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Debt and Investing

The Beginner's Guide to Finding Balance Between Debt Management and Investing


Paying Down Debt versus Investing

New investors are often faced with a choice to use their extra cash to pay down debt or begin investing. Which is the better choice? These resources are designed to help you discover the answer.

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As a new investor, one of your biggest challenges is deciding how to balance saving, investing, and debt management. In the special article saving vs. investing, you learned that there is a world of difference between money designed for savings and money used to make more money (investing) and that both have important roles in building a complete portfolio.

Now, we need to explore the role of debt vs. investing. Is debt good? Is it bad? Should you pay down your debt or increase your 401(k) contributions? These questions, any many more, are answered in the collection of articles, resources, and tools we've put together to help you understand the role of borrowed money in your overall financial picture.

Should You Pay Off Debt or Invest?

The most common question when it comes to debt management is whether you should wait to invest and instead focus on paying off your debt. Is this a good idea? The answer is: It depends. In Should I Pay Off My Debt or Invest? we teach you a quick and easy formula for determining whether you should consider paying down your debt or instead focus on investing extra cash. (This is even more important during recessions, as we explained in Be Cash Rich and Debt Poor During Recessions. Many businesses and individual investors find themselves in a position of having a tolerable amount of debt, but when their income or sales fall off a cliff, they can't keep up with the payments.)

In the article, you learn that the decision to pay off debt or invest should come down to the interest cost you pay on borrowed money compared to the return you can earn on your investments. In most cases, credit card debt is the worst culprit, costing far more than even history's best investors could make by trading stocks, bonds, mutual funds, real estate, or gold. That's why we prepared a 10-part step-by-step guide to paying off credit card debt. It can explain tips and techniques that can help immediately lower your debt balance so that you can have more cash left over for investing.

If you are really in over your head, you may want to read How to Negotiate a Credit Card Debt Settlement. It will explain the process of negotiating a lower payoff balance to avoid bankruptcy and begin saving cash for your investments each month.

Your Total Debt Doesn't Matter - Your Liquidity and Cost of Debt Do

Debt by itself isn't evil. If you could borrow $1,000,000 at 3% to buy a hotel that generated 12% returns each year, the debt could actually help you generate huge wealth for your family. If you buy a car for $30,000 and pay the same 3%, however, you are acquiring a depreciating asset; that is, an asset that loses value each day. One of the biggest secrets new investors need to learn is that your total debt doesn't matter - only the amount of liquidity you have on hand and the cost of your debt. Since we've already discussed the cost of your debt, you need to learn more about liquidity. In The Importance of Liquidity: A Lesson from September 11th, we explain how otherwise sound businesses, men, and women found themselves in bankruptcy court because they didn't have enough cash on hand to weather the crisis, despite having a lot of wealth in the form of assets.

This is the reason that financial gurus tell you to maintain emergency savings accounts and to never invest money that you may need in the next few years. What they are doing is working to ensure you have enough liquidity that you won't be forced to sell assets in a distressed market.

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