Drop your debt or invest?

All through history, debt was a worry

Pay down debt before you invest has been a common-sense financial strategy for a long time. But these days, 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 they also started worrying about being in debt. For most people, being debt-free — and in control of your income — is good for the mind, the soul and the wallet. However, what has changed these days are ultralow interest rates and a robust capital market where one could conceivably make more money investing than paying down debt.

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 and so are the health consequences. But when it comes to mortgage debt, the question becomes harder to answer. With some people paying below three per cent fixed and variable rates these days, the cost of carrying this type of 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 per cent 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, especially if you have contribution room available in a tax-preferred investment account such as a Registered Retirement Savings Plan or Tax-Free Savings Account.

With today’s low rates, the choice isn’t as obvious as it used to be, so talk to your professional advisor who has a good overall understanding of your financial situation and can help you make the decision that’s right for you.