Should I Pay Off Debt or Invest?

Good morning fellow wealth builders! A couple of weeks ago, we covered emergency funds in detail (I had two newsletters covering it, so much detail it took 2 newsletters!! The main jist of it was before you begin investing, you should set some money off to the side to have on hand in the event of an emergency. This way, you don’t have to sell your investments if something comes up and you need to access some funds. Well, the emergency fund is only step one in wealth creation.

What’s the next step after having an emergency fund?

After creating and funding my emergency fund, I would want to look at all my outstanding debt and shift my focus to paying off any HIGH INTEREST debt. I am talking about rates over 6-7%, these are what the finance community start to consider high. Often times this includes any car loans from buy here pay here places, personal loans, and credit cards.

The reason is because you have interest working AGAINST YOU. Say I had a $10,000 personal loan at a 12% interest rate. We’ll keep it simple and ignore compounding interest and say that I’d owe $1,200 a year just in interest on this loan. I got a big bonus at work and instead of paying off my loan I put the $10,000 into stocks thinking I’ll just invest this money and use what I make to pay off my loan.

But… the stock market returns 10% a year on average…. so out of my $10,000, my investment would grow approximately $1,000 in that first year.

You don’t have to me a math expert to know that $1,000 is LESS than $1,200. This plan will most LIKELY never work because the loan in the example is a high interest loan. It's a basic number this 10% will ALWAYS be less than 12%. Imagine if the $10,000 was with a credit card getting charged 25% interest, my $1,000 investment gains don’t even come close to the $2,500 I’ll be accumulating in interest. In a situation where I had high interest debt, I would not be investing any money and instead focus on getting rid of that “bad’ debt.

Not all debt is bad though…. say my only debt was a $500,000 house at a 3% interest rate. Would I focus on paying this debt off before investing? Absolutely fucking not. In my eyes, that is basically free money.

I know you want to think “oh but its $500,000 its better to pay of the loan even at 3%, because the loan is for so much money.” Nope. However you want to think about it, 3% will always be less than 10%. If I can borrow money at 3% and use it to earn 10% by investing, then I can use the money I make to cover the cost of borrowing and still keep 7% in my pocket. Don’t complicate it more than it needs to, just take a step back and look at the numbers objectively.

What I described is called a carry trade and it’s something you see a lot in real estate. The reason is because investors can take equity out of their properties, at a low rate, and it use it to acquire another property that will make them money at a higher rate than what they just borrowed at. It’s the reason that 90% of millionaires own real estate. If you want to learn more about real estate investing, I’m co-hosting a free class tomorrow night with former financial advisor Jaime Ramirez. We will be covering real estate investing 101, taxes, and how you can get started even if you don’t have any money. You can register for free here.

If you’re anything like me, you may have always been taught that debt was bad. To avoid it as much as possible and always use cash or debt instead. But in business school I was taught that the wealthy actually use debt to become wealthier, and working with Jaime has allowed me to see this first hand. As someone who wants to create wealth and break the cycle of poverty, I had to let go of just about everything I was taught about money - especially debt.

I hope you found this valuable 😊Not all debt is bad debt and not all real estate is a good investment. Any of you interested in becoming real estate investors I hope to see you at the training tomorrow, you can register here.

Neyra