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I have just consolidated my debt and am thinking where I want to be in the future. My payment plan is to be debt-free in three years. It is not an extremely aggressive plan; I still want to have a life, maybe travel once in those three years and grow some savings.

The average interest rate on my debt it 13.7% @ $44,000 and I earn $4650 per month after tax.

Now, would it be wise to start investing smaller amounts trying to build some sort of second income? I know my returns are probably less than the losses when comparing debt interest. But would I be better off in say five years with a potential of secondary income from investment if I started now as opposed to starting in, say, three years?

TheRealTy
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    Even if you invest your entire current earnings ($4650 per month) every single month for five years straight, at 5% return, if my math is right you will make about $100 per month in passive income after those five years. The current interest on your debt seems to me to come out to about $500 per month. Getting into the habit of investing is good, but as has been pointed out in answers, at this point, you are very likely much better off with the guaranteed near 14% annual return from paying down the debt. Also, give those creditors a call, or shop around for a cheaper consolidation loan. – user Dec 21 '15 at 15:05
  • Not sure I can get much better in a consolidation loan. Here, they are just a personal loan and always around the 13-14%. – TheRealTy Dec 21 '15 at 21:08
  • You could use something like a house to secure a lower interest rate... – corsiKa Dec 21 '15 at 21:48
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    In doing your calculations, remember that if you put the "investment" money into paying off the debt, it will be paid off in less than 3 years. You can start investing seriously then. – Patricia Shanahan Dec 22 '15 at 05:22
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    For what it's worth, there's a difference between the question "Should I invest when I'm in debt" and "Should I invest when I have five figures of double digit interest debt". Most people who invest are in debt because they can make more on the interest of the investment than they pay on the debt. And why pay off a 3% mortgage early when you can reliably get 5-8% on the markets? So clearly, investing while in debt isn't bad. But your title and your actual question don't match up. – corsiKa Dec 22 '15 at 10:17
  • You've already got a great answer, so one additional thought: Set a reasonable accelerated payment schedule for the loans (something to pay them off faster than normal, but something you can stick to), once the loans are paid off, use those same "payments" for investing. Your budget will have already adjusted. If possible put the debt payments on auto-pay at that amount, then start an auto-invest at the same amount for the next paycheck after the loans are paid off. Once you're done investing in the past, you can switch to investing for the future. – mlibby Dec 24 '15 at 15:15
  • @MichaelKjörling, not sure how you've calculated the $100/month passive income from him investing his entire current earnings. If he invests $4650 each month for 5 years straight, at 5% p.a. he will have roughly $316K in capital, which is about $37K profit up until that point, and a $1320/month in passive income going forward. I haven't taken tax into account but I doubt that would make it anything near $100. – Saeb Amini Apr 12 '16 at 14:24

4 Answers4

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All else being equal, No

The interest on your debt is quite high and is probably not tax deductable.

Any earnings on your investments would be taxed at about 30% based on your income. To positively gear these you would need a return of about 19.5%. The only investment I know that returns this is a roulette table but the risk profile is rather high.

  1. Renegotiate the interest rate - it is way too high,
  2. Pay the debt off as soon as you possibly can.
  3. Get proper financial advice before you considerer gearing for investing - it increases returns and risk.
Dale M
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I'm sorry to be the one to tell you, but you are quite wrong in thinking that your investment returns will "probably" be greater than how much you are paying on your debt. Only someone trying to sell you something would lead you to believe that a normal investment, on average, will earn that kind of return. There are periods where reasonable investments earn more than 13.7%, but then there are periods where you lose that much or more. On average, you do much worse than 13.7%. If you had said your average interest rate was 2%, I might have responded differently, but 13.7% interest is very, very high and should make you very uncomfortable. Pay it down as soon as you can.

Think of it this way, if your bank offered you a risk-free savings account right now that offered 13.7% annually (tax free!), would you use it? Yes you would, because that's far better than any risk-free asset or bank account pays. Well, paying your debt down is financially equivalent to putting money in a fantastic asset that is completely risk-free and has guaranteed returns earns far, far beyond that of any similar asset you will ever find.

You could get lucky and the next two years could be great in the market, but that would be taking a large gamble with your money. You wouldn't break even until the market hit 13.7%. Like Vegas, that gamble has negative expected return (on average the house wins).

The only exception I can think of would be making enough of a contribution to your superannuation to take advantage of the "super co-contribution" if you are eligible, or employer matching if offered. That would be a guaranteed instant return. Once you have maxed that out, I think everything else should go to your debt.

Super co-contributions help eligible people boost their retirement savings.

If you're a low or middle-income earner and make personal (after-tax) contributions to your super fund, the government also makes a contribution (called a co-contribution) up to a maximum amount of $500.

- Australian Taxation Office

TLDR: At that interest rate, you will do much better paying down your debt and then investing than you will concurrently investing and maintaining debt.

Community
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farnsy
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    The man is in Australia - US 401(k) is not an option for him - unless you are proposing he emigrate? – Dale M Dec 21 '15 at 05:50
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    According to my cursory research, Australians sometimes make voluntary contributions to their supers that are company matched. Same principle. But I do think it's less common, so even less likely to make any investment make sense. – farnsy Dec 21 '15 at 05:52
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    Not at his level of income; for very low income earners it is a possibility. Australians have compulsory employer contributions at 9.5% of ordinary time earnings and are allowed to make tax deductable contributions subject to annual and lifetime caps. After tax contributions are not limited. Superannuation accounts have very generous tax treatment. – Dale M Dec 21 '15 at 05:57
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    Oops I edited my comment and now the thread doesn't make sense. Sorry. Anyway, you are right that the exception in question is unlikely to hold. – farnsy Dec 21 '15 at 05:58
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    Thanks, I meant to say returns would be LESS thank my debt interest. But your answer still applies. – TheRealTy Dec 21 '15 at 05:58
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Paying off your debt is an investment.

If you spend $100 to pay off your debt, you will not have to pay the $13.7 interest for that $100, so in some ways you "earned" $13.7 on your $100 investment.

A 13.7% return on an investment is insanely high, especially when you consider that there is zero risk involved. The only risk would be if it were a variable rate and it suddenly dropped to a lower percentage or something. I can guarantee you that it will not drop anywhere near considerably enough for it to not be considered a valuable return by paying it off.

If you think that whatever investment you were thinking of doing could earn more than 13.7% return, then by all means go ahead. Also tell me what it is because that would be a crazy good return. The only way you would be able to match this return would be on something very very risky, such as a casino or something.

So your best investment option would be to pay it off, and to pay it off as quickly as you can. Remember that every extra $100 you pay off means you won't have to pay an extra $13.7, not to mention that with the accumulative interest, you'll be "earning" even more.

Try and save as much as you can and pay it off as quickly as you can. If you really want to travel or spend a lot on something I recommend delaying it a year or two or three because the lower your debt is the less it will cost you to not pay it off. ($ wise, % wise it would still be the same)

Aequitas
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  • Sorry, there was a type in my question, meant to say i knew returns would be less than interest pain on loan. I was more focused on what would put me in a better situation 5 years from now in terms of passive income. – TheRealTy Dec 22 '15 at 04:58
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    As I said, paying off your loan as fast as possible, is the best investment and will result in being in the best position in 5 years. If you had a considerable amount of savings/less debt/more income it MAY be better in the long run (way more than 5 years) to focus on other investments such as property or something. But it's very unlikely, pay off the debt as fast as possible, then you'll have more money to invest and therefore end up with more total income from your investments (even if it's at a lower return). – Aequitas Dec 22 '15 at 05:02
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If your aim is basically to make money, then it only makes sense to invest if the income from your investments will be greater than the losses from your debt.

Your interest rate is very high and it's very unlikely you'll find an investment that will have a higher return than that.

In theory though if you did have an investment opportunity with returns greater than your interest rate, let's say 20%, then you absolutely should invest instead of paying off your debt.

If you find an investment like that please let us all know!

Ian Newson
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