It’s tough to know what to do with the money that’s left after you’ve paid all your expenses.
If you’ve exercised strong willpower not to go crazy and spend it all instantly, then you’ll probably be wanting to do something with all those leftovers. And if you’re reading this, you’ve probably got investing on your mind!
I get heaps of people asking me “Should I save, pay off my debts or invest?“.
Most of us have some kind of debt, whether that’s student loans, credit card debt, that overdraft you wish you hadn’t taken out, or even a mortgage. Unfortunately, it’s tough to pay off debts and invest at the same time!
Don’t stress, though! Like I’ve mentioned, not all debt is created equal. I’m going to chat about a few common types of debt and talk about whether you should focus on paying them off before you start investing.
Credit Card Debt
YES! FOCUS ON PAYING OFF YOUR CREDIT CARD BEFORE THINKING ABOUT INVESTING.
This needed to be in caps and bold, that’s how much I want to emphasise it.
As I wrote about in my article Should you own a credit card? this debt is an absolute killer! Interest rates are often astronomical (20%+) which can crush you financially.
If you have a significant amount of consumer debt, focus on paying that off before you invest. This will save you so much money.
Paying off your credit card will make you far more than investing ever will. If you put extra money towards paying off credit card debt that’s incurring 20% annual interest, you’re effectively earning a tax free 20% return on that money.
When it comes to overdrafts, it’s best to treat these like credit card debt too. Even though they seem like really good ideas at the time, they often charge a monster interest rate – around 14%. The best option is to get rid of these as soon as you possibly can. The reasons for doing this are exactly the same as paying off your credit card – you’re practically making money by paying it off.
What about saving?
As you’re paying off your debt you should also be focused on growing your emergency fund. This is money that you have available to put towards unexpected expenses and will help you not go back into debt in the future. Your emergency fund should be enough to cover at least a couple of months of your living expenses.
Before starting investing, you should have these two things sorted;
- No or very little consumer debt
- A solid emergency fund to protect against unexpected expenses
Keeping your money in the bank is definitely safe, and you should absolutely have a good amount in there in case of the unexpected occurring. And, you know, for general life and having fun, since you can’t have all your money tied up leaving you to live your life like a monk.
If you’re going to have savings, best to shop around for the best interest-earning account types, so your money will be quietly earning a bit extra while it’s sitting there.
You can set up an automatic payment to put money into your savings every time you get paid so the balance will grow with hardly any effort.
If you’re living in New Zealand and have an interest free student loan, then you can feel free to go ahead and invest as opposed to paying extra off your student loan. This is one debt (often a massive debt too) that you can actually be pretty chill about.
With the way student loans are set up, there’s no financial reason to pay them off quicker than you need to. In fact, you might be hurting yourself financially. Your student loan isn’t going to get any bigger, so at the very least it’s worth keeping your money in a term deposit as opposed to paying it off quicker.
As I wrote in my student loans article, the only real issue with this is if your student loan debt is stressing you out big time. If you’re waking up in cold sweats worrying about your student debt, then absolutely pay that shit off ASAP. If you’re fine just ignoring it and letting the contribution come out of your wages, then you can forget about it and start investing with a clear financial conscience.
What about a mortgage?
This is a really tricky one. If you have mortgage debt at 5% interest, it may be tempting to invest as you’ll likely be able to receive greater than 5% returns by buying ETFs. In reality, it’s not as simple as that.
What needs to be taken into account is that paying off your debt is risk-free.
Every extra mortgage payment you make is money that won’t incur interest ever! If you instead invest that money in the stock market, you might get a greater return, but you also might see your money diminish over a period of years.
Paying off your mortgage early can save you tens or even hundreds of thousands of dollars. If you have a mortgage of $400k at 30 years at 5% interest, you will pay around $373k in interest. If you pay that mortgage off over 15 years instead, you will only pay $169k in interest, saving over $200k. You can play around with different mortgage rates and payoff periods using the sorted.org.nz mortgage calculator. This risk-free saving makes a pretty strong case to focus on your mortgage debt before worrying about investing.
If you invest in shares while you still have a mortgage, you’re essentially borrowing to invest. This isn’t really the best idea given the risk of investing. You also open yourself up to a host of other risks including;
- Interest rates going up
- Having to make mortgage payments when you’re out of work
But the potential gains from investing instead are great…
Here’s a fascinating post I read at investmentzen.com. In it, the writer talks about how he’s made significant amounts of money by not paying any more than he has to on his mortgage and investing instead. It’s a cool story and props to him for coming up with a great plan and sticking to it.
However, he’s had some things in his favour that would be difficult to do in New Zealand. The main one is that he was able to fix his mortgage at a low rate (3.25%) over 15 years. In New Zealand, it’s hard to find anyone offering more than ten years on a fixed rate mortgage, and the best rate I found on a 10-year mortgage was 5.75%. For this plan to work, you’d have to be able to lock in a mortgage rate that’s far less than what you expect to return from stocks (which is vaguely between 6 – 9% per year). Unfortunately, it’s pretty impossible to find a mortgage rate like that around these parts – better just to chill on the investing while you’re paying off a mortgage instead.
Due to the risk of sharemarket investing, it’s usually a good idea to pay off interest-bearing debt before starting. It’s possible to profit from investing instead of paying off your mortgage, but NZ interest rates mean that this is essentially not worth the risk.
Don’t worry about student loans, but worry about everything else! Smash out your repayments (don’t forget to save some too) and get it all out of the way. You’ll never be able to achieve financial stability and freedom if you’re loaded down with a bunch of high-interest debt.
If you’re interested in learning more about passive investment providers in NZ, check out some of my articles below:
- My thoughts on the Sharesies Beta
- Dean from Smartshares answers your questions!
- I chat with Anthony from InvestNow
- Breaking news: Simplicity releases new Investment funds
- I compare the fees of Smartshares and Simplicity
- Smartshares compared to Simplicity: Part two
Or, If you want to learn more about general investment strategy, check out one of the articles below: