Jan 3 2009

Investing Now vs. Removing Debt

Recently, I got a visit from a friend and he revealed his current financial status to me. Although he has a seemingly stable job, he’s burdened with many financial responsibilities and debt that are typical of most college graduates. They include:

  • Student loans
  • Car loans + insurance
  • Credit cards (~$10,000)
  • Living expenses (rent, food, and etc.)

He tells me that he’ll be receiving a windfall of approximately $10,000 and he wants to take advantage of the cheap stock market. As a friend and cautious money manager, I highly advised against putting that kind of money in stocks. Although my friend is fully aware of his tight situation, he is hoping that stocks would actually make enough to cover his monthly payments plus more. While that is entirely possible, I suggested the safer road – debt removal. The reasons being:

  • The ability to clear debt is 100% certain. In our current economic state, the stock market doesn’t guarantee a positive return.
  • Removal of debt relieves a source of psychological stress. Participating in the stock market would add a source of psychological stress.
  • Debt is the major roadblock to wealth. Debt accumulates if it isn’t paid off in a timely manner. It will remain a money-sucking leech unless it is completely removed.

I introduced to him the two popular debt removal methods: the Debt Snowball by Dave Ramsey and the Debt Avalanche by Flexo at Consumerism Commentary. Luckily, he had an ING Direct savings account, so mentioned the use of a CD ladder for a higher interest rate and to resist the temptation to spend.

Despite know that I provided useful fundamentals to personal finance, I wonder “what if the stock markets takes a turn for the good”. Surely, at his young age, he should be taking more risks right? What are your thoughts?

Video Credit: MoneyTalkNews

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15 Comments on this post

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  1. Credit Karma Roundup - Wishing All a Happy New Year! wrote:

    [...] Realms of Prosperity looks at Investing Now vs. Removing Debt. [...]

    January 4th, 2009 at 6:19 am
  1. Ashley @ Wide Open Wallet said:

    Ohhh I would be thinking of paying off those credit cards. I would think the payments would be pretty big even if the interest is low. How did he feel about paying down his debt??

    January 3rd, 2009 at 6:40 pm
  2. Simon said:

    He knows it is for is own good and a definite priority but I can tell he really wants to get into stocks. I’m going to keep in touch so that he would focus on his debt.

    January 3rd, 2009 at 7:09 pm
  3. Alberto said:

    Credit card debt is a huge, huge problem and I think it should be dealt with immediately. That is the source of most people’s debt problems, and he should look to eliminate that source. As for stock investing, if he starts being more frugal he may be able to save some of his income each month to put into stocks.

    January 4th, 2009 at 4:17 pm
  4. Chiko said:

    Depending on how much his debt is I would recommend something different. If his debt is below $5,000, I would say to invest the $10,000 in the stock market because their is a greater chance for him to make more money and easy pay his debt off and still have cash to pursue other things.

    January 4th, 2009 at 9:54 pm
  5. Simon said:

    @ Alberto: That is pretty the sum of what I told him.

    @ Chiko: I agree but sadly, he has way more than $5,000 of debt. It would surely be a great time for him to enter the stock market if he had less debt.

    January 4th, 2009 at 10:03 pm
  6. Chiko said:

    How much debt does he have? I guess it doesn’t matter too much. I would advice him to use $7500 towards his debt and use $2,500 on the stock market (penny stocks). For monday I am predicting that these penny stocks will go up (GRMC, NCTW, and SUTM) I might be buying some GRMC tomorrow for the day-trade.

    January 4th, 2009 at 10:22 pm
  7. AJC said:

    I created an improved version of Flexo’s Debt Avalanche, (which is already better than Ramsey’s Debt Snowball):

    http://7million7years.com/2008/12/09/the-cash-cascade-tm/

    In summary, it simply says to treat your debts as investments (i.e. INVESTING in reducing debt), then it becomes relatively simple to stack up all of your debts AND investment opportunities by their AFTER TAX ‘interest rate’ (earned if an investment, or saved if a debt), then it should be easy to put your money where you get the best return.

    January 5th, 2009 at 2:25 am
  8. Monevator said:

    I hate debt and would always pay it off first. There’s a psychological benefit as well as a financial one to being debt-free, whatever the maths says.

    January 5th, 2009 at 10:41 am
  9. PennySeeds.com said:

    I would use the bulk payment to clear that debt right away. If he really wants to get into stocks then he could try doing it in smaller chunks right now until he clears those burdens.

    Have a small portion of your paycheck deposited into a savings account, and when it gets to a certain point buy some holdings.

    I’m very against credit card debt though – So others may think differently.

    January 6th, 2009 at 7:09 am
  10. Simon said:

    Glad to see everyone is supporting the fact the debt removal is of utmost important.

    January 7th, 2009 at 10:18 pm
  11. The Passive Dad said:

    I would personally pay down the debt first and then keep any remaining balance in cash. Heck, if your friend was in cash last year they would have out performed the stock market by 40%. I would also ask if your friend has experience choosing investments and if they also know they will have to pay taxes on any gains derived after the sale. Lot of things to consider. I would encourage them to look at a part time job or another source of revenue before investing the entire $10k.

    January 14th, 2009 at 2:33 am
  12. Tom said:

    Agreed. I was always told that I should pay off my debts before I invest in the stock market. If I have a 13% APR credit card bill, it makes no sense to invest, especially in today’s stock market. Sadly, many college students fit that profile above.

    January 17th, 2009 at 12:35 pm
  13. MoneyEnergy said:

    In his case, it depends on how much debt he has on each of his liabilities and what the terms of repayment are. It might even make sense to pay part of each liability, or just the one with the highest interest rate. It’s really unfortunate that such a windfall would have to go towards clearing off debt, but he can’t avoid it. I’d pay off the debt that will most immediately give him the most leverage for further getting ahead. Which debt payment is most holding him back. If he’s still in the interest-free period on his loans, eg., then maybe just take care of all that credit card debt.

    April 21st, 2009 at 12:24 pm
  14. Kevin T said:

    This article is very enlightening. However, my students seem to be confused on this topic. Would you invest first in a business, say a franchise, and wait for the business to sell before paying off the debts? What’s your take on this?

    January 6th, 2010 at 8:48 pm

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