• Matt Morizio

How to think about money: pay off debt or invest, which puts more $ in your pocket?


Should I pay off my credit cards or start an investment account? Should I pay off my home mortgage early? Are my student loans killing my potential investment earnings?

The underlying question is, “Do I invest, or do I pay off debt?"

If you’ve wrestled with these questions, here comes my knight-in-shining-armor, save-you-from-your-struggles-answer:

It depends.

Womp womp.

Like most conversations about investing, the answer is always relative and situational, always more gray than black and white. Paying off a mortgage makes sense if you are investing in 100% bonds (please don’t ever do that), but paying off your mortgage early is a dumb idea if you’re investing to win and trying to maximize the money you make.

You know the saying, “Give a man a fish, feed him for a day. Teach a man to fish, feed him for a lifetime?” This article will teach you how to think about one aspect of money, about debt and investment returns, and about your finances so you can make educated financial decisions for a lifetime.

Here’s a real-life example I worked through with two of my clients (I changed some details but the concepts are still the same).

The situation

They sold a home and needed to pay $700,000 in taxes, but the taxes weren’t owed until the following year’s tax date. So they had 12 months to figure out what to do with that $700k. Save it? Spend it? Pay taxes early?

In my mind (and theirs), they had 12 months to put that money to work. This is a critical mind shift you need to make when thinking about money. You need to use money. Don’t save money.

And no, a low interest savings account does not count as “putting that money to work.”

So what to do?

A twelve month window is too short to make aggressive investments, but it’s enough time to make some money.

We looked at high yield CD’s (certificates of deposit) online, which are basically glorified savings accounts with some additional stipulations attached that give you a slightly higher interest rate on your money.

Ally bank was offering a 2.75% 12-month CD. In 12 months, they were looking at earning an additional $19,250 on that initial $700,000 investment. Not bad just for using a 12-month CD instead of mindlessly sticking it in their savings account.

But then they told me about a $200,000 balance on a home equity line of credit (HELOC) they had at 6.85%. That means they would pay $13,700 in interest over the next 12 months, only netting them $5,550 on the year.

What if they used some of that tax money to pay off the HELOC? Then they could use that HELOC again next year to get back the $200k they would need for taxes.

If they pay off that $200,000 HELOC, they have $500,000 left to invest in the Ally account at 2.75%, resulting in a $13,750 gain. On top of that, however, they saved $13,700 in interest payments over that 12 month period, putting that money back in their pocket.

So, by paying off a higher rate debt, they actually earned $27,450 in 12 months.

And that’s how you should look at your debt. What’s the interest rate? And what is your typical, or annualized, investment return rate? Figure out which debts are too high, and pay them off. If the interest rate on the debt is low, invest that money instead.

If the interest rate on your mortgage, for example, is 3%, unless you are super-conservatively invested, it makes no sense to pay it off early. That money will work harder for you if it’s invested.

Don’t give it to the bank. All they will do is invest it in higher yielding investments anyway, which is exactly what you should be doing.

Conversely, if your interest rate on your credit card (also called an APR - annual percentage rate) is 19%, pay that off as quickly as possibly. Your investment returns are unlikely to outpace that 19% every year.

And what about the stuff in the middle? Well, that’s the gray area. And for that I don’t have a clear answer, but if you’d like to schedule a call, I’m happy to walk you through my thought process about your specific situation.

To recap, here are the two major takeaways:

  1. Use your money, don’t save it.

  2. Keep low interest debt and pay off high interest debt - your investment returns can be a guide for which debt rates can be considered “low” and which can be considered “high."

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Investment advice offered through Beck Bode, LLC, a fee-only Registered Investment Advisor in the Greater Boston area.