Pay debt or invest?

Should you should invest with your extra money or pay down debt?

In this post I’m going to try to look at some of the issues that might help shape your decision and things to consider when trying to decide whether to invest or cut down debt.

I’m going to first look at when you should definitely pay off debt, then when you should definitely not be paying off debt, invest and finally I’ll look at some circumstances when you might have a decision or two to make around investments and debt.

Remember this all comes from a total amateur, I’m not a financial advisor, never have been, so if you need proper advice I suggest you get off the internet and over to a professional pretty sharpish…

The question usually has roots in whether or not you think you can potentially make more money from investments vs the cost of your debt. I’m going to assume that you have an emergency fund or similar in place already, and the money we are talking about using to invest or pay off debt isn’t going to be money you need to have in your pocket should something go sideways. Conversations like these always have the caveat that the invested money isn’t typically liquid – that is, you can’t necessarily get it back particularly quickly and that any debt paid down to your creditors obviously isn’t coming back to you again.

So let’s start with the easy stuff. If you have credit card or store card debt, get that paid off as quickly as possible and don’t bother investing until you do. The reason is that these cards carry very high rates of repayment, using 20% or above and you simply won’t find any reliable investment that can do better than 20% in a year.

Therefore you are maximising the money you have by getting rid of that debt. Money not spent on servicing debt will buy you just as much stuff as money earned.

As an illustration, and we will keep this really simple… let’s say you owe £1000 @ 20%/year. After a year that will have cost you £1200 to pay off.

There are no investments out there that will pay you a guaranteed 20% return to make you more than that £1200 over the year, so the best thing to do is pay that expensive debt. That’s your money working as hard as it can.


Conversely if you can find a guaranteed rate of return that is higher than the highest interest rate on any debt you carry then you should invest that money for the higher return. I’m talking about guaranteed fixed rate of return here, such as a savings account at a bank.

Saving rates are absolutely dismal so it is unlikely you will be able to lock in a higher rate than interest rates on your debt at this point in time. However I like to brag from time to time that I have a mortgage that is a life-time tracker set at 0.15% higher than the base rate. When I got the loan the Bank of England base rate was something like 5% so at the start I was paying 5.15% on my mortgage in 2007. Now the bank of england base rate is 0.1%, so my mortgage payment is 0.25%. At this point it makes absolutely no sense, from a numbers point of view at least, to pay down this debt early. I can put any spare money in any account paying more than 0.25% and still be in front.

The meat and potatoes of this conversation comes when you have a more typical rate of something around 2-4% on your mortgage payment. On the face of it this is the kind of figure that is probably worth over-paying because the % rate is higher than inflation so in real terms you are getting good value on your money. However if we are to take that spare money we would use for an overpayment and invest it, we might well expect to make more than that, somewhere in the order of 7-10% per year on average if we were to invest that into an index fund, tracking for example, the S&P 500. 

In case you don’t know the S&P 500 is a weighted index of the 500 largest US publicly traded companies. Vanguard, ishares and others offer easy ways to invest in this index which has historically on average returned 10% annually since it’s inception in 1926. To give you some idea what that means, $100 invested in 1926 would be worth $855,667.60 today and that’s without a single further investment.

The difficulty with investing in the stock market is that on a day to day basis it is volatile. Even over months there can be dramatic swings and on a year by year basis there is no guarantee that you will finish exactly 10% in front each time. In fact, almost certainly you will face years when the returns will be firmly in the red. Having said that over a long period of time, you could reasonably expect to achieve results in the order of 7-10% to the good. 

So over a long period of time and I’m talking 10, 15, 20 years or more you are likely to outpace your domestic debt repayments by investing in the stock market by about 3-6%, thus making money while you pay off your debt with regular payments.

In terms of spreadsheets and making money, over a long period of time, I would suggest that investing probably is the way forward and not to make overpayments on something like mortgage debt. 

However, there is more to a financial life than just numbers.

Let’s stick with the theme of mortgages. That’s the most common long term debt anyone will have. There is a lot to be said for not owing anyone any money. When you have paid your mortgage, that home is yours outright. Whatever happens you will always have somewhere to go. That’s the first thing.

The second, is when you pay down some debt you are guaranteeing a return on your investment of exactly the interest rate. It’s fixed and it’s done. In the years when the stock market returns a negative you will have done well here. Further you will be one step closer to no mortgage debt and that may well help you sleep at night. Investing in the stock market offers no guarantee of anything. In theory your investment could go to zero and you would lose all your money. For that to happen, though, we would probably need to see an armageddon style event, but crashes in the stock market do come round every so often and if you can’t stay invested long enough to ride out these lean times, then and fixed return on paying down debt is likely to make you less anxious about the performance of the global economy.

There is much to be said for feeling comfortable. Researching the stock market and what to invest in can be confusing, there is a lot to consider and it can be a pretty intimidating place. Apps like Trading 212 and Freetrade, Etoro and the like are making investing more and more accessible. You will find some links in the description if you would like a free share or two and to support the channel! You should never put your money into something that makes you uneasy or anything you don’t understand. Whether you don’t know anything about investing in the stock market, or you have good knowledge of how it all works but choose not to go that route – this is all good – paying down debt is a great way to spend spare money. There is more than one way to peel this particular financial spud <mr tayto> and after all, you can’t buy peace of mind. No point in stressing about investments if you would be much happier and more confident paying down debt.

So while Excel and all it’s smart formulae will tell you that the longer you invest, the more likely you are to outstrip debt interest rates, if you aren’t ready to make consistent investments and leave them to compound for years then you may well be better off, in a more rounded, overall well-being kind of way to pay down your debt, know that your cashflow will be better and nobody is casting a shadow over any of your stuff.

Good cashflow is a wonderful thing to have. It gives you more options. The fewer monthly obligations you have to make the more choices you are free to make, and obviously the quicker you pay off your debt the fewer monthly obligations you are going to have. Those with long term debt are more likely to be unable to shift that debt and so in many ways will have the rest of their choices over the years significantly hindered even though their ability to pay that debt isn’t necessarily an issue. 

However if you are the patient sort, If you have plenty of time, has a long term outlook on these things and are ready to contribute to an investment account such as a stocks and shares ISA regularly and consistently, then you will could probably benefit from getting as much of your money into the markets to work for you as early as possible. 

Over the years the amount you have borrowed will shrink in real terms vs inflation so as you approach the end of the debt repayment term, it could well be that the repayment amount is relatively small compared to your earnings. I’m approaching another hypothesis altogether that says you should never overpay any debts, but that’s beyond the scope of this video and probably another subject altogether!

The compounding effect on your investments is unreal in the later years for relatively small regular contributions over the years, so it’s never too early to start and no amount invested is too small. As I say, the longer you can stretch your timeline, the more likely the stock market is likely to beat that repayment rate. I have a video all about compounding which I will link to in the description and on one of these nice youtube cards.

I guess if you are choosing between investing and paying off debt, then it could be a good idea to overpay a little and invest a little to try to get the best of both worlds. There really is no wrong answer to this theme of this video. Advocates exist on both sides of this conversation with enormously impassioned views, often borne out of successful or painful experience. Debt has to be paid and investing will lay good foundations for your future, but how you balance this is ultimately up to you.

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