{"id":2174,"date":"2023-04-27T21:19:57","date_gmt":"2023-04-27T15:49:57","guid":{"rendered":"https:\/\/myfinadvisor.com\/home\/?p=2174"},"modified":"2023-04-27T21:19:58","modified_gmt":"2023-04-27T15:49:58","slug":"invest-or-pay-off-debt","status":"publish","type":"post","link":"https:\/\/myfinadvisor.com\/home\/invest-or-pay-off-debt\/","title":{"rendered":"Invest or Pay Off Debt?"},"content":{"rendered":"\n<p>If you are paying off a loan (say a home or car loan) and suddenly find yourselves with some extra cash, you might be wondering whether to put it towards paying off the loan or investing.<\/p>\n\n\n\n<p>It\u2019s a tricky choice, but we\u2019ve got some insights to help them make the right decision.<\/p>\n\n\n\n<p>There are basically<strong> <\/strong><strong>two lenses<\/strong><strong> <\/strong>that they can use to solve the dilemma:<\/p>\n\n\n\n<h5 class=\"wp-block-heading\"><strong>LENS 1: RATIONAL LENS<\/strong>&nbsp;<\/h5>\n\n\n\n<p>The logical starting point is to compare the expected future return from your investment vs your current loan\u2019s interest rate.\u00a0<\/p>\n\n\n\n<p>If,<\/p>\n\n\n\n<p><strong>Expected Return from Investment &gt;= Loan Interest Rate + Safety Margin (4%) = Invest<\/strong><\/p>\n\n\n\n<p><strong>Expected Return from Investment &lt; Loan Interest Rate + Safety Margin (4%) = Prepay Debt&nbsp;<\/strong><\/p>\n\n\n\n<p>Why do we have a safety margin?&nbsp;<\/p>\n\n\n\n<ol class=\"wp-block-list\">\n<li><strong>Buffer for rising interest rates <\/strong><strong>\u2013 <\/strong>In the last few months the loan interest rates have increased from 6% to almost 8-9%. To provide for such rising rates an additional buffer is required.&nbsp;<\/li>\n\n\n\n<li><strong>Buffer for unexpected Investment returns<\/strong><strong> \u2013 <\/strong>There can be times when the Investment returns do not turn out as expected, for such lower-than-expected return outcomes a buffer is required.&nbsp;&nbsp;<\/li>\n<\/ol>\n\n\n\n<p>Here is an example of how this works.<\/p>\n\n\n\n<p>Assume you plan to invest in Equity Mutual Funds and their return expectation is around 12%.<\/p>\n\n\n\n<p>Their current home loan rate is at 9%.<\/p>\n\n\n\n<p>So,<\/p>\n\n\n\n<p><strong>Expected Return from Investment at 12% &lt; 13% (i.e. Loan Interest Rate of 9% + Safety Margin of 4%)<\/strong><\/p>\n\n\n\n<p>This means from a rational point of view, it\u2019s better to \u2018Prepay Debt\u2019<\/p>\n\n\n\n<h5 class=\"wp-block-heading\"><strong>LENS 2: EMOTIONAL LENS<\/strong><\/h5>\n\n\n\n<p>Sure, the rational perspective makes logical sense. But let\u2019s be real, when it comes to making decisions, emotions can play a huge role too. In fact, sometimes our emotions are just as important as the rational side of things, if not more.<\/p>\n\n\n\n<p>So,<strong> <\/strong><strong>let us also wear the emotional lens and check how you feel about the outstanding loan and monthly EMIs?<\/strong><\/p>\n\n\n\n<p><strong>Question 1: Are you stressed that you are a single earner and have unstable job\/incomes?<\/strong><\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>If yes, it is better to prepay debt.<\/li>\n<\/ul>\n\n\n\n<p><strong>Question 2: Do you constantly worry about your large outstanding loan amount?\u00a0<\/strong><\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>If yes, it is better to prepay debt which helps reduce the stress and burden.&nbsp;<\/li>\n<\/ul>\n\n\n\n<p><strong>Question 3: Are you frustrated that your monthly EMIs take away a large part (>30%) of their monthly income?<\/strong><\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>If yes, it is better to prepay debt.<\/li>\n<\/ul>\n\n\n\n<h3 class=\"wp-block-heading\"><strong>Summing it up<\/strong><\/h3>\n\n\n\n<ul class=\"wp-block-list\">\n<li>There are two lenses to evaluate this dilemma of prepaying debt vs investing.&nbsp;<\/li>\n\n\n\n<li>The Rational lens is where you can compare the expected investment returns and the loan interest rate. The Emotional lens is where you make decisions based on how you feel.\u00a0<\/li>\n\n\n\n<li>While both lenses are equally important, you can use the above framework to prioritize.<\/li>\n<\/ul>\n","protected":false},"excerpt":{"rendered":"<p>If you are paying off a loan (say a home or car loan) and suddenly find yourselves with some extra cash, you might be wondering whether to put it towards paying off the loan or investing. It\u2019s a tricky choice, but we\u2019ve got some insights to help them make the right decision. There are basically&#8230;<\/p>\n<p class=\"more-link\"><a href=\"https:\/\/myfinadvisor.com\/home\/invest-or-pay-off-debt\/\"><span>Read More<\/span><i>&#43;<\/i><\/a><\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[7],"tags":[],"class_list":["post-2174","post","type-post","status-publish","format-standard","hentry","category-lifestyle-advisory"],"_links":{"self":[{"href":"https:\/\/myfinadvisor.com\/home\/wp-json\/wp\/v2\/posts\/2174","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/myfinadvisor.com\/home\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/myfinadvisor.com\/home\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/myfinadvisor.com\/home\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/myfinadvisor.com\/home\/wp-json\/wp\/v2\/comments?post=2174"}],"version-history":[{"count":1,"href":"https:\/\/myfinadvisor.com\/home\/wp-json\/wp\/v2\/posts\/2174\/revisions"}],"predecessor-version":[{"id":2175,"href":"https:\/\/myfinadvisor.com\/home\/wp-json\/wp\/v2\/posts\/2174\/revisions\/2175"}],"wp:attachment":[{"href":"https:\/\/myfinadvisor.com\/home\/wp-json\/wp\/v2\/media?parent=2174"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/myfinadvisor.com\/home\/wp-json\/wp\/v2\/categories?post=2174"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/myfinadvisor.com\/home\/wp-json\/wp\/v2\/tags?post=2174"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}