Should You Be Investing Or Paying Down Debt?
|November 19, 2008||Posted by Roshawn Watson under Uncategorized|
By: Roshawn Watson
Because consumer confidence is plummeting and prices are dropping widespread (including real estate, stocks, and gas), many are just ducking their heads in the sands and waiting for the danger to vanish. Although this strategy may help some people cope with sudden and severe losses, blissful ignorance or deliberate disregard is simply too costly for most of us. There are plenty of legitimate reasons to be careful in today’s market, but there are also bountiful opportunities as well. Due to the increased danger and opportunities, it is critical to get your finances in order.
Regardless of how long it took government officials to admit we may be recession, the main issue for your household is that your dollars are receding. Even if you deny the indicators of a deflationary period, you should be aware that those widespread price declines, job layoffs, and deleveraging are not occurring because to increased ingenuity but rather decreases in demand. In short, using information about the economy to protect your economy is what really matters the most to your family.
The next steps that you take really depend on where you are. For example, for some this means getting rid of debt while for others it may mean setting aside a few extra months of an emergency fund. Others may need to gather more courage to invest while prices are low.
Why Charles Schwab May Have It Wrong
I recently saw a CNN money video featuring a financial expert from Charles Schwab. She was talking about a new financial fundamentals program that they are rolling out. I have to say that I was a little disappointed with some of their recommendations but not surprised because it’s pretty standard advice.
Charles Schwab suggests the following steps in this order of priority to getting your finances in order.
- Invest in your corporate retirement accounts up to the match (i.e. 401k)
- Pay down non-deductible high interest debt
- Have a Emergency Fund
- Fund other retirement accounts
Although their rationale is that by investing first you do not miss out on free money from your employer’s match, this argument ignores the fact that because most people are so debt-laden they do not have much discretionary money to invest. Additionally, her argument ignores the inherit risk of living without a fully-funded emergency fund, especially in today’s economy. She mentions that you can use your credit cards if you have an emergency, which I disagree with because the last thing you need during a difficult financial hardship is more debt.
Notice, many businesses are not following Charles Schwab strategy of investing first right now; instead, they are dumping assets to pay off debts (and sadly dumping employees too) in order to obtain financial solvency. Debt is often cited as the number one reasons for business failure. This is prudent lesson that we should all learn because ridding yourself of debts and having cash on hand is what gives you a basic foundation to invest. It’s what makes your investing less risky. Although the details of Charles Schwab’s research is not publicly available (as of the time of my writing this), their advice can be dangerous.
Debt Robs You of the Cash Flow Necessary to Retire
Consider an October study by AARP, 65% of people over the age of 45 say they will delay retirement if the economic situation doesn’t improve significantly. Well the primary reason why the economy is so dangerous for retirement age individuals is because of debt. In many cases, they borrowed on their retirement just to stay financially afloat. It is hard to appropriately fund those retirement accounts while over 60% of your income is going to debt (mortgage, credit cards, car note, student loans). I recently read a sobering statistic that up to 96% of retirees do not have cash flow sufficient to pay for their expenses. Unfortunately, when most people “prepare for retirement,” they are actually preparing for poverty.
I read the perfect example a few months ago. The article was about a 72 year-old lady who still had an $80,000 mortgage. She was trying to live on a monthly Social Security check of $1,100. Sadly, she will likely have to move if she wants to eat!
In fact, debt is the primary reason senior citizens are the fastest growing number of bankruptcies followed by college-aged young people. Debt impact on your finances is devastating.
If You’re Financially Ready, Consider Investing NOW
Statistically, most people are trying to eliminate debt or setting aside their rainy day funds. However, if you have set the appropriate financial foundation, I cannot emphasize how big an opportunity you have right now.
Let me paint the picture. Investors are redeeming their shares from pension funds, hedge funds and mutual funds. Thus, the fund managers are desperately trying to raise cash. All they can really do right now is sale, so the vast majority of investments that carry any kind of risks are on sale right now by about 45%. However, instead of the giants being able to scoop up the bargains leaving individual investors with the scraps, they can do nothing but sell. This is the buyer’s market without buyers (Jason Zweig). If you have gotten rid of your debt and have a sufficient emergency fund, have courage if you are a long-term investor. There is no time like the present to continue down that path for building phenomenal wealth.
Copyright 2012, Roshawn Watson, Pharm.D., Ph.D. All Rights Reserved.