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Pay down debt or invest?

Pay down debt or invest?

Posted on: April 01, 2016
Author: Chris Turchansky, CFA, President, ATB Investor Services

So you’ve managed to save a little money, and now you have to make a big decision: should you use this money to pay down debt or invest? It’s a choice many people struggle with, especially during RRSP season when Canadian savings habits—or lack thereof—dominate the news.

Interest rate vs. investment return

Often the easiest way to make this decision is to compare the interest rate on your debt with the expected return on your investment. As a general rule, you should put your money towards whichever rate is higher.

Interesting fact:

38% of Albertans said if they received a tax refund for 2015 they would use it to pay down debt. 37% would put it into savings or investments.

 

For example, let’s say you must decide between paying down your mortgage (with a 5 per cent interest rate) or contributing to your RRSP (with an average 7 per cent return). Based on the simple math, the growth you would see in your investments would out-pace the savings you’d make on your mortgage by about 2 per cent. After a few years, the difference could be significant.

On the other hand, if you’re deciding between paying down your credit card (with a 19 per cent interest rate) or contributing to your RRSP, you should pay down that card. That 19 per cent interest rate should be your priority.

Whether you decide to pay down debt or invest, be sure to stick with your decision. Contrary to popular belief, the “little of both” solution makes little sense. This is because, if investing is the best decision for you in February, then it’s likely still the best decision for you in April when that juicy tax refund lands in your mailbox. Reinvest that tax refund and continue to earn that 2 per cent advantage. Use that tax refund to pay down your mortgage? That’s kind of like driving the quickest route to work Monday through Thursday, then taking a longer route on Friday.

Investing your money or paying down debt is an important decision, and your amount of debt, type of debt, years to retirement, and expected investment return are all factors to consider. Get expert advice to help you create your own plan by stopping by your local branch to talk to an ATB team member.

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