Invest or Pay Off Debt, It's a No Brainer
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It should not come as a surprise why financial advisors will tell you to start investing now, even though they all agree behind closed doors that eliminating debt should be a financial priority. The reason they do this? They have families to feed, too; if they don't sell their product (investments) they don't eat.
Of course, the power of compounding plays a small role in the "invest early" motto that so many Financial Advisors promote. But what does this do to your lifestyle? Your debt repayment plans?
We can see whether the argument is valid once we know our Cash Dilution Rate. This rate essentially tells us how much of our after-tax dollars we lose to the credit debt we have. So, the higher the rate, the more we pay to creditors; the lower the rate, the more of our after-tax dollars we enjoy and, therefore, can afford to invest without sacrificing our lifestyle.
Let's look at this a little closer. Consider an individual who earns $2,000 in after-tax dollars. With the average American debt of $22,100 and an average rate of 14.5%, this individual's Cash Dilution Rate rings in at 13.35%. This person keeps only $1,732.86 of her original, after-tax $2,000.
One way to understand the severity of this situation is to weigh the $267.14 in monthly credit costs against how much can be invested on a monthly basis. For example, investing an additional $250 per month reduced the amount this individual keeps every month even further to less than $1,500 ($2,000 - ($267.14 + 250.00)).
Now, if this individual had no debt at all, the $250 might make perfect sense as she is already spending more than that on her debt payments. So, what impact does paying debt and investing have on her long-term savings? Of course, there is no easy answer because there are two things we need to consider.
In the first case, this investor might find that an additional $250 per month to invest is, in fact, not much of a sacrifice. If this is the case, then that additional $250 should still go toward repaying debt (assuming there is absolutely no guaranteed financial incentive to invest such as an employer-matching program). This would reduce the debt even faster, from a little more than 57 months until full repayment without using the extra $250, to a little less than 35 months if she uses that $250 to repay the debt. Once all of the debt is repaid, the $250 + $267.14 can be invested for a total investment value of $517.14 per month.
Assuming the investor has 15 years left to invest and can still afford it after the debt is fully repaid, to invest $250 + $267.14 (or $517.14) monthly, then she will be farther ahead by $38,283... and this takes into account that she starts investing 3 years later than she would have if she had started with $250/month! Not only will this investor have no debt left to repay three years later, but she will be farther ahead and better prepared to weather unplanned financial hardship.
What might happen after repaying her debt, however, is that she decides that $250 was too aggressive in the first place. Instead, she will invest only $125 of that amount and spend the remaining $125 on something she loves, something like shoes. Even though she is enjoying her life a little more with more shoes than she ever needs, she will still be investing $392.14 ($125 plus the $267.14 that she used to pay toward debt). What impact will this have? Well, none. Even though she is spending less (392.14 versus 517.14) and is starting 3 years later, she actually comes out ahead to the tune of $7,167. Plus, she will be debt free (yes, there is a theme to this importance of living a debt-free lifestyle).
As evidenced above, accelerating a debt repayment plan should often take priority over investing for the simple sake of future compounded growth. This statement contradicts a lot of what has been written already about wealth building, but the illustration above shows us just one way a debt-free lifestyle allows us to enjoy greater wealth down the road. Of course, there are some rare instances where an investment plan should be used in conjunction with a debt repayment schedule but, again, those situations are rare.
Article Source: Articlelogy.com
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