I have written a lot on this blog about the need to invest. I have opined about the need to the basic need to start, save your raises, investing in index funds, and also revealing my own investments. I hope that some people have found this informational and educational. There are many roads to Rome. You don’t have to heavily invest in the stock market. You could invest in real estate or other income producing endeavors. Whatever you choose the important thing is to start. I just think that for the average person investing in a retirement plan, primarily from your job, but also from IRAs is the best way for a normal person to build wealth.
The key, of course, when you are investing is that you want to see your money grow. Last week I helped a friend who was heavily invested in bonds and cash readjust his portfolio a bit. He was actually prodded by his wife to make some changes. I hope my advice helped, but I also told him to go to a professional to get even more advice. I will talk more about that encounter later and what it inspired, but it got me to thinking about another way he could get a better return on his money. In fact this strategy will get you an instant return. You can’t lose. THe answer: PAY DOWN YOUR DEBT.
Now you make ask yourself how do I get a return on my money if I pay down debt. I mean isn’t the point that you are paying someone else? That is certainly true. However, your debt comes with interest. If you credit card debt that interest rate is probably around 10% or more. In other words, you are losing 10% of that balance every year, if you keep a balance, which most Americans do. Most students who graduate from college will have student loans with an interest rate upwards of 6.8% or more if they are private loans. If you buy a car you will have an interest rate or a mortgage. In other words, we spend thousands of dollars per year on interest payments per year. The good thing about those payments is that you also pay principle. The more money you pay, the more your eventual return will be.
For example, let’s say you have $2000 in credit card debt at 10%. If you just pay a normal minimum payment of $40 or so it will take you probably about 20 years to pay off the debt or more. However, if you pay above that amount, save $200 a month or more. You will pay off the credit card in the year, reduce the life of the interest payments, and by the end you will have an extra $200 to do with what you please (hopefully you will save it and put it into more productive means).
Paying off debt is a drudgery. I hate it. It seems like we are doing nothing with that money. It appears that it is not doing anything for your financial life. That is why we, including myself, need to change our mindset. Paying off debt, as long as you don’t create more, is a means to create more wealth and you get an instant return for your money. How much of a return depends on a couple of things: 1) what debt(s) are you paying off; 2) how much the interest rate is on that debt; 3) how long it will take you to pay off that debt. Depending on the answer to those three items determines how much of a return you receive on your money.
The reason why this is important is because you here the constant drumbeat of articles that lament the savings rates of Americans. And I am certainly one of them. The average savings rate in the United States is around 5%, which is certainly not enough of a savings rate to retire at a normal retirement age, let alone retire early. However, if we start to think about paying down debt as a means of savings then we can perhaps change the way that we save in the United States, just as long as we are not adding huge amounts of debt for things that depreciate in value (e.g. cars, clothes, etc).
When I think about it that way my savings rate is actually much higher than just what I contribute to my retirement accounts. In fact, my savings rate is probably somewhere near 30% or more based upon the amount of debt I am paying down, where I am paying that debt down, and the increase in my net worth.
For someone who thinks about their net worth and has financial goals this mindset change can be a great revelation. It can even be inspiring.
I know that some people can’t save a ton of money into retirement plan or whatever. I still think you should. However, every one has bills. Most people have some form of debt. Paying off more of that debt is a form of savings. You get an instant return on that money because you reduce principle, the amount of interest you have to pay in the future, and possibly paying off the whole debt can offer a larger return.
WOO HOO! Let’s go out and save people. Make your money work for you.