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Investing vs paying off debt

Here's some perspective into getting rid of that debt first before you start investing.

If you’re reaching the end of the month with spare money hanging around you might think it’s worthwhile to invest it, which may be a good option. But if you’re carrying debt, it may be a better option to clear your debt before getting started. But how do you decide between paying off debt and investing? We’ve crunched some numbers to help you put it into perspective.

How high is your interest rate?

This is one of the key things to consider when you’re weighing up your options. The average APR of a credit card is around 22%. Think about it this way: could you feasibly earn the equivalent of your APR in profits when you invest?

Let’s pretend you have $1000 to play with. Say you’re considering investing $750 of that. You also have a credit card with an APR of 22% with a balance of %10,000 which you’re currently paying off $250 per month. At present, this accrues to about $2,114.19 per year in interest.

If you chose to pay $250 towards your balance as usual and invest the $750 each month, you’d find yourself still owing $9,114.19 at the end of the year, thanks to the interest that accrues. If your investments earn 5% in a year, you’ll have $9,247.51 at the end, including interest gained of $247.51.

Instead, if you put the whole $1,000 each month towards your debt you only accrue $1,148.88 in credit card interest, but you’d receive no interest from investments. This would still make you $717.80 better off by paying down debt instead of investing.

Of course, this would change if you believe you could make more than your interest rate in investment profit, but consider that most stocks made around 11% in the 5 years from 2015 to 2020.

If you’ve got a low interest rate, such as a mortgage, loan or a low interest credit card, there’s the chance that you could be better off using your extra money to invest in the stock market rather than pay down your debt. The main issue with this is that there’s no guarantee that you’ll make a profit, and you could get back less than you invest, so it would be a gamble that you’d be taking.

Your credit score could be impacted

If you choose to invest the extra money instead of paying off debt, your credit score might be impacted by you paying lower sums off your debt. This won’t matter much to you if you’re not looking to apply for a mortgage or significant loan in the coming years, but may be worth thinking about if you’re investing for the purpose of getting a house deposit and will therefore require a mortgage.

Bottom line

Take a minute to work out how much interest you’re accruing each year and work out how much you’d need to make in investment profits in order to make an overall profit.

Think of it this way – if you choose to pay off debt instead of investing, it’s almost a guaranteed win, because you won’t then accrue more interest on it over time. Carrying debt is expensive. Investing has risks, so you don’t really know how much you’ll make from it.

Online stock trading

Disclaimer: This information should not be interpreted as an endorsement of futures, stocks, ETFs, options or any specific provider, service or offering. It should not be relied upon as investment advice or construed as providing recommendations of any kind. Futures, stocks, ETFs and options trading involves substantial risk of loss and therefore are not appropriate for all investors. Trading forex on leverage comes with a higher risk of losing money rapidly. Past performance is not an indication of future results. Consider your own circumstances, and obtain your own advice, before making any trades.

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