Let’s say you have $10,000 invested in the stock market and you have another $10,000 of credit card debt. Now you are already probably seeing where I’m going with this, but hear me out because this scenario happens all the time. It is likely that you are in this situation yourself.
Now let’s say that you $10,000 in the stock market gets a return of 15% in a given year. That would actually be a really good return. The market average is around 10% and the likes of Warren Buffett makes around 20%.
Let’s say that your $10,000 credit card debt has an APR of 18%, which is pretty average. That means in that year, you made 15% on $10K and PAID 18% on $10K. What was your net gain? You didn’t have one. Even finding great stocks to buy that get exceptional returns in the stock market, you LOST 3% that year.
Now this doesn’t include commissions and taxes that would eat into your stock returns. It also doesn’t include the fees and additional charges that come with credit card debt.
This is why it is super important to pay off your debts before you start investing in the stock market. You will have to peddle extra hard to get positive returns because you always have to make up for the lost ground with interest rates on your debt.
What About Car Loans and Mortgages?
I feel the same way about car loans. Even if you get a really good interest rate, say at 3%, you will still lose in the long run. Most of the time, there are fees and charges involved in getting a car loan. But the big loss comes in the fact that it is a depreciating asset. You are going to lose 40% of the value of the car in 4 years. That means you are losing around 50% on this deal.
Now if you take that car payment and put it toward a stock investment instead, not only are you not paying interest, but you are buying into an appreciating asset.
Mortgages – The Exception
The exception here is the mortgage on your house. But there is a caveat here as well. This assumes that the house is appreciating in value. That used to be a given, but no longer. That means you need to be very careful to buy a house in a great location in a growing area with rising real estate values, even during a recession.