Should you pay off your debts or invest?

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I’ve heard two answers to this question. Like one commenter, many people say you should not invest until you have paid off all you debt. Others say it depends.

According to this article on about.com, one should ask two questions before deciding to pay off their loans or to invest.

1. What is the rate of after-tax interest you are paying on your debt?
2. What is the after-tax rate of return you expect to earn on your investments?

If you your return rate for investments is higher than your interest rate on your student loans, you’ll be better off lengthening your payment on student loans and investing. Think about it.

Let’s say you decide to not invest and pay off your student loans. Depending on your salary, it might take you years to pay it off. During those years of paying off loans, you missed out on high investment returns where some of that money could have been working for you.

I’m not in that big of a hurry to pay off my student loans because we have the rate locked in at a low 4.25%. But additionally, the interest on student loans can be written off on taxes. So, in some weird way I’ll actually save money by having loans. The money that I save can be used to pay down my loans even more.

If most of my debt consisted of high interest consumer debt, then I agree that I have no business investing until I had paid it off. However, Mrs. FLS and I avoid using our credit card like the plague, so we don’t have any high interest debt.

My plan is to pay a reasonable amount each month towards my student loans. However, at the same time I plan on investing 10% of my income. That way, I’ll not only be working off the loans, I’ll be putting my money to work.

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2 Comments

1. JMG on 07.11.2006 at 11:39 (Reply)

   What’s the difference between the return you “expect” and the return you are guaranteed?

   Ummm, how about the entire difference between losing your principal and your expected “return.”

2. Trent on 07.11.2006 at 12:19 (Reply)

   If you’re locked in to a 4.25% loan, even putting extra money into an HSBC or ING Direct savings account is better than paying down this loan quickly, especially since the interest is tax-deductible. Never over-pay on a low-interest loan.

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