Today I want to talk about digging a hole, specifically referring to the hole being dug when a person carries debt, especially high interest debt. One of the most quickest and assured ways of building wealth is to get rid of bad or high interest debt like it is a bad weed.
The tricky part is it’s not as easy as getting your handiest herbicide or grabbing the sickle and sparying or cutting debt down like it was a weed. We incur debt for any number of reasons some being out of our control and some being “choices or wants”. The emergencies that spur us to incur debt can be the curve balls that life can throw at us. To deal with that the idea of keeping an emergency fund account can be one tool that is effective. But even this takes patience and good saving habits.
But if we think about it paying off high interest debt gives us the return on our money that is going to be hard to duplicate in investments, the bonus is it is a guaranteed return no risk what so ever. What ever the rate is for interest on that debt is your automatic return when extra money is put down on it.
Where the water becomes a little more muddy so to speak and the choice between investing or paying down debt becomes harder to distinguish is on low interest debts say like a mortgage or a real low line of credit interest rate. It is here that the possibility with taking on some risk of you getting more of a return on your money versus paying down a mortgage or other low interest debt can take place. I truly feel though regardless of what the “numbers” say there is also the factor that some people just hate debt all together and the stress it brings along with it.
In the case of paying down debt that is low interest or to invest and potentially make a better return, it really comes down to a by situation or person scenario we all have different levels of risk/reward and also stress differently at different levels and topics. But it truly can be a rewarding venture if one can accept a little risk, and invest extra cash instead of paying down low interest debt. The key obviously is how reliably you think you can make more month to month, year to year on investing that money versus paying down the debt.
This is one use I can see for the TFSA that we as Canadians are now able to enjoy since January of 2009. For as long as you monitor your contributions any money made within this account is not taxable and you are free to withdraw. So just for a simple example let’s say you hold a line of credit with an interest rate of 6.5% but you also have been watching a stock that pays out a monthly dividend and its stabilized yield is 8%. Now you come into a lump sum of money of $10,000, which also just happens to be the amount owing on your line of credit. If we look at the percentage spread we quickly see there is a 1.5% surplus if the money was invested versus paying down the debt. Then a person could take the dividends that accrue every month from that investment and pay the interest as well as gain on the principle on that line of credit all while keeping their $10K at work for them. Bonus…. Right?
Again there is some risk involved here as the stock could go down making your investment worth less but dividend would be the same unless of course the security picked was in some sort of trouble and also started reducing dividends as well. That’s why it is important to do your own research and/or consult a financial professional. My objective here is to spur some thought and illustrate different options we have to get ahead bit by bit by letting our hard earned money work for us.
In future posts I will talk about the TFSA some more as it really has become my favorite option for investing extra cash if conditions are right. Below will be some links where you can find out more about the TFSA and also see what the contribution limits have been since its inception.
Would love to hear from you all and your thoughts opinions on this topic.
Good Night from GFW 🙂
Revenue Canada link for TFSA Info