Many people are periodically faced with the financial question, “Should I take this extra money and pay down my debts?”
A financial planner will likely reply, “Yes, because it will improve your net worth and financial stability. Debt is a fire that destroys your income and financial future”.
A financial analyst will likely reply, “It depends because you have to compare the rate you would earn by investing to the rate you are paying on your debt. All of these calculations are based on after-tax amounts”.
Although those are fine answers, my best advice is “Almost never”. First the ‘almost’ part – similar to the financial analyst, if the rate on your debt is a lot higher than the rate on your potential investments, then I think that you should use the extra money to pay down on that expensive debt.
But for the ‘never’ part – if you have reasonably low-cost interest rates on your debt, I recommend that you do not pay them down, directly. Here is how a banker explains personal finances, “A normal family is permanently in debt. Although their mortgage is being paid down over 30 years, they keep refinancing and pushing that date back another 30 years. Their car loans or leases are 2 to 5 years, but as soon as they are paid off, they get a new car with a new loan and start the clock again; and it is the same with their other debts. Your minimum financial goal must be a plan to permanently extinguish your debt. The alternative is big monthly debt payments and a very poor retirement”.
Look at your debts and figure out how long it would take to pay them all off. Whether it is 15 years or 30 years, at least you now have a starting point to improve upon. Chip away at your debt and get it out of your life. And in my opinion, the best way to make extra payments to extinguish your debt is the two-step method. The first step is to take a percentage of all your earned income and consistently invest where it earns dividends or interest. The second step is to take a percentage of that investment income and then use this money to make the extra payments on your debt. Your debt-extinguishment plan may start as a 30-year plan, but you will be turning it into a 29-year plan and then continue down until it is gone.
Why does it matter whether you pay down debt with earned income or investment income? It is my experience that people who wait until their debts are paid off before they start investing become the worst investors. (Investors that procrastinate saving money, opening their monthly statements, or wanting someone else to handle financial matters are symptoms of the investors that lose the most money. It is investors with either ostrich-thinking or ‘hoping that everything will turn out fine somehow’ that are most likely to hear their heels clicking down the hallway of bankruptcy court). If you don’t have money for investing, you won’t start looking for investments. If you are not looking, you won’t find investment opportunities. You won’t read investing articles, books, or seek financial advisers to advance your knowledge. If you don’t invest and see the actual results of your investing, you won’t develop financial skills. There are skills that you only acquire by actively doing something, and investing is no different. If you lose some money in a particular investment, you will quickly learn lessons that aren’t in any book, so that you can perform much better the next time. Successful investing requires knowledge, skill, and habits that come from actual investing.
Another important reason to start both saving and investing immediately is to build up the size of your pile of money. Your investment returns will start to compound over time and slowly build into something more sizable. But if you wait until all of your debts are paid off, years from now you’ll be starting with a very small amount of money. Meanwhile, someone who started today would have built up a much larger amount of money and that translates into investment access. Access is important for higher return investments because there are investments, programs, brokers, funds, and advisers, etc., that have minimum dollar-amount requirements. Access to better investments with lower risk and higher returns will add to your wealth quicker, helping you pay down your debt faster. And today there is really no excuse for not investing even if you start with a tiny amount of money. You can buy a partial share of stock for $10 or open a money market account with $20. Find an internet connection and look up terms such as ‘no minimum investment’.
The benefit that I like the most for paying down debt with investment income is that when your debts are paid off, you’ll still have all the investment income paying you every month or quarter. And as I have said before, investment income is the ultimate financial goal of personal finance – managing your money until it can pay all of your expenses through investment income. So begin with the end-goal of investment income immediately and two-step your way out of all of your debts.
Francis Kier has an MBA in finance and shares his two decades of experience with investing and personal finance. More of his articles are available at http://investing.real-solution-center.com
Article Source: http://EzineArticles.com/?expert=Francis_Kier
Technorati Tags: Personal Loan , bad credit , Bad Credit Loan , Credit , Mortgage , Loan , Money , Finance , Debt
A financial planner will likely reply, “Yes, because it will improve your net worth and financial stability. Debt is a fire that destroys your income and financial future”.
