Every time a relatively spare chunk of money comes our way, we’re gripped by the same dilemma: should I pay off my debts first or should I invest? It’s a complex question that you should look at from many different angles. Depending on the type of your debt and your situation, the answer can go both ways.
Here’s our practical list of questions that will lead you to an unbiased decision.
What debts can be OK to ignore?
British consumers alone have racked up over £200bn debt, and data shows that personal debt is once again on the rise. Consumer credit, which covers debt like auto loans, credit cards and personal loans, is rising almost 10% a year, while wages are dropping at 0.4% a year, taking inflation into consideration. It seems that not only have we learned to live with debt, we no longer know how to resist buying stuff that we can’t afford.
But is all debt bad? If you’re like thousands of conscious savers around the world, you know that investing early is key to building a strong and diversified portfolio. Yet, if all your money goes to repaying debt, investing is hardly possible. While it’s generally a poor idea to invest while anchored by debt, there is a handful of situations when rules can be overlooked. Let’s explore some of the scenarios that make investing while in debt an OK decision.
#1. If you have a mortgage with a decent interest rate. For most of us, buying a property almost always means being locked into a 25-30-year debt sentence. Does that mean property owners should not invest? Absolutely not. If you have a mortgage with a low or fixed interest rate, it’s okay to start investing while keeping that debt. However, for those who are paying a high-interest rate or have a balloon payment (that’s when a significant amount of credit is deferred to the final payment), investment is too risky of a move - pay off your debt first and start investing after that.
#2. If you have a personal loan with ultra-low interest rates. It could potentially be reasonable to invest while keeping that debt. However, read your loan agreement carefully to ensure that the interest rate will not rise at some point down the line because such unexpected expense could push you into even more debt.
If you have a drawer full of maxed out credit cards, it’s another story. Let’s look more closely at ways of juggling the interest rate on your debt and potential returns on your investment.
What’s the interest rate on your debt?
You want to invest your spare cash so that it can go on to make you more money. But if the interest rate on your debt is higher than what you can reasonably expect to earn on your investments, than investing makes no sense as it would put you into more debt. The first thing you should do is audit your current debt repayments and calculate the interest rate on the total amount of debt. Once you have your figures on black and white, it all boils down to whether the interest rate on your debt is lower than expected returns.
At Fast Invest, our customers are bringing in 8% to 13% returns a year on their investment in consumer loans. That’s a significant amount of money that can either be withdrawn every month or reinvested in other loans. Depending on how much debt you have accrued and the monthly repayment costs, you might get away with investing your spare cash in P2P loans or another profitable product and hitting two birds with one stone. However, if the interest rate on your debt is higher than the potential returns, you’ll be going backwards and actually losing money.
Last but not least, think about getting a balance transfer card. Provided you’ve been paying on time, and your credit history is in good shape, you should have no trouble moving your current credit to another credit card that offers a low or 0% deal. This would allow you to pay off your debt faster while also making a significant saving on interest rates. You can use Which? balance transfer calculator to shop around for the best deals.
Do you have an emergency fund?
Whether you’re debt-free or have a high-interest debt, putting a fraction of your spare money into an emergency fund can be the one thing that will save you next time your finances start spiralling down.
The Aviva report has found that low-income families in the UK have just £95 in savings and investments. The same report shows that payments on debt are likely to be eating into people’s saving power, as families are spending £216 a month on debt repayments. An insurance giant Legal & General have found that an average employee has only about a month’s savings to maintain their lifestyle if their income suddenly stopped.
We live in a rapidly changing world, where instability and financial insecurity is part of the daily hustle. Making sure you put aside money every month won’t put you at ease completely, but it will give you the peace of mind you need to get through any hurdles that come your way. Handling your finances responsibly is a habit. Once you train yourself to save money every month, you will quickly notice a huge difference in the way you manage your income.
How to prioritise your investment
If having weighed up your risks and impacts versus potential returns you decide to go ahead with investing, there are several investment vehicles that deserve your consideration.
First of all, aim for middle-ground. Leaving your money to sit in a savings account is not ideal. MoneyFacts show that the average return on a five-year fixed bond was 1.93% in September 2017, while the average five-year fixed ISA offered 1.68%. Even the worst 10-year return for a well-balanced investment portfolio is just above 2%. To ensure that risk-taking pays off in the end, choose an investment product that has a strong track record and offers a robust earning opportunity, but at the same time poses manageable risks. Low-entry investment options, such as peer-to-peer loans or pension funds, offer more control over your investment and greater long-term profits.
If you have a higher tolerance for risk and would rather gamble with a prospect of winning than watch someone else win while clutching your money safely in your pocket, then making the debt vs potential returns calculation is guaranteed to nudge your decision one way or the other. But the truth is, there is no clear-cut answer as to what you should do. One of the best ways to approach this situation in case you can’t settle on a decision is to default to a 50/50 split. Put 50% of the extra income you have towards investments and 50% towards paying off debt.
Use fintech tools to balance saving and investing
Do you ever wonder how other people seem to be on top of their finances all the time? They’re buying properties, going on luxurious retreats, actively saving for retirement, maybe even building a house… All that, while your savings amount to nothing at the end of the month. What’s the deal? The secret to staying organised and keeping track of your money is in making good use of the available tools. Here are some of the most popular fintech products that can improve your saving and investment efforts.
Acorns is a micro-investing platform that allows you to have a diversified investment portfolio while investing as little as $5. The app requires you to connect your card and spend like normal - they will round-up your purchases to the nearest dollar and invest your spare change.
Mint is a budgeting app that helps you track your balances and pay your bills, all in one place. The budgeting feature automatically allocates budgets for recurring expenses based on your past spending, so you can get a more realistic overview of your balances and stick to your budgets.
The Plum app describes itself as the savings butler we all need. It monitors your spending, automatically sets money aside for you and is always available on Facebook Messenger. Once you connect your bank account, Plum analyses your transactions and learns about your spending so that it can put money aside automatically.
Finding the balance between debt and investment
Easier said than done, but striking a balance between debt repayments and investing is the best way forward. Differentiating between good debt and bad debt (yes, not all debt is the same) will allow you to remove barriers keeping you from making money. Bad debt can really stall your investment plans if the compounding rates are higher than potential returns. Look into strategies like credit balance transfer to try and pay off your bad debt faster and save on interest rates. Once your debts are manageable, you can apply the 50/50 rule, splitting extra cash between repayments and investments.