Should You Pay Off Debt or Invest? FIRE Logic
This has been a question that's been weighing on my mind lately. Today, my husband and I have two large debts: a car loan and his student loans. I've been trying to weigh what our best strategy is towards these. Should we pay these off quickly or use some of the money to invest instead. We already have existing investments in retirement accounts, a 529 plan and taxable accounts.
Those in the FI/RE community will probably have a different way of looking into this.
Peace of Mind
A part of me wants to pay off debts for peace of mind. I would love to not have to think about the two open debts we have. In the grand scheme of things, these aren't necessarily large debts, but still they weigh on my mind. In the Energy of Money, Principle 9 talks about "Making & Keeping Promises". These loans are open promises that we have made and it is necessary that we pay them off to ensure a good flow of money energy.
Our car loan is 12 months from being paid off. I'm excited for that day to come, but I'm also trying to see if we can do it much sooner. The interest rate is fairly low, but still it weighs on my mind that a few hundred dollars are going to this car every month. For about 4 years, I didn't have a car loan and it was the best thing in the world so when we finally decided to purchase a car, one that we knew would last long, we wanted to put down a significant down payment. Now, it's not a fancy car, but it works for us and I cannot wait to downright own it. I think in hindsight too, I would choose to buy a used car just to have that depreciation already accounted for. Though in my last KBB check, our current car is worth triple what we owe on it so that's nice.
The second loan is my husband's student loans. It is significantly higher in terms of interest rate and amount so it's something that I want to tackle. Strangely, a few years ago, I would have left this loan to him since it wasn't my expense to begin with, but I'm realizing that this Journey to Financial Independence is for the both of us, so this loan is now both of our responsibility. I think that's a sign of maturity right there, but also a sign that we have the same goals in mind.
Currently, we are overpaying the minimum on both loans, not by a significant amount, but enough for a well, even rounded number. Every single dollar helps to reduce the interest accumulation and get us faster to Debt Free Living.
I'm also thinking about Opportunity Cost on multiple scenarios:
Instead of paying off these loans, could we instead use them to invest? Since the interest rates on these loans are fairly low, could we instead make the minimum payment and use any additional money to purchase an investment that has a rate of return higher than the interest rate of the loan? This is very possible. Of course there are some risks associated with it.
What can we be doing with this money once we are done paying them off? Even though we are a year out from completing the car loan, I want to start thinking ahead because this will be a significant amount of money that we will gain back each month. I also want to be prepared in case we do end up paying it off early and want to make sure things are automated before we spend the money on something else.
The mental energy thinking about these loans are also weighing on me. What's the opportunity cost of me calculating these debts and writing about it? Could I focus my energy on something else more productive and more valuable in the long run?
We really have to sit down and understand what debt does to us. What it costs us, not only in terms of money, but in terms of time and mental energy.
The Greatest Secret Between Debt and Wealth
The Wealthy Account just published a post called The Greatest Secret Between Debt and Wealth. He does a great job of articulating why eliminating debt is the most important for building wealth. I kinda agree with him on this but of course, he articulates it so much better so I've quoted him below.
Here is the secret if you were distracted by the bright lights:
If you have no debt you start each day with a clean slate. You own nothing to anyone as you start your day. You still need to take action to cover your daily needs, but at least you are not behind before you start.
The secret again is:
Without debt, but with investments, interest accrues to your account before the coffee is brewed. Dividends were earned, wealth created.
The secret again:
Investments in interest baring accounts build slowly, yet daily. Investments in index funds means virtually every purchase by every man, woman and child added something to your nest egg. Each sale added to the coffers that pay you dividends. Each sale adds value to the companies you own in the index fund. Each sale is part of the wealth creation process.
- The Wealth Accountant
So there it is, the most important action is to eliminate debts as fast as you can. The sooner you can pay off debt, the sooner you can wake up with the clock ticking forward and reclaim the life that you want to live. So onward to getting these debts off the books as quickly as we can and start each day with a clean slate.