As people enter adulthood and start to get serious about personal finance, there are a lot of questions that need to be answered before we can enter financial maturity. One of these conundrums is whether or not to invest while in debt. If you’re looking for a clear Yes or No, that’s not the way to understand this problem. There are many kinds of debt and many kinds of investment, and if you aren’t careful, one can cancel out the other.
It all comes down to percentages and time. Percentages are the easiest factor to understand so we’ll start there. No matter what kind of debt or investment you have, you’ll understand its growth in terms of an annual percentage. For debt, fees and interest payments are totaled in the debt’s annual percentage rate (APR). For a short term bad credit loan this might be on the high side, and for something like a mortgage loan it would be very low.
In general, healthy debt are loans like student loans and mortgage loans. These are loans which are essential for most people to advance themselves in life. People who take on these loans tend to pay them back, especially in the case of mortgage loans, because if they do not they will lose their homes. There’s also the consideration that the government incentivizes lenders to make these loans affordable, because homeowners are desirable for a stable tax base. Finally, the lending market is still recovering from the 2007/2008 crash, and rates are still extremely low. For all of these reasons, a home loan will be had at as low an interest rate as a consumer is likely to find, often less than 4% annually.
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If you were to compare that 4% to the amount of money you were likely to make on an investment in the stock market (let’s assume a healthy 10% for this argument), you would easily outpace the interest on your loan with the returns you achieved in your investment. It’s a no-brainer to see that it’s OK to invest this way, even if you are paying off a loan term loan like a mortgage.
But when the interest rate of the loan is higher, things get a bit trickier. Let’s say you have credit card debt that is growing at a rate of 25.9% each year. This is considered high interest debt. There are few investments that would match or exceed 25.9% in annual growth, so investing would be a losing proposition (unless you had far more invested than the total of your debt…in which case, why not just pay it off?).
But there is one last consideration: time. We all know that compound interest is an important factor in investment growth, and that time is the biggest determinant in how much compound interest will affect your investment. For people with small or mid-level debt, it can make sense to invest while working to pay off that debt, if only to give your investment money as much time as possible to grow.