Pay Off Debt or Invest? Think About Your Rate of Return

Andrew writes in:

My girlfriend and I bought a home last year and qualify for the First Time Homebuyer Credit. When you include my share of this, I will be getting back around $4500 in my tax refund. This is a lot of money to me and I’m trying to decide what to do with it. About half will go toward an engagement ring, but I’m torn between investing the other half or paying off my $2,000 in credit card debt. I currently have a very low APR on the credit card and can pay more than the minimum each month. As a licensed broker, I am very involved with the markets and believe I can make 10-15% a year. If I can get a higher percentage return on the investments than the APR I pay on the card, doesn’t it make more sense to invest?

In essence, Andrew is comparing two rates of return here.

First, there’s his credit card. An investment in paying off a credit card has a guaranteed rate of return – the interest rate on the card.

On the other hand, there’s the stock market. An investment in the stock market might have a higher hypothetical payoff, but it’s not guaranteed at all.

Regardless of whether the year was 2008 or 2010, paying off a 9.9% credit card will net you a 9.9% annual return on your money. Alternately, if you were able to get a 10% return on your stock investments in 2008, you were an absolute magician.

The reason that the standard advice is to pay off your high interest debts before you invest is because paying off high-interest debts is a far better investment than the stock market. Why? That rate of return is guaranteed – no stock market investment is ever guaranteed.

Here, Andrew might argue that he can invest in the stock market and return a bit better than average. That may or may not be true – we won’t argue that point here.

Even if Andrew can beat the market by 2% at any given time, his investment is still tied to the ups and downs of the stock market as a whole. In 2008, when many indexes lost 40% of their value, Andrew would have lost “just” 38%, for example.

Obviously, then, the investment Andrew is talking about is a long term investment, one that will likely pay off with a profit over a long stretch of time. If he can actually beat the market a bit, it’ll earn him a tidy return.

But that’s still not a good reason to throw money in in the short term.

Here’s what I propose, Andrew. Pay off that credit card debt, then cut up the credit cards until you can use them without accruing a balance. Then head down to your local bank and set up an automatic withdrawal from your checking account equal to the amount you were paying on the credit card debt. Channel all that money into your stock picking expertise.

If this is truly a long-term investment – and that’s when most people should invest in stocks unless they’re actively day trading – then it doesn’t matter exactly when you get into the stock market. Putting in a bunch of money now versus putting it in slowly over the next year makes little difference when you look at a fifteen year timeframe with unknown ups and downs.

Good luck.

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  1. Shannon says:

    Wow, LOTS of question and answer type posts this week…

  2. Kat says:

    Since he is getting an engagement ring, one would assume a wedding and honeymoon are not far off, and those are not usually cheap (even with frugal choices, or family paying, if anything, he may want to make the honeymoon extra special, for example). And they just bought a new house, they may want some nice new furniture for starting their married lives together or upgrade the water heater, or whatever else pops up that new homeowners weren’t expecting. My point is that there are a lot of uncertainties coming up for him, he should be sure that he has an emergency fund nice and strong. I would recommend paying off the credit cards, and then saving the money in some safe investments he could tap quickly if they suddenly decide to invite an extra 20 people to the wedding, or the roof leaks, or they decide to upgrade to a luxury suit during their honeymoon. While I am not saying that $4500 is not a lot of money, that he mentioned he thinks that is “a lot to me” is probably an indication that he doesn’t have a lot more sitting around to pay for all the extra expenses he is about to face.

  3. Peggy says:

    Trent’s advice is pretty much what I would say in the same situation — although pardon me while I recover from this bit:

    “About half will go toward an engagement ring, …”

    Considering that I got married for $46 and had a $250 reception, that comment made me hyperventilate… May I respectfully suggest that the engagement ring be scaled back or even skipped, and the money saved put toward the house, furnishings, etc., as Kat (#2) suggested?

  4. lurker carl says:

    You say $4500 is a lot of money? Your past actions and future plans for the tax refund do not reflect this. There is no mention of saving any of this money. It sounds like cash burns a hole in your pocket.

  5. J says:

    I don’t even know where to begin with this one. The letter writer sounds young, inexperienced and about to get himself wrapped up into a whole world of trouble.

    1. A $4500 tax return? If you are so good with money, why in the world are you giving the government a $4500 loan? That’s $375 bucks a month going to Uncle Sam. Uncle Sam needs that money right now, mind you … but if $4500 in a year is a “lot of money” to you, what would another $375/month be to you?