A financial analyst will likely reply, “It depends because you have to compare the rate you would earn by investing to the rate you are paying on your debt. All of these calculations are based on after-tax amounts”.
Although those are fine answers, my best advice is “Almost never”. First the ‘almost’ part – similar to the financial analyst, if the rate on your debt is a lot higher than the rate on your potential investments, then I think that you should use the extra money to pay down on that expensive debt.
But for the ‘never’ part – if you have reasonably low-cost interest rates on your debt, I recommend that you do not pay them down, directly. Here is how a banker explains personal finances, “A normal family is permanently in debt. Although their mortgage is being paid down over 30 years, they keep refinancing and pushing that date back another 30 years. Their car loans or leases are 2 to 5 years, but as soon as they are paid off, they get a new car with a new loan and start the clock again; and it is the same with their other debts. Your minimum financial goal must be a plan to permanently extinguish your debt. The alternative is big monthly debt payments and a very poor retirement”.
Look at your debts and figure out how long it would take to pay them all off. Whether it is 15 years or 30 years, at least you now have a starting point to improve upon. Chip away at your debt and get it out of your life. And in my opinion, the best way to make extra payments to extinguish your debt is the two-step method. The first step is to take a percentage of all your earned income and consistently invest where it earns dividends or interest. The second step is to take a percentage of that investment income and then use this money to make the extra payments on your debt. Your debt-extinguishment plan may start as a 30-year plan, but you will be turning it into a 29-year plan and then continue down until it is gone.
Why does it matter whether you pay down debt with earned income or investment income? It is my experience that people who wait until their debts are paid off before they start investing become the worst investors. (Investors that procrastinate saving money, opening their monthly statements, or wanting someone else to handle financial matters are symptoms of the investors that lose the most money. It is investors with either ostrich-thinking or ‘hoping that everything will turn out fine somehow’ that are most likely to hear their heels clicking down the hallway of bankruptcy court). If you don’t have money for investing, you won’t start looking for investments. If you are not looking, you won’t find investment opportunities. You won’t read investing articles, books, or seek financial advisers to advance your knowledge. If you don’t invest and see the actual results of your investing, you won’t develop financial skills. There are skills that you only acquire by actively doing something, and investing is no different. If you lose some money in a particular investment, you will quickly learn lessons that aren’t in any book, so that you can perform much better the next time. Successful investing requires knowledge, skill, and habits that come from actual investing.
Another important reason to start both saving and investing immediately is to build up the size of your pile of money. Your investment returns will start to compound over time and slowly build into something more sizable. But if you wait until all of your debts are paid off, years from now you’ll be starting with a very small amount of money. Meanwhile, someone who started today would have built up a much larger amount of money and that translates into investment access. Access is important for higher return investments because there are investments, programs, brokers, funds, and advisers, etc., that have minimum dollar-amount requirements. Access to better investments with lower risk and higher returns will add to your wealth quicker, helping you pay down your debt faster. And today there is really no excuse for not investing even if you start with a tiny amount of money. You can buy a partial share of stock for $10 or open a money market account with $20. Find an internet connection and look up terms such as ‘no minimum investment’.
The benefit that I like the most for paying down debt with investment income is that when your debts are paid off, you’ll still have all the investment income paying you every month or quarter. And as I have said before, investment income is the ultimate financial goal of personal finance – managing your money until it can pay all of your expenses through investment income. So begin with the end-goal of investment income immediately and two-step your way out of all of your debts.
Francis Kier has an MBA in finance and shares his two decades of experience with investing and personal finance. More of his articles are available at http://investing.real-solution-center.com
Article Source: http://EzineArticles.com/?expert=Francis_Kier
Technorati Tags: Personal Loan , bad credit , Bad Credit Loan , Credit , Mortgage , Loan , Money , Finance , Debt
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