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Question:


Should I pay off all my debts before I start investing?
-DonnaWilliams


Answer:


Paying down debt that accrues at any given interest rate is equivalent to putting the money in an investment with the same rate of return. If you owe $1,000 on a credit card that charges 15 percent, paying off the balance will save you $150 in interest after one year. An investment that you make in a stock, bond or other asset with that $1,000 would have to earn 15 percent to produce the same $150 benefit that you would get from paying off the card. Whatever interest rate your debt carries, it’s probably close to impossible to find an asset that offers the prospect of a similar return with no risk, so paying off debt before investing seems like a prudent move – at first.

It’s not that simple for two reasons. If you invest in a retirement plan like a 401(k), there are tax breaks and often employer contributions that make the effective return on your investment far greater than even the most onerous interest rate that you’re likely to be charged on your outstanding debt. By putting money away for retirement, you also reap the intangible benefit of cultivating the habits of thriftiness and setting and executing long-term financial plans. That’s the second reason not to pay off all your debt first. Financial advisers often encourage clients to set a range of priorities – debt payment; charitable giving; saving for retirement, a vacation, a down payment on a home – and contributing some amount, no matter how small, to each one. It allows them to feel a sense of accomplishment toward each of several goals, and before they know it, they find that they’ve built up significant savings.

-Conrad de Aenlle



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