    2. Now, apply that same idea to the ball and chain you are carrying around. No, not your finacee — the credit card. Whatever mound of debt you are servicing is decreasing your agility to do things like invest — by bleeding away money every month. I’m also guessing there are likely student loans and car loans tied up here, too — taking away your agility even more. Not to mention the mortgage. And as already mentioned in the comments, a failed water heater or dishwasher is going to run you $1000 in a heartbeat. How are you going to pay for that?

    3. Single stock investing is about the same as heading down to the casino and plopping down some cash. A lot of my “sharp” friends spend a lot of time and money “getting rich quick” picking stocks. In reality, they ended up breaking even or losing money, in addition to spending hours watching stock tickers when they could have been honing their skill set, which would put them on a better road to financial security.

    4. I propose that you don’t touch another dime until you do three things. First off, talk to your future wife about money and what you want out of life, what you see for the future. If you don’t argue about something during this conversation you likely haven’t talked enough. Then read “The Total Money Makeover” and “The Millionaire Next Door” together. Then have another talk.

  6. Johanna says:

    If Andrew really is a stock-picking genius who can get an average return of 10-15%, he ought to be able to use this gift with other people’s money in ways that will net him a whole lot more than what he would get by playing the market with his own $2000.

    Also, what Kat said.

  7. matt says:

    I would shop around for an engagement ring, several thousand dollars is a lot of money to spend on one when you don’t have the money to spend so to speak. I would use the money as a seed emergency fund, now that you have a house you are now likely to have a house emergency that can cost that much or more. Long as you have a debt repayment plan in place, you could use some of this to accelerate this, but I would save as much as possible. I’m guessing you are a recent college grad based on thinking that 5k is ‘a lot’ of money. I used to think that way too, after having had a house and several emergencies that cost more than that I don’t feel safe without at least 10k I can liquidate within a week or two (as an example a new heating system will run you about 4-6K installed) If you were a really great broker and felt sure you could get the 10% return I don’t think you would have even asked the question in the first place.

  8. Kat says:

    J, it sounds like he is actually getting around a $500 tax refund, which is reasonable, since the homebuyer credit is $8000 and he is splitting it with his girlfriend (and that is a one time thing that makes it tough to adjust your withholding just the year for).

    Everything else you said I agree with 100% though!

  9. Thomas Strohmann says:

    Another thing to consider is that even if he gets a 10% return per year, once he sells the securities, he will owe capital gains taxes which can lower the after-tax return per year to maybe 7-8% (depending on his federal/state tax brackets and whether these are going to be short term or long term capital gains). Since credit card interest is not tax-deductible, paying off the credit card guarantees a 9.9% after-tax return.

  10. Maggie says:

    This is much more of a puzzle for me with my student loans though. I have lots of student loans that altogether total a little over $230,000. They have fixed interest rates of 7.65%, 6.55% and 1.75% and each interest rate applies to about 1/3 of the total. I’ve just finished with school and started working. After taxes, my 401(k) contribution, living expenses, and the frighteningly large minimum loan payment, I can send about $40,000 extra to the loan companies each year.

    I think paying off the 1.75% loans early would be a mistake since that rate is so low and for 30 years. But the other two piles of loans are more confusing. I’ve been focusing on paying off the ones that costs 7.65% right now. Someone said that every time I send extra money, it’s like I’m “investing it” at a 7.65% rate of return which is hard to get right now with the stock market struggling. So I’ve been send the loan company every spare dime. (Don’t worry, I have the emergency fund.)

    My problem is, I’m not sure if I’m missing out on investing it b/c most people think it’s safe to hope for at least an 8-10% return over 10 years. And if I do keep paying this portion off, next year is a harder decision about whether I should start chipping away at the pile with the 6.55% rate or let that sit and invest instead. My inclination is to pay back the loans as fast as possible because the loan payment is so big it freaks me out. But does anyone think I’m being too conservative and should just get used to it since my income will cover it?

    I’ve researched consolidation and it doesn’t that it will reduce my interest rate. Also, because of my income level, I’m pretty sure the student loan interest tax deduction won’t apply to me. One final factor is that these are all federal loans, so if I should happen to die, anything I haven’t paid off would be canceled rather than being deducted from my estate.

  11. Joanna says:

    I have a friend in a similar situation (we’re in our late twenties). He just bought a house with his girlfriend (who earns more than he does), and he will be in the market for an engagement ring soon. Knowing that they just took on a mortgage debt, I’d advise him to scale down on the engagement ring (no more than $1,000) since the money on the ring can be better spent on the house, wedding, honeymoon, etc. And he should pay off the credit debt if they are going to get married (and therefore be liable for each other’s debt). Consider being credit debt-free as another engagement gift to his fiance.

