Should you pay down debt or invest?

Choosing to pay down debt or invest is a personal decision that depends on many factors. To determine whether it would be better for you to pay down debt or invest in the market, you need to look at your situation holistically. Start by understanding your relationship with risk and the type and amount of debt you have.

Your relationship with risk

To understand your relationship with risk, it's important to understand your risk tolerance, risk capacity and time horizon.

Risk tolerance is a measure of your willingness and ability to withstand volatility in your portfolio. Some people can tolerate high volatility while others get anxious at the thought of their investments losing value.
Risk capacity can be thought of as how much your investments could lose in value before affecting your life. If you’re on a fixed income, you’d likely have a lower risk capacity than someone with a well-paying job, little debt and saving 20% of their money.
Time horizon refers to how long you intend to invest. Generally, the shorter the time horizon, the less risk you should assume.

The type and amount of debt you have

Debt can come in many different forms, but there’s good debt and bad debt. When used responsibly, debt can help you reach many of life's milestones, like owning a home or completing education. An example of good debt is a mortgage that provides you with a home and an asset. Bad debt includes a balance on a credit card with a high-interest rate.

If you have credit card debt, you would probably be better paying it off first. On the other hand, if potential investment return is higher than the interest rate you pay on your debt, it’s better to invest.

Advantages of paying down debt

Reduces money-related stress - Many Canadians are experiencing anxiety and depression over financial worries. If this sounds familiar, reducing debt may have a bigger influence on your life than just the financial impact.
Improves cash flow and financial flexibility - When you reduce debt, your cash flow improves because you now allocate less money to principal and interest charges, leaving you more money for other goals. Your financial flexibility also increases. For instance, when you pay down debt on a line of credit, you not only increase the amount of credit available to you if you need to borrow again, but it can improve your credit score.

Some trade-offs

Reducing debt might be a smart decision for your personal situation but be aware by not investing today you have less time for your money to grow. The earlier you invest the more assets you’ll accumulate.

Inflation is another factor, as it erodes your purchasing power. This combination of less time investing, and inflation may force you to work longer to reach your retirement goals. For these reasons as well as government savings incentives, like RRSPs and TFSAs, many people opt to carry low-interest rate debt while investing their savings.

What may be right for you is unique to your situation. Consult with your Edward Jones advisor to help you determine the best option for your unique circumstances.

This article was written by Edward Jones for use by your local Edward Jones Financial Advisor.

Number of Words: 523