Reduce Debt or Invest?

Dear DTA, 

I’m excited to start investing. But I have some debt. About $50,000. Should I take care of that first? I don’t want to miss out on gains, but I’m not sure what to do about this debt. 

-Diana B.

Hi, Diana.

Thanks for writing in. Really appreciate it.

That’s a great question.

Before I provide my answer, I want to give you some perspective on where I’m coming from.

I’m a huge fan of the US stock market.

The US stock market is one of the greatest long-term wealth generators ever known to man.

It’s hard not to be a huge fan of something like that.

Being a fan and taking advantage of that wealth generator has been a massive boon to my life and money.

But it hasn’t always been this way for me.

I used to avoid the stock market.

I’d instead buy things I didn’t need, with money I didn’t have, to impress people I didn’t like.

And I was broke because of it.

Then I started investing at the age of 27.

Things quickly turned around for me.

I went from below broke at 27 to financially free and retired at 33, as I lay out in my Early Retirement Blueprint.

That Blueprint is Exhibit A when it comes to showing how powerful the US stock market can be.

Exhibit B is my FIRE Fund, which is my real-money stock portfolio.

The Fund produces enough five-figure passive dividend income for me to live off of in my 30s.

Now, I’ve gone about it a bit more specifically than just investing in the stock market as a whole.

That’s because even the US stock market has some duds in there.

Jason Fieber's Dividend Growth PortfolioI’ve used dividend growth investing to get to where I am.

Fellow contributor Dave Van Knapp explains exactly what this strategy is, as well as how to use it to build serious wealth, in his Dividend Growth Investing Lessons.

This strategy essentially involves buying shares in world-class enterprises that are paying their shareholders reliable and rising cash dividends.

You can find many examples of these enterprises in the Dividend Champions, Contenders, and Challengers list.

This list contains invaluable information on more than 800 US-listed stocks that have raised their dividends each year for at least the last five consecutive years.

Now, as you can see, my perspective is shaped by my wonderful experience with strategically using the US stock market to my advantage.

That said, I wasn’t $50,000 in debt when I started.

But I did have debt. Plenty, actually.

I had about almost $30,000 in student loan debt.

However, this is arguably some of the best possible debt to have.

That’s primarily because of the availability of favorable terms – low interest rates, tax advantages, income-based repayment plans, etc.

And one should have a degree as an “asset” to balance against that debt.

I don’t know what kind of debt you have, Diana.

So it’s difficult for me to tell you exactly how aggressive you should be with paying it off.

But I’ll say that if it’s debt with a high interest rate, such as credit card debt, you should focus on paying that off before ever touching a stock.

Even a loan on a used or new car should be paid off with maximum swiftness.

The logic is simple.

The odds that you’ll get a better forward return on stocks, especially with current equity valuations, are low in comparison to the “guaranteed return” you get on eliminating the debt servicing costs of a high interest rate. 

I would probably use a low-single-digit interest rate as my “line in the sand” for the purposes of deciding whether to invest or aggressively pay off debt.

Let’s call it 4%.

You should still be paying off this debt, regardless of the interest rate.

Don’t get me wrong on that.

It’s just that the aggressiveness of that pay-off strategy might vary depending on exactly how detrimental the debt is.

For instance, if you’re talking about a $50,000 mortgage debt on your house with a 3.2% interest rate, I’d personally be making the minimum payments and using excess capital to invest.

I’m not necessarily recommending this.

I’m just using that as an example from my point of view, using math.

That’s because the US stock market has historically offered a ~7% annualized long-term real rate of return.

7% sure beats 3.2%. And that 3.2% interest rate is on something (a house) that should mildly appreciate in and of itself over the long run.

Equity valuations would appear high right now, potentially limiting that return on a forward-looking basis, but interest rates are also currently quite low.

The latter, based on your situation, could be a huge benefit, making the former not all that burdensome.

So I’d take a good look at how that $50,000 breaks down, Diana.

Consider drawing a line in the sand for what makes sense for your own situation.

Maybe it’s 3%. Or maybe it’s 6%.

Putting aside math, however is the question of being able to sleep well at night.

I’ve talked to many people over the years that would rather pay off debt and sleep well at night, no matter how the math broke down for them.

Undervalued Dividend Growth Stock of the Week by Jason FieberThey’d rather not deal with the volatility of stocks, especially knowing they had debt.

If that’s the kind of person you are, you might want to strongly think about paying off your debt as fast as possible.

You can then start to plow money into stocks when you’re debt-free and sleeping soundly.

When you’re ready for something like that, we’ve certainly got you covered with plenty of great long-term investment ideas.

The Undervalued Dividend Growth Stock of the Week series, which I helm, is a great example.

I share a compelling dividend growth stock idea every Sunday.

These are high-quality dividend growth stocks that appear undervalued at the time of publication.

And I only share these ideas after they undergo a thorough analysis and valuation.

I hope my perspective has helped you, Diana.

No matter what you decide to do, the most important thing is that you start today.

I wish you luck and success.

Jason Fieber

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Disclaimer: Jason Fieber is not a licensed financial advisor, tax professional, or stock broker. Please consult with a licensed investment professional before investing any of your money. If your money is not FDIC insured, it may decline in value. To protect the privacy of our readers, any names published in this article are under aliases. In addition, text may be edited, omitted or paraphrased for grammar or length.