  12. MrzFitz says:

    ??ah how about put $1000 or $2000 in emergency fund, payoff credit card (and any other non house debt) and THEN save up cash for the ring. Save the investments for later. I’m sure since he is a licensed broker he wants to invest. It’s like going to a surgeon for a consult – usually they want to proceed with surgery. It’s just what they know and do! But taking care of his foundation and keeping a safety net at home is much smarter, low risk and will be a much better gift to his wife-to-be as they sleep easy at night with a security blanket of less debt and a savings cushion. Is it as exciting? No. Save that for a little bit later and then have a blast with it!!

  13. J says:

    @Kat — thanks for the explanation. I guess from having lived through my 20’s I’ve heard this very similar story sooooooo many times it’s not even funny. Now that we are closing in on being debt-free (except for our mortgage), it’s amazing to me to think how we used to “accept” living with debt service being such a large part of our income. “Conventional wisdom” really seems to be quite the oxymoron when it comes to consumer debt!

    (I just wish I had known this and not dug a hole so deep when I was younger!)

    Also another thing to think about is taxes AFTER marriage — I recall the first time we filed after being married owing a pile of money. That was NOT pleasant.

  14. Johanna says:

    @Maggie: If having a big loan freaks you out, then pay it off. The thing you want to maximize is your emotional well-being, not your net worth.

  15. matt says:

    @#10 Joanna or even less, maybe $500 you can always trade the ring in for an upgrade as an anniversary present 5 years down the road. Or get her a new one when you _can_ afford it.

  16. Des says:

    @Johanna #6 – I think it is reasonable to assume that Andrew IS doing this with other people’s money, since he says he is a licensed broker. And really, if that is what you are doing professionally I think it is prudent that you have “skin in the game.” He says he has a very low interest rate, but does not give specifics and Trent assumes this to mean 9.9%. I wouldn’t classify 9.9% to be “very low”. Under 5%, max. If that is the case, I think Andrew makes a good point. He is knowledgeable about the markets and starting with $2,500 to get your feet wet is a good way to learn what it feels like to invest with your own money.

    I would also add my voice to the chorus of people that think that if $4,500 is “a lot of money” to you, you really have no business buying a $2,000 engagement ring. Try $500.

  17. Leah says:

    I like Trent’s advice here except for nothing written about the engagement ring. Unless you’ve already earmarked and saved that money from your paycheck, I don’t think that’s a good purchase. I’d talk frankly with your soon-to-be-fiance (and perhaps some family members) about ring expectations, heirloom rings, and scaling back the ring.

    I’ve already told my boyfriend that I will be unhappy if he spends more than a few hundred on a ring. The only reason I say as much as a few hundred is that I’d like a ring made in the US, by artisans, using fairly sourced materials, and that adds up a bit more. Turtle Love Committee and Etsy are two great places to get those kinds of rings and not break the bank.

    Otherwise, I’d definitely pay off that credit card, and I would put the rest toward building up a strong emergency savings account.

    I’m getting about $1,000 back from taxes (not foreseen — thank you earned income tax credit, poverty, and my emergency savings account for making sure that I didn’t need unemployment nor welfare). I plan on putting most of that into my high-yield savings account to replace the $1,000 “loan” I made myself this month to make ends meet. Hopefully, I’ll have a job soon and not have to reloan myself that money.

  18. Jason says:

    The answer should be:
    Pay off debt. 100% no question.

    All you have to say is RISK. Guaranteed ROR on debt plus you’ll lose the stress of it. Then DON’T go into debt again!! :-)

  19. Anastasia says:

    I have worn my engagement ring every day for 7 years, and I plan on keeping wearing it for the rest of my life. I think the $2400 that my husband spent on it was well worth it. I wouldn’t advise someone to spend way more than they can afford, but don’t skimp on a piece of jewelry you want your fiance/future wife to treasure forever.

  20. Spreadsheet Man says:

    Here’s a spreadsheet showing what happens if you pay off your debt whole hog and then go after your retirement vs. doing both at the same time. You can play with rate of return, etc.

