Investing while in debt is a touchy subject for obvious reasons. Some believe that investing while in debt is an effective financial decision while others believe it is counterproductive. Money owed increases with time due to compound interest. With no guarantee of returns, investors who have debt put themselves at risk of bankruptcy. Many may, however, find that waiting to invest presents costs in terms of unrealized profits that could have been made from investments.
Investing While in Debt
Individuals who want to invest while in debt should take into consideration the interest rate on their debt. Debts which attract high-interest rates may call for lower risk appetite by investors. An investor with a debt that carries 6 percent or above may have to be cautious about purchasing stocks that have a potential return of 9.5 percent.
With debts, cash flow may be significantly reduced. Losses from investments may further deepen pressure on cash flow, leaving individuals with less cash flow than prior to making their investments while in debt. Having an emergency fund of savings set aside before investing can help reduce related risks.
The implications of investing while in debt may include higher tax bills. The rate of after-tax interest that is paid on debt could result in tax deductions. Coupled with the after-tax real rate of return, these factors can determine how much an investor with or without debt pays in taxes for their investments.
Individuals who want to invest while in debt may find it advisable to build an emergency fund with liquid checking and savings accounts. Accumulating three months worth of expenses can serve as a good buffer against risks tied with investing while in debt.
Funding a Roth IRA can also help with reducing tax obligations. Roth IRA’s retirement accounts provide tax benefits, allowing contributions and investment earnings to grow tax-free. This allows for lower taxes in retirement funds. A Health Savings Account could also help. Funds contributed to health savings accounts are not subject to federal income tax at the time of deposit.
Credit Card Debt
Investing while in credit card debt presents very high risks. Credit card debt interest rates are between 15 and 20 percent. Costs of credit card debt build up significantly as debtors continue to owe money. Individuals with credit card debt may be better served if they refinance their debt so that the rate of interest they are charged is reduced.
Increasing cash flow is by far one of the best courses of action to take if an individual with debt wants to invest. Decreasing expenses while increasing income helps to increase cash flow. Unnecessary lunches and dinners out can easily be replaced with home-made food which is not only healthier but more cost-effective. Making a few more hundred dollars a month isn’t as difficult as it may seem. The gig economy presents more opportunities than ever to make income in your spare time.
Investing while in debt is a difficult decision to make due to the high risks associated with debts and the uncertainty presented by changing economic dynamics.
Calvin Ebun-Amu is passionate about finance and technology. While studying his bachelor’s degree, he found himself using his spare time to research and write about finance. Calvin is particularly fascinated by economics and risk management. When he’s not writing, he’s reading a book or article on risk and uncertainty by his favourite non-fiction author, Nassim Nicholas Taleb. Calvin has a bachelors degree in law and a post-graduate diploma in business.