

Paying down debt is like investing

1:10 PM, Feb. 24, 2014  |  Comments
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The other day a few of us were discussing the importance of smart investing. The discussion included all of the smart investing advice you could get from professionals. Discussions on risk versus return, regular deposits, averaging, mutual funds vs individual stocks and so on. After listening to the discussions for a while, I asked how many of them carried a balance on their credit cards. Two of the five admitted they carried a balance.

I pointed out that the average American family has over $8,000 in credit card debt besides the debt they carry on their home and vehicles. The average credit card interest rate is currently over 15%, some personal loans and care loans are at 10% or higher.

I asked if they realized paying off debt was like getting a guaranteed return on their money. There was some puzzlement in their eyes. Here is the logic: Every dollar you pay toward your debt reduces the amount of interest you're going to pay over the long term and that is equal to a return on your money.

For example, if you pay off $1,000 on the balance of a credit card with a 15 percent interest rate. The result is you'll owe $150 less on your credit card over the coming year and for each subsequent year. So it is the same as an investment, and it's an extremely good investment with a guaranteed return.

The average return in the stock market over the last 50 plus years has been around 8%, so you can see the benefit of paying off that 15% interest card is almost double the average return in the stock market.

Also the "return" on paying off your debt is tax-free. You don't owe income taxes on the savings you get from lowering your debt. It you would have invested and seen a return in the stock market the gains or return on your investment would be taxed by the Internal Revenue Service.

There is one exception to my suggestion of paying off the debt when you look at returns. That is to make sure you are taking advantage of any matching funds you may get if your employer offers matching funds in your 401(k). Matching funds are an immediate return on your investment and in most cases is the best return you can get on your money. For example, if your employer will match 25% of your deposit or savings that is an instant return on your money of 25% and a smart move.

Many of us are worried about the future but fail to realize that focusing on the present is the first step towards a secure and stable financial future. By eliminating high-interest debts and not incurring additional debt you can get a great return on your money.

Ignoring your current financial situation and debt load can be a huge mistake. Take an inventory of your debts and develop a plan in to systematically reduce your debt. Remember the goal is long-term security and stability.