    See it:
    https://spreadsheets.google.com/ccc?key=0Ar6zgIsMeEJkdGVtTmFQZjlwb2VpY001MGdUc081UXc&hl=en

    Download it:
    http://spreadsheets.google.com/pub?key=temNaPf9poeicM50gTsO5Qw&output=xls

  21. JS says:

    @Maggie –

    My wife and I are in a similar (but on a smaller scale) situation. My wife is a veterinarian (I assume you’re a doctor) and has around 100k in debt from vet school. 80k is at 1.75% fixed and 20k is at 5%. We’re working hard to pay off that 20k at 5%. The remainder at 1.75% I think we are going to leave alone and pay off over the life of the loan.

    You will not be able to deduct any of your student loan interest if you’re single and your adjusted gross income exceeds 75k or if you’re married and your AGI exceeds 150k. I’m figuring you’re over that level.

    One thing to consider is when you actually go invest your money, unless it is in an IRA or 401k, you will have to pay taxes on that interest whereas the rate you “earn” from saving interest on your student loans is not taxed since the student loan interest is not tax deductible.

    So basically, looking at your 6.55% student loan, if you’re in the 25% tax bracket, you would actually need to earn 8.7% to get 6.55% after taxes (.0655 / 1-.25).

    That only applies if you’re investing in a taxable account, if you’re in a 401k or IRA then you’d just need to hit 6.55% to match your student loan.

    If I was in your shoes I’d definitely max out my 401k and then pay off my loans (the higher rate loans). An 8.7% sure bet is hard to beat.

  22. jim says:

    I like Trents advice to pay off the credit card then use the money you were using for the minimum payments to build up a brokerage account.

    For the engagement ring, sometimes being extremely frugal on that purchase simply isn’t going to be your smartest move. Maybe your GF values a more expensive ring and maybe its not that high priority. Find out what SHE wants. ONce you’re very ready to get engaged then I would recommend talking to your girlfriend about rings and find out what kind of ring she wants. Don’t go buy her a 1/2 carat princess cut with large inclusions on a yellow gold band if she would prefer a .25 carat round with slight inclusions on a platinum band. Find out how important ring cost would be to her. Maybe the ring is very important to her and maybe it isn’t. You could ask her if she prefers a larger carat ring or a more expensive honeymoon or if she thinks having some money in the bank is most important.

  23. Des says:

    I treasure my ring as well, but it cost under $500 (engagement & band set). I would have been just as happy with silver & CZ.

    It is not about how fancy the ring is, it’s about the wonderful man that gave it to me. That is what makes it special to me. It’s not usually like me to be so sappy, but in this case it suits the situation.

  24. chacha1 says:

    I agree the engagement ring question didn’t seem to send up Trent’s antennae as it did some of ours! As others have said, if $4500 is “a lot of money” then there should be no question of spending half of it on a mere trinket. (Oh, I can hear you now, “it’s a symbol of our sacred luuuuurve!!” but no, it’s a trinket.)

    The meaning of an engagement is in the emotional commitment of the engaged. One shouldn’t require a flashy diamond (and that’s what you get for half of $4500) to remind one of that commitment.

    I realize a lot of women place a LOT of sentimental value on their rings, but I would ask each of them why the *financial* value of the trinket needs to be high in order for them to have that attachment? Shouldn’t the sentimental value be in the actual wedding ring?

    I agree with J#5 that the questioner and his fiancee need to do a lot of talking before deciding what to do with that money. Among the subjects they should discuss is what she is doing with HER half of the homebuyer’s tax credit (which I assume from the question he is claiming, and then paying her half?).

  25. Brent says:

    “I wouldn’t advise someone to spend way more than they can afford, but don’t skimp on a piece of jewelry you want your fiance/future wife to treasure forever.”

    More likely just the rest of their life. (If you do not get divorced that is).

  26. Henry says:

    Wedding rings are a terrible ripoff, a horrible thing to buy into. For example my friend has a wedding ring set that cost $800~ in 1983. According to the inflation calculator, that would be about $1723 in 2009 dollars.
    He checked into liquidating them, and the shops that buy such things (pawn, jewellers, antique shops, etc.) offered him $70 tops, which was the value of the gold weight in them. The diamonds were utterly worthless for resale.
    He was unsuccessful in getting any responses at all through Craigslist and Newspaper adverts trying to directly sell to anyone looking to get married.
    Sure that ring is “a symbol of our sacred luuuuurve!!” but how powerful is that symbol when you wind up divorced? What is it worth than besides a good swift kick in the pants?
    People that buy those are the same ones that spend $3.49 per greeting card per person for every little event or holiday from Hallmark. Just a bunch of crap dreamed up by cunning salesmen to get money.
    You’d be better off spending whatever you plan to spend on a diamond and gold stocking up a liquor cabinet. That’ll give you both something to look forward to and a refuge from each other during rough times, you’ll have better odds of making it last that way.

