It is a question you often here around the personal finance traps, and the answers are as diverse as us ourselves. The truth is, as in all areas of personal finance, the answer is… personal! There are so many factors involved, there is no absolute right answer. If we were robots on the other hand, of course there would be – if the compounded rate of return on your potential investment was guaranteed to be higher than the interest you would pay on your debt over its life then you should invest – however we are not robots (well not yet anyway) so a little more thought needs to go into the topic.
No I am not talking about the long running Australian boy band, but the behavioural traits of the billions of individuals who occupy our planet. Humans are emotional beings and money is an emotional subject!
Risk tolerance is a term that comes up frequently in the personal finance industry, usually in the form of debt and the willingness to carry it. Some people just hate debt, it keeps them awake at night, it fills their thoughts during the day until they have paid off every cent. This is not a bad a way of operate, who wouldn’t want to spend their life debt free! Never owing anything to the banks! Unfortunately for 99% of the population at some stage we will need to take on some debt, be it for education, transport, shelter or a myriad of other things.
There is an argument that debt comes in two forms – Good Debt and Bad Debt.
Good debt is debt that supports an income generating asset like a investment property or a business. If your tolerance for debt/risk is a little higher than the average person you can use debt to accelerate your wealth accumulation by ‘gearing’ your investments via a investment loan. Of course this is only beneficial if the return on investment is greater than the interest you will pay on the loan. Also on the negative side is of course you can compound your losses if things go pear shaped so you need to be very selective in the assets you choose to invest in.
Bad debt is the debt that everyone should look to pay off a quickly as possible. This is the credit card debt, the high interest car loan or the store card. You should avoid this debt like the plague as that is what it become if it is allowed to get out of control. These sorts of debt are usually accompanied with very high interest rates which can spiral out of control very quickly.
A Balanced Approach
Perhaps it is because I was born under the seventh astrological sign in the Zodiac (Libra for those playing at home) but I like to try and strike a balance between playing down debt (this is generally the mortgage on my primary place of residence) and investing. Home loan rates in Australia are currently at all time lows so it is not too difficult to out pace those returns with your investments, however history says interest rates will eventually rise so I think it is still important to continue to pay down that debt at a steady rate, in fact you could argue now is the best time to smash that debt while you are getting so much bang for your buck.
I believe this question will forever float around the vast expanses of human thoughts as it is and will forever be, a very personal decision.
I would love to here your thoughts on this subject, please post a comment below!