Investing versus paying off debt?

(FOX Providence) - It's a challenge many people face. We know we should save for retirement, education, and for a safety net, but with bills coming each month, is it a better bet to pay off debt instead?

Both are important, but if you don't have enough cash on hand to cover both, which to choose?

Certified Financial Planner Jeff Massey joined the Rhode Show to talk about which decision is right for you.

Almost nothing trumps the pure numbers. If you pay 12% to 20%+ interest on a credit card, could you earn that much safely and consistently on an investment? Not in today's world.

So you might as well pay off the debt. What's the best use of your money? Sometimes, the best investment is avoiding the interest on a loan.

What is good debt versus bad debt?

Yet not all debt is the same. Some is considered "good debt." Examples would be mortgages or student loans or margin interest on a brokerage account. Some of the interest you'd pay on those loans is tax-deductible. That changes the equation.

For example, if you have a 6% mortgage and you pay a 35% income tax rate, the after-tax cost of your loan is only 3.9%. That's pretty cheap money. You may be able to make at least that much or better on investments, so invest.

Credit card debt is "bad debt." You can't deduct the interest you pay on credit cards from your income taxes. Interest rates on credit cards average 14.39%, according to Bankrate.com. And those rates aren't going lower any time soon.

It's important to know your interest rate on your credit cards. That is a critical part of this decision of which card or debt to pay off and which to continue making payments on.

Still, saving for retirement is so increasingly vital that if a 401(k) or some other long-term tax-advantaged savings vehicle is available to you, I suggest that you invest in it even before you pay off debt. You should put at least the minimum you need to invest in a 401(k) to get your company's maximum match.

Many companies match at least some of your investment, and your money grows, tax-deferred, over time. If your company matches, say, 50% on the first 6% of pay you invest in a 401(k), you get a 50% return immediately! In other words, take the FREE money from your employer's matching program before using that money to pay down your debt.

You stress the importance of the emergency fund. Why?

Have an emergency fund. You need to have money set aside for emergencies so you won't end up using a high-interest-rate credit card if trouble strikes.

A home equity line of credit may be the best option if available to you. Interest on that type of loan is tax-deductible. And if you pay off credit card debt, you'll further increase your available credit.

Bottom line is to get out of the credit card mind-set and have a separate emergency fund, such as a money market account, with a bank or a brokerage firm.

 

What's the bottom line here?

Although you may be eager to invest, you need to do what is best for your bottom line. Regardless of which is the wiser course of action at this stage in your life, the ultimate goal should be to have no debt and an abundance of great, lucrative investments. With enough patience and hard work, this is a goal that you can, and will, attain.

More information:

Jeff Massey at 401-333-8000
www.masseyandassociates.com/