Income and investments go hand in hand. When you generate an income, you are able to meet with your expenses and then invest the surplus. Investing helps you create your wealth portfolio. This is why investments are so important and popular as well.
Debt, on the other hand is also a popular option for most income-generating individuals. So, just because an individual is generating income and has investments in his portfolio does not mean that he would be completely debt-free!
Debt becomes inevitable for big-ticket expenses and also if there is a sudden financial emergency. That is why different kinds of loans are available in the market for all your financing needs. When it comes to investments vis-à-vis debt, you might wonder, is it a good idea to invest when you are in debt?
There is no right or wrong answer. It totally depends on your financial situation and needs to be evaluated on a case-to-case basis!
There are instances when people continue their investments as well as debt repayments together every month. While investments help in building a corpus, debt repayments take care of loans and credit card dues.
However, it is often argued that it is better to clear off any outstanding debt before directing your money to investments. The main reason is to save on the interest payment. As you know, debts involve interest charges and if you have high repayment tenure, the interest paid is also high. That is why it seems better to pay off the debt with surplus funds to cut down on interest payments.
So, the age-old question continues: Debt repayment before investments or together?
However, there are some aspects to consider before you consider putting debt repayment before investments:
- Type of loan
Credit card debts and personal loans are considered “bad” loans. They are unsecured loans with extremely high rate of interest. They also have a very bad effect on your credit score if there is a default in repayment. Therefore, if you have these loans, paying them off should be your first priority.
- Impact on your credit score
Home Loans and Education Loans are considered to be “good” loans, usually for their tax efficiency. However, auto loans, business loans and other types of secured loans are not too bad as they help you build a healthy credit score. Regular payment of these loans reflects positively on your score as it helps in building up a credit history.
So, if you pay them off quickly, your credit score might get hampered as your credit mix would be impacted and your credit history would be for a limited period. So, holding onto these loans is a good idea. You can maintain a good score and use your surplus funds to create investments which would give returns more than the interest payable for these loans. You can, however, make part prepayments on these loans to reduce the interest outgo but paying off the full loan might not be a very good choice.
- Tax efficiency
Home loans and education loans give you tax benefits. While home loans give tax benefit on both the principal repayment as well as the interest outgo, education loans give you tax reliefs on the interest paid for the loan. Given the tax efficiency of these loans, repaying them off is a bad idea. You should weigh in the interest paid vis-à-vis the tax saving availed. If tax saved is more than the interest saved, hold onto these loans and use your funds for investments to generate additional returns.
Given these reasons, investments are good even when you have debts, especially if the loan helps you in a way of building your credit score or with tax efficiency. If you are wondering which course of action you should take with your savings, you need to consider the above-mentioned factors.
In a nutshell:
- If you have bad loans (personal loans or credit card loans), make them a priority over investments.
- For other secured loans which have low interests and help you with tax saving and building up a good credit score, continue them.
- Achieve a balance between debt repayments and regular investments so that you can save tax and create returns too.
- Take the help of a financial advisor to create a financial portfolio for you with debt and investments balanced perfectly for maximum gains.
Thus, a balanced portfolio with debt and investments can co-exist and fuel your finances.