  27. Nicole says:

    My husband carved my engagement ring out of wood. We were young and broke and living in a state where most people only wear the wedding band after marriage, not the ring and band. 10 years and one kid later I still think it’s the sweetest thing. I think you can substitute thought for more than a thousand of those dollars and get a personalized ring that speaks to her (Etsy mentioned above is a great place to start). If speaking to her really is getting the largest sparkly diamond you can get… well, there’s always pawn shops (and definitely have that conversation about money!).

  28. Trent – another point to support your advice… life comes with no guarantees. If this young man lands on the unemployment line tomorrow he will be wishing he didn’t have any debt to deal with as well!

  29. Aaron says:

    I am in a similar boat as Maggie (#9) though not as serious. I have student loans (16k @ 4.5% fixed and 48k @ 3.15% variable) that I am paying extra on. With such low rates I suspect that I may be able to get a better rate of return somewhere else, but I am new to investing and don’t know where to look. I hear that stocks usually provide decent returns, but how do I figure out what to expect? Can anyone point me to some resources or suggest some specific investments that are giving good returns?

  30. Anthony says:

    I only had a chance to read through some of the comments, but… There are a few people who suggest going with a less expensive ring. Doing this will free up money for a better wedding and honeymoon. How does this hold up as sound advice?! If anything, investing in a diamond is a better investment than throwing away money for a wedding, reception, or honeymoon. Of all of those things, the diamond (presumably diamond, but it doesn’t have to be) ring is the only thing that will have calculable value in 10 years.

    On the other hand, go with a less expensive ring AND pay off the credit cards, that is sound advice.

    If $4500 sounds like a lot of money, then I’m sure there is no emergency fund in place. You should fund it, at least partially, with that $4500.

  31. bobsmith says:

    Or how about don’t pay off debt, don’t invest, but spend like a college kid with a credit card. That’s what our government does.

  32. Brittany says:

    “You’d be better off spending whatever you plan to spend on a diamond and gold stocking up a liquor cabinet. That’ll give you both something to look forward to and a refuge from each other during rough times, you’ll have better odds of making it last that way.”

    Love it. Shared it with my boyfriend, who says he will be sure to remember to propose with a bottle of whiskey. =D

  33. Evita says:

    I agree with Trent’s point of view on this one. Pay off the credit card first! But why insist on cutting up the card? just LEARN to use it without accruing balances! Trent, please don’t assume that carrying a balance on a card is necessarily due to reckless spending! $2,000 is not a fortune to anyone!

  34. Patty says:

    Pay off card then make what was the card payments into emergency fund, wedding fund, house maintanence fund and OVER PAY HOUSE fund. He’ll save the interest on the credit card then start saving the interest on the house. He can start brokering his retirement accounts but get some stability back before going risky.

    I would question too if when he was buying the house if he was thinking…I can afford X size house but since I’m getting this $8K tax credit then I can actually buy this bigger house. Then he gets the credit and forgets about buying a ‘bigger’ house and thinks he has the magical windfall of $4500. Might want to use that on the house as initially planned or plan for some surprises when the home bills get high down the road.

  35. JB says:

    I’d pay off the card first and stop using it until you have proving to yourself you can pay it off in full monthly. Or else you will get yourself in the same situation.

    Making 10-15% in the stock market right now is not something you can count on. You could just as easily lose 10-15% of that money (or more).

  36. Amy B. says:

    Two points –

    1. Tax withholdings drive me crazy. Despite using the irs calculator virtually every year for the past 4 years, I am once again collecting money from U.S. once I file. sigh – wish that there was an easier way to get that right, finally.

    2. We received a good piece of advice for selecting my engagement ring. Let her pick the setting (often, but not always the cheapest part of the ring), but let finances determine the quality and size of the stone. That way, she can have the look she wants, with the price that can be afforded.

  37. Pam says:

    I would agree that it’s important to pay down high interest debt such as credit card debt before purchasing investments. It’s good to have a balance, such as maintaining a mortgage and some investments, but when it comes to credit cards, the priority should always be to pay off the balance every month before even considering putting money into investments.

