With today’s low rates, the pay down debt or invest debate isn’t as clear cut as it used to be.
Ever since people started borrowing money centuries ago, people also started worrying about being in debt. Nearly 250 years ago philosopher and economist Adam Smith made a comment that still rings true today: “What can be added to the happiness of a man who is in health, out of debt, and has a clear conscience?”
As Smith suggested all those years ago, for most people, being debt-free – and in control of your income – is good for the mind, the soul and the wallet. However, what Smith didn’t have back then was ultra-low interest rates and a robust capital market where one could conceivably make more money investing than paying down debt.
For today’s savers and investors, that’s the big question: pay down debt or invest?
There are many reasons why paying down debt first makes sense. It delivers a risk-free, after-tax return. This is especially true when you consider costly, high-interest credit card debt. The more you put towards paying off debt, the more you save in interest costs and that can equal more money in your pocket.
It can also have a profound emotional impact. In 2012, a study out of the University of Nottingham looked at the links between debt and depression and found that those who had trouble paying their debt obligations also showed evidence of poor psychological health.
Paying off credit card debt first makes the most sense because rates are often high. But when it comes to mortgage debt, the question becomes harder to answer. With some people paying below 3% fixed and variable rates these days, the cost of carrying debt is far lower than it has been in the past.
At the same time, the S&P/TSX Composite Index has returned 4.6% annualized over the last five years, according to S&P Dow Jones Indices, which is higher than the mortgage rate you’re paying.
In other words, if your debt is affordable, putting extra cash towards an investment with the potential for a higher return may be the better option.
With today’s low rates, the choice isn’t as obvious as it used to be, so talk to a financial advisor who has a good overall understanding of your financial situation. They can help you make the decision that’s right for you. And perhaps, you can get a little closer to Adam Smith’s philosophy of happiness.