Debt can feel so oppressive. Will the day ever come, you wonder, when you’ll have paid off your student loans, the mortgage, that car loan and, oh yes, those pesky high-interest credit cards you’re using to pay for diapers, tiny shoes or after-school activities? That’s why millions of people throw up their hands and avoid saving and investing for the future. There’s a better way.
First off? Know what you owe. Put all your debts on a single sheet of paper. (If they can’t fit on a single sheet, call 911.) Then, see if you can modify any terms or interest rates.
After that, consider the following: Do you qualify for public service loan forgiveness on student debt? Can you refinance any debts? (Ideally, you want to get a lower rate, not just lower monthly payments. Student loan consolidation might be a mistake if it just means you’ll carry the debt longer and ultimately pay more interest.) If you have high-interest credit card debt, call the card company and say you’re going to pay off your balance and leave them unless they lower your rate. Tell them other card issuers are clamoring for your business. (While you may not hear it, they are) This will often work. It can sometimes make sense to use a home equity loan to pay off high-rate card debt, if—and only if—you promise yourself that you’ll pay off the entire monthly card balance from now on.
In theory, you should always compare the after-tax return of paying down debt (paying off an extra $100 a 15 percent credit card earns you 15 percent) with the after-tax return on an investment. But since you don’t know what the return of the stock market will be, such thinking might cause you to focus more on debt repayment than you should.
Here are some rules to live by:
1. When an employer offers to match 50 or 100 percent of your contribution to a 401(k) plan, grab the deal.
Always. This is the only chance you’ll ever have to earn an immediate 50 or 100 percent on your money. Life should always work this way, but, of course, it doesn’t.
2. Focus on paying off high-rate debt (anything above eight percent).
Make it the main priority. Otherwise, you’re just losing money.
3. Start saving and/or investing even while paying off expensive debt.
We’re throwing math out the window here because saving and investing are both addictive. First, accumulate an emergency fund of six months living expenses, then open a retirement account. Starting small is fine. (In both cases, have the money automatically debited from your paycheck or checking account. If you never feel you actually had the money, you’ll miss it less.)
A big benefit of investing even while you still have non-mortgage debt: you’ll feel as if you’re making financial progress rather than just being stuck on a debt treadmill. It’s this great feeling that makes investing addictive.
4. Don’t obsess with debt because you’re afraid to invest.
Many people make the wrong moves out of fear. They opt for the certainty of debt reduction instead of the near-term uncertainty of investing in stocks.
Understand this: to a new investor, it always looks like the wrong time to invest. Today we are in the ninth year of a bull market and we have a president who is, uh, unusual. Clearly, a suboptimal time to invest, right?
Well, during a bear market, many would-be investors will be too terrified to invest. And in a flat market many will feel no urgency to do so. So the kitty they might invest keeps accumulating and, the bigger it gets, the harder it is to commit because now you have more to lose.
Solution: if you have a large chunk of cash earning little or no interest, invest it in stock and bonds gradually—say, one-sixth of the amount in each of the next six months.
5. Don’t pay down a cheap mortgage or cheap student debt at all…
A balanced stock and bond portfolio should return six-to-seven percent a year, so opting for the guaranteed three-percent return of prepaying a mortgage is not smart.
6. …Unless paying down debt helps your partner sleep at night.
My wife and I recently refinanced to a 2.75 percent mortgage. She wanted to pay down our mortgage balance by 20 percent. It would make her feel better, even though the math wasn’t on her side. So we did what she wanted. (Note: we already had almost all of our money in stocks.) And if the market rises by more than 2.75 percent per year, as it is likely to, I promised not to say I told you so.
Andrew Feinberg is a writer and money manager. He is the author or co-author of five books on investing and personal finance, including Downsize Your Debt. His work has appeared in the New York Times Magazine, GQ, Barron’s, The New York Times, Playboy and The Wall Street Journal, among other publications.