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Paying Off Debt: A Guaranteed Return

If I offered you an investment with a guaranteed return of 15%, would you invest? Honestly, I hope you initially said "no" because you should be suspicious. Suspicions aside, my guess is that you would figure out a way to invest as much as possible in this investment opportunity. Who could resist? This is a higher return that what the S&P 500 averages (abot 10% per year), and you have to handle a lot of risk to get that return.


Here's the thing, though, if you have any debt, paying off that debt is the same thing as getting a return on an investment equal to your interest rate.



Believe it or not, getting paid interest and not having to pay interest are the same thing.


Debt has many meanings, so let's explore some of the ways in which we owe money.


Credit Cards


Some of us have credit card debt. The average credit card interest rate is north of 15%. Paying off that debt will earn you 15% because you won't have to pay that interest anymore. This is among the easiest decisions for us; even most who aren't in the personal finance industry would agree that paying off credit card debt is a good investment. What about some other debts that aren't so obvious?


Car Loans


What about car loans? Car loans have lower interest rates (typically) than credit cards. Wouldn't you be better off keeping the car loan and investing any excess money in the stock market?


Yes and no. This, like so many topics in personal finance, comes down to your comfort level. Just because there are people who would prefer to invest rather than pay off a car loan does NOT mean it's right for everyone. I want to make sure you have enough information to make an informed decision.


Many assets we buy we expect to go up in value. Think about houses, investments, antiques, and so on. Assets that are expected to go up in value are called appreciating assets - they are expected to appreciate. There are other assets we buy that we know will go down in value, including cars. There are many situations where it makes sense to take out a car loan, but an investment isn't one of them. Consider this, by taking out a car loan we are effectively borrowing money to buy something we know will go down in value. A better plan is to save for the car - think of it like a car payment to yourself. This way to earn interest instead of pay it.


Besides, after you pay off a car loan, you will have more cash flow that you can invest if you want to. Paying off a car loan, no matter the interest rate, is a guaranteed return.


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