  38. LMoot says:

    I am 25, single homeowner, making under 30k (gross) a year and even I do not consider $4500 “a lot of money”…and that’s before I bought my house. I am due to receive the full 8k FTHB tax credit this year, and about 1500 minimum additional for deductions. I’m basically expecting close to 10k. That’s already been spent/saved/invested before I’ve received it. I don’t have debt, not planning a proposal, and therefore a wedding. About 4k will go to new windows (figured I’d at least capitalize on another tax credit, and the windows badly need replacing). I’m saving 3k to add to my emergency funds, and the rest will go into savings as I will be needing to replace the air conditioning and the roof in the next couple years. I guess my point is 5k, 8k, even 10k is really not that much money when you own a new home (which you don’t really have a grasp on what will need fixing/replacing when), when you have cc debt, and when you don’t have liquid savings. I may be ASSuming , but I can’t imagine you could have substantial savings and still allow cc debt and need to use an unsaved windfall to fully fund an expense like the engagement ring. I would pay off the debt and put the rest in an emergency fund (so you don’t have to run to the credit card again when an emergency happens and just start up that cycle again), then put a modest amount away each month/paycheck into a discretionary savings fund for the engagement ring. I’m sure your girlfriend would prefer for you to be able to assist in any household oopsies so that she doesn’t have to use her half of the credit on replacing the heat-pump

  39. Eve Mathis says:

    if I could go back 18yrs , I would have been happy with a simple gold band rather than a expensive wedding ring. As a active mom with 3 kids , I dont even wear my ring anymore, and when people ask why I dont wear a ring, I tell them, ” Its in my heart”. Save your money, pay off your bills, or go on a great Honeymoon. In time, when you love someone, all that matters is being with the one you love and enjoying the rollercoaster ride of Marriage. Remember, marriage is a work in progress, and who is really going to care what your ring looks like anyway.

  40. I think paying off the 1.75% loans early would be a mistake since that rate is so low and for 30 years. But the other two piles of loans are more confusing. I’ve been focusing on paying off the ones that costs 7.65% right now.

  41. IASSOS says:

    If Andrew is a stock broker who can make ten to fifteen percent annual return, why is $4500 a lot of money to him? If I could do that reliably I’d be sitting pretty!

  42. IASSOS says:

    The engagement ring is a stupid custom. Spending $2500 on that doesn’t prove you love her. Your ongoing actions speak louder.

  43. Wolf says:

    When ever there is a question like this, there never seems to be the additional math put in. That is when investing and carrying debt there is RISK + inflation+ tax. So 10% on $2000 is $200 – 25% for capital gains tax -6% for inflation (or devalue of the dollar ) – risk. I dont know about finance so I cant put a risk percentage. Or you could just pay off the debt and be done with it.

  44. Rory says:

    To put the reader’s question another way, would he borrow $2000 on his credit card to play the stockmarket? If he would not why would he do effectively the same thing with his existing debt? Often I find turning these types of questions around clears up the question quite quickly for me.

  45. Jeroen says:

    wow… over 2k for an engagement ring… I payed 365 EURO. And my GF got angry because she said it was too much. :)

  46. Mel says:

    @Nicole #24
    “My husband carved my engagement ring out of wood.” That is amazingly sweet! Thank you for brightening my morning. :)

  47. Man,

    Save a little bit of money on that ring, dude.

    If you’ve got that far to go in CC debt, I would send a little of that money to your CCs.

    You need to get a better deal on your ring, or downsize a little

  48. deRuiter says:

    Suggest paying down debt, going to pawn shop for nice ring, and paying down any left over money on the mortgage on the house. USE THE FULL $4,500. this way and you will have made enormous strides towards a financially secure future. Trent, if a person pays off a loan where the interest was 9.9%, he / she is actually saving 12% or more BECAUSE YOU HAVE TO PAY THIS IN AFTER TAX DOLLARS. By paying on the debts, you earn a higher rate of return because you don’t have to spend precious after tox dollars, and no one can tax you on the money you now have because you saved it by not spending it, it is saved income, not earned (taxable) income. To get a dollar to keep, I have to earn about $1.40 counting all the taxes. This situation is about to get worse because the US Government continues to borrow and our country is broke, our AAA bond rating is about to be downgraded by Moody’s which will enable those buying out debt to charge higher interest. The united States is not improving, we are about to be swept away by our government’s profligate spending. The market went down 200 points yesterday. If this young man could make 15% trading stocks reliably he would have already been snapped up by a cartel of multimillionaires to manage THEIR money.

  49. EF says:

    An 8-12 month emergency fund is more important than anything at this point.

    Some people have been without substantial income for 1 year and counting. The job situation worsens, and a 3 month emergency fund is no longer viable, and will not be for possibly a decade or more.

    Save. Save. Save.

