Invest or Pay Down Debt?

03 January 2020

“Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn’t, pays it.”

—Albert Einstein

As the New Year begins, many of us will be setting resolutions for the coming year ahead. Some of these are likely to involve our finances and committing ourselves to improving our financial situations. However, with only so much money to go around, should you use any surplus funds to invest or to pay down existing debt?

Some friends I speak to absolutely detest debt. They aim to pay down their mortgages as quickly as possible (note that this is not recommended for car loans, due to the “Rule of 78”). Whereas others swear by using their free cash to invest and generate higher returns above their loan interest rate.

What really is the best option?

It depends. Everyone has different emotions and circumstances to consider when it comes to investing and taking on leverage (loans). Nonetheless, here are some simple questions which serve as a guide to helping you make the right decision:

  1. What are the realistic expected returns on your investments?
  2. How likely are you to panic when your investments lose money?
  3. What is the interest rate you are paying on your loans?
  4. What is the tenure of your loans?
  5. How many more years do you have before the official retirement age?
  6. How fixed or variable is your current income?
  7. Do you have any free cash flow after paying up the monthly installments on your existing loans (house, car, renovations, credit card, etc)?

Inputting your answers into an Excel spreadsheet could help you see the right decision from a logical and mathematical perspective. However, the decision whether to pay down debt or invest is, for many, an emotional rather than rational decision. Some prefer to pay down debt as quickly as possible because they feel uncomfortable being in debt, and are willing to sacrifice potential investment returns until later. Others who are more guided by their left brain may prefer to invest their free cash flow to capture potentially higher returns by starting early.

Everyone is different. The only no-brainer decision is to make sure you pay off any credit card debt, which – depending on which card and bank – can reach astronomical levels of >26% p.a.

Still, if you remain keen on seeking an answer, this simple ‘to-do’ list can help:

  • Pay down any debt that has high interest rates relative to the returns you are receiving on your spare cash.
  • Pay down any debt that has high interest rates relative to the expected returns on your investments.
  • Always seek refinancing options whenever there is a significant differential to the interest rate you are paying and what is being offered by financial institutions (but be aware of your lock-in period and penalty clauses, if any)
  • Invest in globally diversified evidence-based strategies with relatively reliable long-term returns expectations, especially returns that are higher than the interest rate you are paying on existing debt.

There is no one-size-fits-all solution. It is important to figure out your own values and goals when it comes to your finances. A fiduciary adviser can help you talk through and work through tough decisions like these, and then design an intentional and disciplined plan to help you achieve your life goals. As the saying goes, if you have no target, you will never hit it!

Managing debt is just one of many complex decisions to be made as you approach each new life stage and milestone. If you would like to start making smart decisions with your money, we invite you to schedule a non-obligatory, 30-minute appointment with us to discuss where you are with your finances and where you would like to be.

It is always good to take stock of your finances at the beginning of a new year, and make adjustments to ensure you are on the right path before it is too late.


If you have found this article useful and would like to schedule a complimentary session with one of our advisers, you can click the button below or email us at customercare@gyc.com.sg.

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