It seems like every other meeting we have with new clients, we get the same question: "Should I invest, or pay down my credit cards?"
It's a great question that most people probably know the answer to, but they ask anyway. Why? They're hoping we'll tell them something different.
Here's the general rule: if you can earn more interest by investing than your debts are costing you, then investing makes sense. But can you earn more on your investments than the interest rate on your credit card?
Probably not, unless you're Warren Buffett or Gordon Gekko.
So, why do so many people choose to invest instead of paying down debt? It's your human behavior and emotions' fault!
The Psychology Behind Our Choices
There are about a dozen human "biases" that make us WANT to invest instead of paying off debt.
Here are a few:
- Optimism bias: We overestimate potential investment returns while underestimating the impact of compound interest on our debt.
- Present bias: We prefer immediate gratification (potential investment gains) over long-term benefits (debt reduction).
- Loss aversion: Paying off debt feels like "losing" money, while investing feels like gaining.
- Social influence: There's more social prestige associated with investing than with paying off debt.
These biases often DISCOURAGE you from choosing to pay off credit card debt. Things get even worse when you involve friends and family. You probably have a friend (or two) who love to brag about their investment returns.
But how many friends excitedly tell you about their credit card debt payoff?
Investing is exciting and fun, while paying off debt is hard and boring... or is it?
Reframing Debt Payoff as Investing
Paying off debt might not have the immediate glamor of investing, but it has its own satisfaction and long-term benefits. Imagine the relief of seeing your credit card balance drop to zero, and the freedom of not having to allocate a chunk of your income to high-interest payments every month - now that's exciting!
Paying off high-interest credit cards is like investing because:
- It's a guaranteed return: You're earning a "return" equal to the interest rate you're no longer paying.
- It offers high rates of return: Credit card interest rates are often 15-25% or more. Try finding investments that consistently offer such high returns!
- It's tax-efficient: The money you save by avoiding interest payments is effectively tax-free.
- It improves your financial health: Paying off debt boosts your credit score and overall financial stability.
- It reverses compound interest: By paying off credit cards, you're avoiding the negative compounding effect of debt.
- It's risk-free: Unlike most investments, paying off debt carries no risk of losing your principal.
A New Perspective on Investing
Often, just changing your perspective about what "investing" really means can make paying off credit cards more exciting. If you paid off a $5,000 credit card, you could brag that your $5,000 investment just made you a $1,250 gain – that's a 25% return!
Paying off debts leads to a more stable financial foundation, where you can then invest with greater peace of mind. It can improve your credit score, opening up opportunities for better interest rates on mortgages and loans. Plus, it reduces financial stress, positively impacting your overall well-being.
The Bottom Line
While investing might seem more appealing in the short term, paying off your credit card debt is crucial for long-term financial health. It's about finding balance and understanding that sometimes, the most exciting financial moves are the ones that set you up for future success.
Next time you're faced with this decision, consider the peace of mind and financial stability that comes with being debt-free. It might just turn out to be the smartest investment you ever make!