  50. Stephanie says:

    We spent nothing on my engagement ring- I told my husband that we have a house and wearing the cost of a new couch/dining room set on my finger was stupid. My mother left me a beautiful engagement ring that belonged to my great grandmother in 1915. I wear it every day and when we had it appraised for insurance purposes we discovered it was worth as much as my car.
    He should think about family and heirloom rings before spending money they don’t have on a diamond.

  51. Steffie says:

    No matter what size ring you buy, make sure you have the correct insurance, you may need a rider on your home insurance. And if I got a $4500 tax refund it would go this way…fill up deep freeze with meat, fill up cupboard with food, fill up liquor/wine cabinet, pay the winter heat bill in full. Maybe enough left over to buy a night out at a ‘good’ restaraunt, one with real tablecloths and waiters in black.

  52. Kevin says:

    Also, taxes.

    Paying down his credit card debt is an AFTER TAX gain equal to his credit card interest rate.

    Any return he earns on his investments is BEFORE TAX, and thus needs to be adjusted downward appropriately, once taxes are factored in.

  53. Kevin says:

    I’m surprised everyone is picking on Andrew about the engagement ring. He doesn’t mention what his salary is but if he’s a broker, he’s likely making a decent income. Since we all know the rule for engagement rings is “2 month’s salary”, then if Andrew directs $2,250 of his $4,500 toward the ring, he’s either horribly underpaid, or hopefully already has another $5,000 set aside to go toward the ring.

    I’m joking, of course.

    The truth is, we don’t have enough information to give Andrew truly meaningful advice. Does he have an emergency fund already? What other debts does he have? What are the interest rates and minimum payments? What’s his income? Andrew, if you’re reading this and want a more in-depth analysis of your finances, get yourself over to the Fiscal Fitness Journal section of the forums on GetRichSlowly.org and lots of people will be happy to help.

    But based solely on what you’ve posted here, I’d use the money to pay off your credit card. If there is anything left after that, I’d save $1,000 as a starter emergency fund, and put the rest toward other debt. Postpone the engagement until you get your finances in order. By all means, move into the house together, but hold off on the engagement/marriage/honeymoon until you can do it properly.

  54. Andrew says:

    WOW. MY QUESTION GOT POSTED!!! Thank you Trent for the advice on my question and to all of you who have commented. As many of you have suspected, I am young (24) and not as experienced with money as I will be. However, I just want to clarify a few things about my post. First of all, I’m very frugal with my money, pay myself 10% first, and have started my debt snowball. As Kat posted above, my large return is the result of my half of the $8000 tax credit. My credit card rate is 1.5% right now and will be until the promotion period runs out later this year. Then it will go to 5%.

    Additionally, trading and learning about the markets is my passion in life. I love it and actually made money in the stock and currency markets in 2008 and 2009 by being short stocks and long the dollar. I know that 2 years of positive performance doesn’t mean I’m a market wizard but I am a little more sophisticated than the average investor who throws their money into expensive mutual funds. I’ve earned well over 30% my first two years trading, but I used the money I made to buy our house and want to replenish my investment accounts now.

    I do not use my credit card anymore. The balance is the result of buying a computer for school and to get by before I started my job after graduation. I do have the mortgage payment, a car payment, and student loan debt which I am making all my payments on. My girlfriend and I have already furnished our home so we don’t need anything there, although I know there will always be those emergencies that come from owning a home. I really want to build the emergency fund, but it is difficult to throw my extra money into it when I am so interested in trading and want to fund my brokerage accounts.

    Probably the best piece of advice you all have given me is to reevaluate how much I spend on the engagement ring. I always thought one was supposed to spend 1-2 months of salary on the ring. Apparently, I am grossly mistaken. Trust me, if it was up to me, we would be married as cheaply as possible. I’m all for foregoing a wedding and going down to the courthouse to legalize the thing. I’ve taught my girlfriend a lot about being smart with money, but she wants the nice ring and wedding. Thankfully, I’m only responsible for the ring.

    I appreciate all the words of wisdom. I will definitely take them all into consideration in making my decision on what to do.

  55. Michael says:

    The other thing that Andrew ignores is the fact that there are taxes on income.

    So even if he made a 10% rate of return on his investment (others have commented on the probablity of that) he then has to take into account any sort of tax (figure capital gains at 20%) which would reduce his gains; reducing his 10% rate of return down to 8%.

  56. Sean says:

    If $4500 is a lot of money to him, got to say it is probably a little premature to get into the speculative trading side of investing over debt killing. That, and starting a marriage in as financially stable a position as possible trumps the $200-300 he believes he can eek out of the market.

