This is a question that comes up much more often than we may think. Deciding between paying off the debt that you have and making an investment is something that will be quite subjective. Your view on the topic may be completely different than what someone else thinks.
In order to understand what the best solution is, we need to basically look at all the sides of the question in an objective way. You will surely first think about the higher number. You have a possible investment with a possible return and a debt that was gained in time.
An Example Of How Difficult It Can Be To Decide
Let’s think about a $10,000 debt since this is the highest debt amount I ever had. In this case let’s say that you have to pay off an interest rate of 10%. Let’s say you now have the $10,000 available. Since this is the case, you are tempted to just pay the debt but what happens when a really good friend of yours says that he has a “sure thing” investment that will pay you 30%?
Things just got really complicated. When you pay off your debt you basically win 10% since that is how much you will keep in your pocket. When you invest in the business you have absolutely no guarantees. However, you could earn that 30% or even make more. The problem is that you can also lose everything. At the same time, your friend knows you have the money and you might decide not to help your friend. This can be seen as a betrayal and can create huge problems before friends.
How can you choose?
You are basically choosing between the 10% that is a sure thing and a 30% or more that is possible. This means you have to estimate how likely it is to earn that money through the investment. When chances are high, it may be a good decision. All in this case boils down to your personal risk tolerance. If you do not know what that is, this article talks about it.
What Should You Do When This Question Appears?
When we simply think about finances, the truth is you need to think about both alternatives. You need to think about debt costs and how possible it is that the alternatives will offer the money that is initially possible. There is so much that you have to think about strictly from the financial point of view. Also, we have that emotional aspect that will influence your decision.
Generally speaking, you can make a decision when you think about the following possibilities:
- When debt is paid off and investments go well
In this case you might think that you still made a good decision since you are debt free or you will feel that you missed out on a huge possibility to make more money. Which one is your reaction to this?
- Investments crumble and you pay off the debt
You will surely feel great about your decision in this case.
- You do not pay your debt and the investment goes well
Think about the reasonable expectation. What will your life be like if this happens? Is it worth the risk for you or not?
- You do not pay your debt and the investment crumbles
Is it an option for you to simply remain with the debt and lose money? Remember that this situation can lead to more debt. As more debt appears and you keep making bad decisions, debt increases. Eventually you will be faced with bankruptcy.
My Personal View On The Topic
Most financial education specialists will analyze the situation and based on so much data a recommendation is made. You are not always going to have the luxury of getting this analysis done. Most people know nothing about how to make the analysis and will not go to a financial advisor for help.
Based on what I saw in many cases, people that end up in debt do not actually make really smart financial decisions. When I ended up in debt I made some huge mistakes that could have easily been avoided. It took me around 3 years to get all the knowledge I have now. Because of this, from my point of view, when you have the money to pay off your debt, you should do it. The alternative would be to invest a smaller part of the money you have and to at least pay off a larger chunk of the debt. Living with lower debt is always better.
If you decide to invest, make sure you know everything about the investment. Also, please do not put yourself in the situation in which you end up without money to live as you are used to. If your mind is affected, you will keep making bad decisions.