It's a question that haunts many people: what should I do with my outstanding debt? Should I allocate my monthly savings into my debt? Should I sell my investments to pay off debt? What makes sense for you? Depending on your comfort levels, debt can be one of the most financially and emotionally paralyzing things to a person.
Over the 14+ years I have been in the industry I have seen people who feel absolutely embarrassed by their debt and I have seen people who don't lose a wink of sleep at night over it, but I would say for most, one of their main priorities in their financial plan is debt elimination. So what makes more sense, investing or paying off debt? Given that we're in election season here I'm going to give you a very political answer: it depends.
As many of you have heard me say over the years, there is always a math answer and then there is the emotional answer. You can guess which one wins, but let's start with the math. It's true that interest rates have risen in Canada over the last little while and so your debt servicing is likely a little more expensive than it was a few years ago, but generally speaking we are still dealing with fairly inexpensive debt historically.
In speaking to mortgage brokers we work with I know that just recently there were 5 year fixed mortgage rates under 3% per year which is incredibly cheap (if your mortgage is coming up for renewal it is worth the conversation, please feel free to reach out). So for the sake of an example let's use round numbers and say that your mortgage conservatively has an interest rate of 3.25%. Now, let's compare that to an investment portfolio.
For this example, I am going to use a standard balanced portfolio because the vast majority of investors I have dealt with are comfortable with the volatility that comes with it. In a well diversified balanced portfolio with a rough allocation of 35% to bonds, 50-55% in quality equities (companies), and 10-15% allocated to alternative asset classes, we would expect that you will average a 5% per year net of cost return or higher. Given the option to invest and earn 5% or pay off debt that only costs you 3.25%, the choice would seem obvious. However, that is not always the case.
What the numbers and traditional financial planning strategies fail to take into consideration is the human component. The fact is, some people make themselves sick over the amount of debt that they have. The stress can quite literally cause sleep loss and in these situations the difference in returns of your investments over what the debt costs would have to be significantly higher (if even possible) for them to choose to invest overpaying off debt.
This is also where I think many advisors are failing their clients by not recognizing this. If you are going to live your life stressed out the extra money you earn is likely not worth it. But does it have to be one over the other? Do you have to choose to pay of debt or invest? I have found that given the option, many clients will choose to do a combination of the two options. When looking at a family's disposable cash flow we often will take a portion of it for investing and a portion of it for extra debt payments and develop a plan for paying off their debt faster.
I have found that the biggest contributor to stress relief in this area is establishing a plan to have the debt eliminated by a certain time and once that is established, most people feel as if a huge weight has been lifted right away. Debt can be a very powerful tool if it is managed properly. It can enhance your wealth, fast track your lifestyle and even help you to build your dream career or business. But, left unchecked, debt can spiral out of control and become a weapon of mass financial destruction.
Lenders will often give you more money than you need and so you need to ensure you are being responsible on your end and that your borrowing is considered in your overall financial plan. Make educated decisions. Make 'Smart Money' decisions.
- Grant White, CIM, CFP
Grant White is an award-winning Portfolio Manager/Investment Advisor at Endeavour Wealth Management with Industrial Alliance Securities Inc. Together with his partners he provides comprehensive wealth management planning for business owners, professionals and individual families.
This information has been prepared by Grant White who is a Portfolio Manager for Industrial Alliance Securities Inc. (iA Securities) and does not necessarily reflect the opinion of iA Securities. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Portfolio Manager can open accounts only in the provinces in which they are registered.
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