One of the most important lessons as an engineer was to not always trust the numbers without doing a practicality test. When you punch numbers into spreadsheets it is too easy to come up with answers that just don’t make sense. You may have all the right calculations, but your assumptions used to set up your calculations may be completely wrong. When setting out to tackle your debt you need to make the right assumptions about yourself.
If you have arrived at the decision that you want to get out of debt quickly – a must in my opinion before serious investing. It may seem complicated with questions about interest rates, minimum payments, refinancing, and debt consolidation. Fortunately, the scientifically proven way to get out of debt faster will let you forget almost all of that.
- Mathematically – strictly mathematically – the fastest way to get out of debt is to make minimum payments on all your debts except for one. Take the one debt that has the highest interest rate and throw every bit of money available at it. When that one is eliminated start throwing all the money you can at eliminating the second highest. Just go down the list doing the same thing until you are debt free!
- Scientifically, the fastest way to get out of debt is to ignore the math! You heard me right. According to some studies by the University of Michigan and similar studies by Harvard Business Review people paid off debt faster when they paid off the smallest balance debt first. As Business Insider said, “ultimately, the researchers concluded that the factor that made the biggest impact on how hard participants worked wasn’t the amount they were paying back or how much was left in the account afterward, it was the percentage of the balance they ended up getting rid of.” When working with your finances you have to take into account the math and your behavior.
I highly recommend the smallest balance first method, but if you think you will remain more motivated with the first strategy do that, just know that it doesn’t work like that for the average person.
I know many people that are very excited to start investing and want to do that before they pay off their debt. Years like 2017 where the stock market goes up 20% make it is easy to say, “why not keep my 4-10% interest rate debt and just invest and reap the difference.”
Personally, I think that is a very bad move. First, investing wisely is much easier when you don’t have debt hanging over you. Next months payments often will cloud your judgement when investing. Second, why invest in something that could decline 50% next year when you could get a guaranteed return of 4-15% every year over the term of your debt?
The average credit card interest rate is around 16% a year. This means every dollar you use to pay off credit card debt gives you a guaranteed return greater than the historical average of almost all good investments. Even debts with lower interest rates should give you plenty of motivation to pay them off before investing because again you are getting a guaranteed return. In my opinion the only investment worth having a loan to do is a mortgage for your personal residence, but that doesn’t even always make sense.
Take this final scenario of a person in December of 2000 who had $100,000 cash and a $100,000 loan on their house at a 2% interest rate. Well from December 2000 to December 2010 the stock market had an annual return of 1.18%. That means by paying off the mortgage at the beginning of that ten year period the investor would have almost doubled the effective return for the 10 year period. What is your lowest interest rate loan. Would you prefer to have that interest rate as a guaranteed return or maybe get as low as 1.18% for the next ten years while still paying interest on your loan?
Please keep in mind I am not a financial adviser. All investments are risky. Follow me here or at my other locations: blog, Twitter, Steemit, YoutTube, Facebook, or Collective2. I actively trade the stock markets and you can set up your brokerage account to follow the same trades as me for as little as $25 a month at Collective2.