I spoke with one of The Best Interest‘s wonderful readers who had the following financial stats:
- $50,000 in debt remaining on a mortgage
- $150,000 sitting in a savings account
- $200,000 invested in stocks and bonds
We talked through various options. Spend this, invest that, etc. Without much prompting, the reader said,
“Well I’m in a $50,000 hole. Shouldn’t I fill that in before doing anything else?”
The mortgage. He’s talking about the mortgage. In my head, I thought, “It’s probably at a low-interest rate. Not a big deal. But I want to hear more about it…”
It’s true. Debt is a hole. It can be a hole in your boat. Fill it in or you’ll sink. Or a hole in the ground, with you stuck down in it. Shouldn’t you lift yourself back to the surface before the hole gets deeper?
Holes are bad. Debt is bad. Get rid of it.
But in truth, there’s a more nuanced answer. Enter the “debt vs. investing” debate.
I won’t go into deep detail. Only one important equation matters in this debate. If your investment return is greater than your debt interest rate, then you’re better off investing your cash than using that cash to pay down debt.
Let’s use this reader as an example:
Should our reader use $50,000 cash to pay off his house? If his mortgage is at a 3% interest rate, he might be better off investing in the stock market (where historical average returns are 10% per year). In this case, long-term investment returns will likely be greater than his savings from extra debt repayments. It makes sense to invest.
I explained this idea to the reader. He responded:
“I follow your math. But the hole is still there, right? I’d rather get a clean slate, ya know? Just fill in the hole.”
Personal finance is a balance of math and psychology. This reader gets the math. But his psychology is screaming, “The hole! What about the hole?”
All he can think about is his leaky boat. And there’s only one solution to that psychological barrier: fix the hole!
The best plan for this reader might not be the mathematically optimal one. The best plan involves filling the hole – at least part way.
Maybe he’ll feel better when his mortgage is down to $25K or $10K. Or perhaps true comfort will only come when he’s completely out of debt.
It’s not what I’d do. But I’m not the important character in this story! This reader’s personal finance is personal to him, and him alone. My role is to understand his needs, wants, goals, etc., and provide the most helpful advice based on his responses.
The more time I spend helping people, the more I realize there’s no one-size-fits-all answer. There’s an arsenal of best practices, sure. Many of them will apply to you. But not all.
One of The Best Interest‘s founding principles is to “maximize the ratio of success-to-stress.” Today’s story is a perfect example of the principle in action. I want this reader to have a successful financial plan that won’t stress him out.
Through listening to his needs, we realized what that meant for him: fill in the hole of debt, then move forward with future investments.
For this reader, the hole was the biggest problem. Our first job is to fill it.