Drumroll please…. The most passive investment award goes to…
PAYING OFF YOUR DEBT
I mean think about it. Paying off your debt requires little to no effort. All you have to do is pay a little extra each month then eventually you will never have to make that payment again. It is, in fact, easier to maintain your finances when you don’t have any debt. So how is that for passive!
But is this really an investment?
Yes! Once you pay off the debt, you will have increased your net cashflow each month by the amount you would have been giving away for that payment. Even all of those early payments are saving you interest you would of had to pay. So even though your payment does not lower as you make early payments, the amount you will end up paying in interest will!
But what if other investments can make more money?
One of the most common arguments people point out is, “if I invest in the stock market and get an 8% return and my debt interest is 5%, then I can make 3%”. Fair point, but you are overlooking the many other advantages of paying off your debt:
- Paying off debt is GURANTEED IMMEDIATE return. As soon as an extra payment is made towards debt, it is applied directly to the principle. That paid off principle is then no longer able to accrue interest and make money for the debt collector. Not many investments offer that kind of velocity and guarantee.
- Less risk. Sure the stock market averages 8-12% but what happens in the down years. And lets be honest, the stock market does not have many down years where it only goes down 5-10%. When the stock market has a bad year, it usually means an over 20% drop and sometimes more than a 50% drop like in 2008. Not to mention, that usually means the economy is not doing too hot, so that “safe” job you have, might not look so safe anymore. I know I am speaking a lot of “what if’s” but you need to think of if you can weather any financial storm? Paying off your debt prepares you better for the bad times because it reduces you financial obligations. And guess what, the debt collector does not care if you lost all your money in the stock market crash or lost your job, they still want their money.
- Paying off debt is motivating! The nice thing about paying off debt is there is a finish line. You get motivated to get to that finish line and start to make lifestyle changes in order to get to that finish line faster. Instead of buying a lunch everyday, you bring a lunch just so you can put an extra $200 per month towards reaching the finish line.
- Financial Independence is most simply reached when you have fewer, smaller payments. Plain and simple, it is easier to reach FI when you don’t have payments. The fewer payments you have, the fewer dollars you need to be FI. Rather than trying to have an investment cash flow enough to cover a debt payment, why not just use the money to pay off the debt directly then wala! No more payment!
- You won’t need as large of an emergency fund. 3-6 months of expenses is the typical recommended size for an emergency fund. That can be a lot of money if you have a lot of payments. Eliminate some of those payments and you can deploy more of your savings towards investing instead of an emergency fund.
WARNING: Other side effects of paying off debt may include: less stress, happiness and financial independence
Paying off debt is slow and boring. I get that. It’s not nearly as fun as “playing” the stock market. But often times, investing is and should be boring. Investing should provide more stability and comfort in your life so you can focus on the important things. Sure, paying off debt may not give you the highest ROI on your dollars all the time, but there are many advantages that people overlook like how passive it is. And remember, the goal is not to have the highest ROI, the goal is to be have less stress and more confidence when it comes to finances.