A frequent question that I get asked as a financial advisor revolves around paying off debt versus investing when the opportunity arises.
Typically, someone has some extra money as the result of a bonus, tax refund or some other windfall.
However, as we have worked our way through the Covid-19 pandemic, the questions have oftentimes been spurred after someone has received a severance package.
No matter what the source of the money is, you should give careful consideration to the decision of paying off the debt or investing.
There are many financial experts who recommend first paying off debt.
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There are good arguments for this, for both financial and non-financial reasons. Financially, the debt is paid and you are no longer paying interest — and those are good things.
There are also psychological and emotional benefits, as well. Mortgage-burning parties used to be a big deal. These parties were meant to be a celebration of becoming true owners of a property, free and clear of the responsibility and risk of the property being encumbered.
Homeowners didn’t have to worry about what would happen if they lost their job or some other economic misfortune arose. They could sleep a little easier at night knowing that, if nothing else, “I’ve got a roof over my head.”
Now, on the flipside, a school of thought suggests that if your after-tax return on investments is greater than your after-tax cost of your debt, then you should invest the money.
A simple example works like this: You owe a debt that comes with an interest rate of 4%. We will assume that the interest is deductible.