We already talked about credit card debt. Credit card debt is obvious. You can’t hope to come out ahead if you’re paying a 20% interest expense. Other debt can be more tricky. Let’s say you’re locked into a 30 year mortgage at 4%. Should you invest in the stock market or pay off your mortgage quicker?
There’s no right answer to that question. If you pay off your mortgage quicker, then you’re guaranteed a risk-free rate of 4%.(link) If you invest in the stock market, then you it’s essentially like you went to the bank, took out a 4% loan, and then threw that money in the stock market. (Ignoring the tax benefits of home ownership of course.)
That can be a winning strategy. If your money earns more than 4% a year, which is reasonable, then you’re going to look pretty smart. But if the market crashes and you lose your job, then you’re probably going to be wishing you had been paying off your mortgage quicker instead.
Anything higher than 4%, I think you’re playing with fire. Student loans in the 5-7% range for example. Again, you could come out ahead and look pretty smart, but the safer play is to take the guaranteed 5-7% return.
Written in 2015
1. Warning
2. Emergency Fund
3. Credit Card Debt
4. Employer Matched Retirement Funds
5. Other Debt
6. Time Horizon
7. Index Funds
Podcast: Investing 100