Invest or pay down loans? What to choose
Invest money in funds and stocks, or pay down debt and loans? What is the worst thing about your personal finances, and what saves you the most money?
Money has a nice review of this issue in its article from 2012. Although it is an old news and the world has changed a lot in 8 years. The advice is pretty much as good now as it is then.
The smart order to spend your money on
1. Have some emergency money
Crisis or emergency money is not your usual buffer of 1-3 monthly salaries. Crisis money is something as simple as a small and easily accessible sum of money that allows you to deal with smaller crises, such as replacing a defective washing machine with one that is bought used and cheap.
What is a good sum for you depends on how much you think can go wrong. But a decent sum is usually between USD 5 and 10,000.
Credit cards, sms and consumer loans
Consumer loans or credit card debt do not necessarily have to be due to overspending or poor handling of money. Sometimes having to take out a short-term loan may be necessary to avoid something worse, the most important thing is to take lessons and pay down the debt.
Use the extra money you have to get rid of expensive interest-bearing credit card debt or consumer loans. It is not uncommon for interest rates to be between 17 and 25%, often if you include annual fees, so you may want to refinance the debt you have and get a lower interest rate.
If you pay down this expensive debt you will be able to save 17-25% interest a year, you have the extremely expensive SMS loans with effective interest rate of hundreds of percent repayment of this debt will provide the best return you can get on your money and beat any mutual fund.
Save a buffer
You have paid down the expensive debt, now you can save a good buffer equivalent to 1-3 monthly salaries.
This buffer should you place in the bank, high-interest or regular bank account does not have much to say. This is not investment money, but will be your “insurance” against taking up new expensive interest-bearing debt in the future.
The savings buffer could cover crises that occur in the home, in your spare time or damaged assets, be it water leaks, car accidents, etc. If an unforeseen expense should occur you can use this buffer to avoid more debt, just remember to fill up the buffer again after use.
Pay down car loan, caravan, motorcycle loan, etc.
Get rid of more debt by attacking mortgaged and medium-cost loans such as car loans and boat, motorcycle, etc.
A normal level of interest rates on such loans is between 5 and 10%. Now that you’ve released more of your income by getting rid of your credit card debt or consumer loan, paying down the car loan will go even faster than expected.
Start saving in funds
You have gotten rid of expensive loans and you have a nice buffer on your account. Your payroll account is noticeably bigger month by month now that you have fewer and fewer downs – and installments to think about, now might be a good time to invest.
For example, start saving in one affordable index fund. If you have not saved in funds in the past, saving and fund services such as LendGet Finance will be a good resource for learning more. Start with a low-cost index fund that follows the stock market level over time.
Have a goal of being able to save 10% of your monthly income. Now that you have no down – and down payments other than mortgages and a possible student loan, saving 10% will be fully feasible, but if you thought it was a bit much, you can start with, say, USD 1000 a month. Try Kron’s saving robot.
Pay off extra on the mortgage
Regardless of whether house prices go up or down, repayment of the mortgage will increase your security. A down-paid, or low-mortgaged home will be a solid security in case you lose your job, become disabled or if interest rates rise.
While you spend 10% of your monthly savings and investment income, you can use excess extra funds to repay the mortgage.
Get rid of the student loan
The student loan is not among the worst debts one can have. This is due to relatively low and stable interest rates and because you have to give up the loan in the event of death or disability. However, there are still debt and monthly installments that you can spend on something else.
If you now have a comfortable loan-to-value ratio on your property or maybe even a down payment, you can now aim for your hopefully most recent debt.
Save, give and live life
By the seventh stage, you are hopefully now debt free and with a repaid (or very low mortgaged) home. Without any down or down payments, you can now spend all your money on three things:
Save and invest them. Give them away. Use them for consumption.
Feel free to use this debt overview to keep track of your debt and financial development month by month, year by year. This is a slightly nicer version of my personal debt overview that I have used over the past year to see the development of debt and loans over time.