  57. AnnJo says:

    If $4,500 is a lot of money to him, he should pay off his credit card and put the rest of the $4,500 in the bank to cover the first unexpected home repair disaster. Then he should get his girlfriend to put her $4,000 share of the home buyer’s credit in the bank for the second home repair disaster. Then they can both start saving for the third, for the higher taxes they’ll pay next year as a married couple, and for their emergency fund.

    Was it a new home he bought, so there is a warranty against any disasters? Maybe, but is the company that warranted against defects still going to be solvent when disaster strikes? Were the property taxes he was quoted at closing calculated on the finished construction value or the land value? A lot of buyers of new construction see major property tax increases in the year after closing.

    When they’ve got no debt other than the mortgage, a healthy home repair reserve and a six month emergency reserve, then is the time to start investing modestly in the stock market.

  58. Rebecca says:

    I wear a claudah and a small wedding band, both made from sterling and worth about $35. I didn’t get an engagement ring, I got my husb. And our tax return this year, as in years before goes towards paying off the credit cards and school loans. In a few months we will be free of credit card debt FOREVER!

  59. John Soares says:

    It’s nearly always best to pay off, or pay down, credit card debt whenever possible.

    And I’d say, depending on total debt of the couple and their income, they should consider a far less expensive engagement ring and a very simple wedding and honeymoon.

  60. JessicaV says:

    OK, so I must be in the wrong, but I agree with #18. I LOVE my ring… my very expensive ring! I wouldn’t trade it for anything, and will wear it for the rest of my life. I hope to pass it to my eldest daughter. So I would say, spend what you wish on the ring, then use the rest for debt.

  61. GregB says:

    If he knows he can get a 10-15% return he should max out all his lines of credit under 10% to put in the market and become rich.
    Will he do this? No, because it does not make sense and will not make him rich.
    Do a Small emergency fund, then pay off all debts except house, 3-6 month emergy fund, max out Roths or 401K’s, THEN PUT MONEY IN THE MARKET.
    Then get wealthy.

  62. IASSOS says:

    Marry her.

  63. Christine says:

    Do you have any emergency fund? Any homeowner or anyone with an older vehicle should have 3-6 months of income set aside. Actually, this really applies to anyone…even renters…at least have your renters and auto insurance deductible set aside.

    Secondly, I would definitely pay off the credit card with your refund.

  64. Bender says:

    1 – the after tax/transaction cost return on paying off debt is equal to interest rate. This is both the annual and annualized return.

    2 – assuming going bankrupt is not really an option, the return on paying off debt is riskless.

    3 – assuming you do have a realistic oppotunity to make a 10-15% picking stock in the market, do you have any idea what the risk is? Do you know what the Sharpe Ratio of your trading/investing strategy is? My guess is that you don’t (prove me wrong). I also suspect that you don’t really have a firm grasp of what “average annual return” means and why it is dangerous to think solely in terms of those terms.

    Sorry if the forgoing sounds harsh, but when you “believe” they can make 10-15% trading and then ask how to compare the returns/risks I become highly skeptical.

  65. Lori says:

    I’m not understanding the debt payoff/invest argument as well as I would like. If you payoff debt and get a guaranteed rate of return, that is the rate of return for that year but what about subsequent years and compound interest? Isn’t the money you would pay for debt but invest instead getting a return year after year. So the same $2,000 would earn a return year after year, not just that year so would in fact be a better deal? As long as the return is reasonable and you leave it there to make money…. I’m trying to be clear myself about paying off debt or contributing more than the match to a Simple IRA.

  66. triLcat says:

    I know couples who got married young and bought beautiful rings with very nice gold setting and CZ’s with the stipulation that when there’s more money, there will be a diamond.

    My husband and I got married a little later and both of us had no debt and substantial savings, so we decided to go for a real diamond. We went for 20pts, because I didn’t want to be walking around with something that was terribly stealable, nor do I want a diamond that gets caught on every sweater I put on, scratches my kids’ faces, etc.

    Right after we got married, we bought a dishwasher. We joked that it was the other half of my ring. (believe me, it does more for my hands than my ring does!)

  67. Sarah says:

    @Maggie, if you’re in the profession I think you’re in, let me let you in a little secret: the odds that you will have fled that high-paying job for one that doesn’t suck the life out of you within three years are quite high. Unless, of course, your minimum monthly payment is so high that you can’t afford to take a different kind of job (the dropoff in salary from one level to the next is huge). Pay off those loans as fast as you can; they are nothing but fetters.

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