Debt and Investment: How to Prioritize Your Allocations

on Dec 5, 2016
Updated: Sep 17, 2019

The ideal investor has Zero debt and unlimited growth potential in well diversified assets. But few people are ideal investors. Most of us enter the investment arena still lugging around a little financial baggage. For some it’s student loans, for others it’s credit card debt, with lots of other variations besides. There are ways to consolidate debt through online lending and other methods, but first we’ve got to understand the priority system we’re going to use.

The problem for many would-be investors is the knowledge that time is one’s best friend when investing. Most investors can count their remaining decades of life on one hand, so the time to start maximizing investment allocations is now. But then there’s that debt. So should an investor focus solely on debt before investing, put money into both to give the investments that greatest amount of time to grow, or put every spare dollar into investment and just cover the minimum payments on the debt? The answer, it turns out, isn’t the same for every person.

The answer you will decide upon depends entirely on the sort of debt you have. Debt comes in roughly three types, for our purposes: Affordable, Manageable, and Unaffordable. The amount of debt you have in each category will determine how you should attack your debt and allocate for investments.

Affordable debt is the kind that you have to have to make a good life in the world. This might include a mortgage, student loans, and some kind of vehicular loan or other. Mortgages and auto loans are usually well below 5%, though car loans can be higher depending on the loan type you select. Student loans are almost always below 10% APR and often under 5%. This is the money that you lose each year, to pay for the privilege of borrowing this money. It’s the inverse of investment, actually. When you invest, you are letting corporations borrow your money. As they grow, they give it back to you as the value of the company grows. You should invest in investments that will grow faster than your debt. So if you have money invested in the Total US Stock Market and you are expecting annual returns of 9%, you can do that all you want if you only have a mortgage loan at 3.625%. The investment will grow faster.

If you have higher interest debt like credit card loans, these will either be manageable or unaffordable. Let’s say you have the best credit score on the planet and you have a credit card that needs to be repaid at 12% interest. This is very good for credit card debt, and can be considered manageable, as long as you are maintaining the payments. Anything in the 20’s and 30’s percents is unaffordable. If you have debt like that, cancel all your investment plans until it is paid off.

Of course, personal reasons can outweigh some of this logic. If you have a house, for instance, it may be mentally rewarding to pay it off completely before investing seriously in stocks. You can do what you want, but always be aware the the numbers can tell you the most sensible course.

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