts, and there will likely be just as many great opportunities then as there are now.  Paying off high interest debt is paramount to staying financially healthy.