I have a job, I'm investing in my retirement, I have an emergency fund, and I have a non-retirement investment portfolio. But, here's the reader's question...I have some credit card debt and an auto loan. Should I use my non-retirement investment portfolio to pay down my debt?
These kind of financial decisions are complicated because they involve multiple factors. The first is an assessment of risk and financial priorities and second is a little bit of financial math.
I always start with the risk assessment. Before you make any money decisions you should make sure you have the minimum safety nets in place. In my opinion, that means you have a couple of months of income in a savings account and you've started to contribute to a retirement account. In this case, it sounds like those basis are covered so let's move to the math.
Interest rates are the key to many of the personal finance decisions you will make. Whether it is lowering your mortgage, negotiating a better credit card rate, or picking the right savings option--comparing interest rates is a key factor. In this case, you are comparing the compounding affects of interest rates. With the debt that means how much the creditor will add to your debt. With investments it means how much you are expecting to add to your investment. Notice the key difference in these statements--for debt it is a guarantee, for investments it is a guess. Keeping that in mind, I would look at the decision like this:
- Use a reasonable estimate for your investment rate of return
- List your current interest rates on credit cards
- List your current interest rates on the auto loan
Here's my guess on this question, without knowing all the specific numbers: The investments (assuming mutual funds or stock portfolio) can be estimated to make a 6-8% annual rate of return. Meanwhile, on the debt side the credit cards are probably ranging from 13-19% and the auto loan is between 3-6%. Therefore, by quickly eyeballing the numbers you can see that trading the investment income for the credit card compounding debt is going to put you ahead. In contrast, you are probably better off staying the course on your auto loan in the short-term. Of course, this advise is only considering the straight math and some limited assumptions we have developed on other aspects of this persons financial situation.
Get Back On Track
If you are in this situation it is so important to make it a one time decision. You don't want to end up in this position again, trading investment income for debt pay down. You'll never get ahead. My recommendation is to make sure you know why you ended up with the debt. Make sure that you have fixed that problem. Then make the (one-time) correction and get back on track with a long-term money plan that gets you to bigger goals.
What do you think? Is that good advice? Have you been in a similar situation? What did you do? Let's discuss it in the comments...
Get more ideas on how to build your stash of cash at YourMoneyDrawer.com.