Should people invest when they have credit card debt?
Our society is addicted to the idea of easy money – I get that. Heck, I only really became interested in personal finance when I saw how compound interest could allow me to work 4,000 or so less days in my life – with a much higher standard of living to boot. The only problem is that this pursuit of easy money is complicated by our irrational behaviour. This often results in people making uneducated decisions that are completely irrational when they have the simple information they need right at their fingertips.
Basic math isn’t really a suggestion
The perfect example of this is when people ask me (or post on forum boards) what they should be investing in, and then go on a few sentences later to talk about their credit card debt. I’ve even noticed several personal finance bloggers out there making charts proudly showing off theirmeagerinvesting portfolios only to find an article lower down on their page about how they are focusing on paying off their credit card “a little at a time”.
The one caveat I will toss in before I throw down the gauntlet is that if you have an employer-match pension plan, I can see why you would put that above paying down debt in certain situations. Other than that scenario – these people are INSANE! Yes, that level of ridiculousness does deserve the Caps Lock treatment that has become all-too-common on the internet. Ignoring a debt that carries an interest rate of 20-30% in the hopes that your long-term investments can return 8-10% is completely irrational/crazy.
Not all debt is equal
Student loans with relatively low rates of interest (prime + 0 for several provincial student loans now), where that same interest is tax deductible are a different matter, as is a mortgage. There is probably even an argument to made for investing at the same time you pay off low-interest loans or lines of credit that are at all-time lows. Rational people can disagree on these points, but I don’t personally believe that all debt needs to be paid off before someone starts investing – only debt that has interest rates above what one can reasonably expect to earn through long-term investments.
If you offered most investment-educated people risk-free, tax-free investment returns of over 8% they would snap that up in a heartbeat, so that’s probably a pretty good benchmark for when you start to become counterproductive by investing instead of paying down debt.
You’re poorer than you think
Sorry if this all seemed a little generic or basic for some of you more advanced readers out there, it’s just the amount of relatively smart people who have been asking these sort of questions around “RRSP time” (didn’t you know that you could only contribute to your RRSP when your investment advisor comes to see you in February once a year?) has. Likely much of this conversation is driven by investment advisors who are looking to make some bank. Long story short, the advisers will make a nice commission on any new investments you make, but won’t make a dime off of you paying off your ultra-high credit card debt – so guess what advice they have more incentive to give? That’s another debate for another time though I suppose.
For now, if you still have credit card debt do yourself a favor and cancel your subscription to “Stock Picking Weekly”, quit watching “Mad Money” with Jim Cramer, and stop reading investing blogs written by dudes/dudettes who are either smarter than you, or (more likely) just lying. Keep it simple – pay off the damn credit cards before you worry about becoming a millionaire!
It’s really weird to see people bragging about their investment portfolio indicating that they’re earning and yet they have debt that grows an interest of more than that what they are earning.
You alluded to a key point, but it can’t be repeated enough:
Unless it’s in a TFSA, you pay taxes on any returns your investments make. (My rule of thumb for quick tax estimates is usually 1/3 of the gain. So your 6% return is really only netting you 4% after the taxman gets his cut.
Paying off debt principal is tax free, and saves you the full amount of interest.
Like the author says – do the math first, and know how much you really will bank in the investment. (It astounds me how many people don’t know their tax rates, btw)
I agree that one should get out of consumer debt first before investing but like you mention not all debt is considered equal. I also believe that if one has an employer handing you money on a plate in the form of a pension matching scheme or RRSP’s, anyone would be a fool not to take it. There are many people who opt out simply because they just don’t know any better or can’t afford that extra cash from their pay.
I have a defined benefit pension plan, and RRSPs, two mortgages! and credit card debt. I opted NOT to invest further in my RRSP and not to pay off my debt, and use some equity to buy another home, a rental property which makes $700/month more than it costs. I also live in an area that has a good real estate market. I also drive a 5 year old car, which is finally paid off. My plan is to use my car payment money and pay off my credit card debt. My car will easily last another 5 years as I have been taking good care of it, so I am very hopeful that my financial picture will be much brighter in 5 years. By then, another investment property will perhaps be possible. Some people call me crazy. But hear this …
My ‘investment advisor’ (and I use that term loosely) has tried to get me to borrow anywhere from $25,000 to $50,000 to sink into RRSPs (at 5% interest) which would make 0-2% if it performs ‘as good’ as the rest of my portfolio. Now – in my mind – THAT is crazy.
At least with my little scheme I have some control of the situation. With RRSPs … None.