Recently, I had an individual write to me, telling me a lengthy tale of his mortgage. He was currently paying about 6% on it, but he had an adjustable rate on it and it could go up to as much as 7% in a few years. It was clearly worrying him, even though he knew he could make more by investing it elsewhere. He wrote to me hoping, I think, that I would tell him that investing it was the right idea.
Instead, I told him to get rid of the debt.
That will probably surprise some people, especially since I regularly tout the returns of index funds that have been returning in the double digits (on average) for years. A double digit return will blow away that mortgage interest rate, putting the investor way ahead of the game in a pure numbers sense.
Strictly on paper, it does make more sense to invest extra money instead of putting it into debt repayment if the debt’s interest rate is low. To me, though, personal finance is more than just what’s on paper. The “what’s on paper” part is the finance part, not the personal part – the personal part is much, much more than that.
It comes down to your personality and your tolerance of risk. Debt is a risk – don’t let anyone tell you otherwise. You’re putting your future self at risk every time you incur debt – you’re making the assumption that your future self can repay that debt.
If you’re kept up at night by debt, it means that your current financial situation is exceeding your risk tolerance and you should be focusing on getting rid of that debt. Ekeing out a couple more percentage points in an investment is not worth being uncomfortable with your investment situation.
Some people have more risk tolerance than others. Mine is pretty low, so I’m always in favor of getting rid of that debt. Others have very high risk tolerances – people who flip real estate, for example. It’s not bad or good to have a high or low risk tolerance; it’s just different. People with low risk tolerance might not get the best return, but they’re much more prepared for situations where the future doesn’t turn out as expected. People with high risk tolerances might nail a massive return, but if the future deals them a bad hand they may be completely unprepared to handle it well.
If some aspect of your financial life is keeping you up at night or occupying your thoughts, take care of it. If you’re sitting there nervous about your mortgage and you have the money to pay it down, pay it down – don’t sweat the fact that you might make a couple percentage points more in an investment. If you’re paying extra on your mortgage and it’s bothering you that you could potentially get a better return in the stock market, investigate and invest appropriately.
For me, I’m pretty much looking straight ahead to the day that I’m debt free – I’m dipping my toes just a bit into investment, but my real goal, above all, is to be free of all debt as soon as possible. It is debt that worries me and keeps me up at night – it’s debt that makes me feel locked into certain lifestyle choices. Thus, debt reduction is my personal finance target.