This article offers general information about investing and the stock market, but should not be construed as personal investment advice. It has been provided without consideration of your personal circumstances or objectives. It should not be interpreted as an inducement, invitation or recommendation relating to any of the products listed or referred to. The value of investments can fall as well as rise, and you may get back less than you invested, so your capital is at risk. Past performance is no guarantee of future results. If you're not sure which investments are right for you, please get financial advice. The author holds no positions in any share mentioned.
Investing vs paying off debt
If you’re trying to weigh up whether you should pay off your debt or start investing, we’ve put it into perspective.
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. If, however, you also have debt that you’re paying off, you might find that it’s 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. Think about it this way: could you feasibly earn the equivalent of your APR in profits when you invest? The average APR of a credit card is currently around 22%.
Say you have £750 that you’re considering investing. You also have a credit card with an APR of 22% with a balance of £10,000. You’re currently paying off £250 per month. At present, this accrues about £2,114.19 per year in interest.
If you chose to pay off £250 as usual and invest the remaining £750 each month, you’d find yourself still owing £9,114.19 at the end of the year, thanks to the interest that will have been accrued. If your investments earn 5% in a year, you’ll have £9,247.51 at the end, including interest of £247.51.
Paying off £1,000 each month instead would mean that 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 the FTSE 100 only 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 0% 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
Think carefully about whether you choose to invest or pay off your debt. 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. Investing has risks, so you don’t really know how much you’ll make from it.
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