Pay of your loans

Investments and loans are two sides of the same thing. Together they will form the basis for your net worth. If you want to have a rich future you will need to manage both your debt and investments in an equally skilled and well planned manner. Debt allow you to leverage your investments and earn more money. As such it can be a very useful tool. But debt can also be very dangerous if you do not managed it well or if you assume debt for the wrong reason.

It is important to remember to only borrow money when you can put it to good use. It is also important to remember that the best investment can sometimes be to pay your debt down and de-leverage your investments. You can read more about when this is a good idea further down on the page.

Should you strive to be without debt?

No, debt can as earlier mentioned be a very powerful tool if used correctly. It allows you take advantage of opportunities you might otherwise not be able to take advantage of. It allows you to leverage your holdings in such a way that you can earn more money on your investments. It is very important to remember that leverage work both ways and while leverage can be very profitable in a bull market it can also be very damaging in a bear market. It is very easy to loose an entire position if that position is leveraged too high when the market moves against you.

I do however think hat you should try to keep your personal debt. Debt that is tied to personal consumption rather than investments to a minimum. It is good to borrow money of you need working capital. It is a bad idea if you just want to buy a new TV.

Invest or paying of loan?

You should always considering paying of your loans as an alternative to investments. Paying of your loans can give you a good completely risk free return. This return consist of the interest rate you no longer have to pay.

Lets look at an example:

You have 5 000 USD to invest and you are looking for the best opportunity you can find.

You also have a 7 000 USD credit card debt. The debt carries an 14.99 APR interest rate.

In this situation it is a very good idea to pay of your debt. This gives you the equivalent of a 14.99% completely rick free return. It is very hard to find a low risk investment that gives you a similar return. This is due to the fact that a dollar saved (by not paying interest) is worth just as much as a dollar gained. An added benefit of paying of debt is that you know exactly what effect this will have on your future economy. You are not at the mercy of future market developments. You lock in the benefits the moment you pay down the debt.

I generally recommend that you choose to pay of your debts whenever you have debts that carry an interest rate that is 5% higher then the national rate set by the central bank. If you have a cheaper loan than that then it usually worth investing the money instead of paying of your debt.

This is only a general guideline. The best course of action in your particular case can differ.

My friend who recently paid of all his personal debt was recently telling me about another benefit of paying down your loan. The calm and sense of liberation that comes from getting out of debt. He was telling me how that gave him a new financial confidence that have allowed him to invest better and save more money than he ever though possible.

Another benefit that you gain if you choose to pay down your debt is that you lower your overall economic risks and become more prepared for a down turn in the market.

You should never use your money to pay of your debt if you have no cash buffer. If you do not have a pre-existing buffer then I do no recommend that you use the money to pay of your loan. This make you vulnerable to unexpected expenses. Always establish a buffer of easily liquidated assets before you pay of your debt or make other investments.