by Stacy Francis, CFP®, CDFA
At a recent get-together at my parents house, one of their friends was excited to tell me his company had given him a substantial bonus – one that far exceeded his expectations. Thrilled to have a financial expert at the party, he asked whether I thought he should invest the money, or use it to pay down debt.
This is a brilliant question, and one that is fairly simple to answer. It depends on the cost of your debt, as well as the return on the investment you are considering. Some types of debt, like credit card debt, are expensive, so if you have them you should definitely use the money to pay them off. I know it sounds boring, but you will be happy later, when financing charges stop eating half your paycheck.
Other types of debt, such as student loans and mortgages, tend to have fairly reasonable rates and long payback times. Hence, you may be better off investing the money than paying them off. Say, for instance, that you pay 6% interest on your mortgage, and the yield from the investment you would like to try is 8%. In this case, depending on what kind of risk comes with the potential investment, you may be able to walk away with an extra 2% per year if you invest the money rather than dumping it into your home.
As all the debt my parent’s friend had was a low-interest mortgage, he decided to invest the money – after treating himself to a cruise with his wife. After all, life’s supposed to be lived. As for you, next time you come across a larger-than-expected sum of money, compare rates. The answer to this question is simply mathematical.