Sound advice and insight. I urge you to read the full story
By Adam M. Grossman | May 31, 2020
IF YOU HAVE a surplus in your household budget, what’s the best use for it? Does it make more sense to pay down debt or to invest those extra funds? With interest rates at such low levels, this is a question I’ve been hearing with increasing frequency. Suppose your mortgage rate is 3.5%. If you pay down that debt, it’s like earning 3.5%. By contrast, if you invested in the stock market, your annual return would be uncertain. You might earn more than 3.5%, but there’s also the possibility you could earn less—this year being a case in point. Historically, the U.S. stock market has gained 10% a year, on average. Even if the market did just half as well in future, you’d still be doing better than 3.5%.
It seems like there’s an easy answer to this question: The rational choice would be to invest any extra money you have. That’s the logical answer—and it’s hard to dispute—but I don’t think it’s the only answer.
Instead, I see this as a question with a lot of nuance. I would also consider the following five issues:
1. Taxes. If you’re doing a calculation like the one above, be sure to adjust for taxes. Most debt doesn’t carry a tax deduction, but mortgage debt does (up to $750,000, or $1 million for home purchases prior to 2018). That means that, if you itemize your deductions on your tax return, a 3.5% mortgage might be costing you little more than 2%—or even less if you’re in a high federal tax bracket, plus you live in a higher-tax state like California. Similarly, every investment has a different tax profile: Some stocks issue dividends, while others don’t. And in the bond world, some pay interest that’s subject to income tax, while other bonds don’t. Bottom line: If you’re doing a comparison, be sure to compare apples to apples.
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