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Pay Debt at 25%-35% or Invest In The Market?

Posted by Sean | Posted under Debt, Investing | May 17, 2008

Anecdote from a recent Dave Ramsey Show podcast:

A caller had a financial windfall and asked if he should use it to pay debt or invest in the stock market. It is not an unusual question, and those familiar with Dave’s "Baby Steps" know he wants the debt gone ASAP. The amazing aspect was the caller’s interest rates: 25% on his car and over 30% on his credit card.

The implications are staggering. More commonly, you hear this question with interest rates from 4% to 8%, i.e. investing vs. paying off the house or equity lines. At those rates, it becomes a discussion of risk and psychology, in addition to the expected returns. But at 25% to 35%, we are entering the financial twilight zone.

Who expects to earn long-term, after-tax returns of 25-35%?

  • Warren Buffett earned numbers like that for long periods,
    but would he borrow at those rates to break even?
  • And who can expect to become the next Warren Buffet,
    without an understanding of math and risk?

I can only hope the caller paid off as much debt as possible, as soon as possible, followed by a long-term love affair with personal finance.

+ + +

Hopefully, 99% of the people reading this will not make a mistake in a similar situation. Our danger here is in feeling financially superior and not learning. Our opportunity is in recognizing our own financial blind spots, as if they were this obvious. Because to people who know more than we do about finances, our problems are exactly this obvious.

Personally, I went a long time without a "pay myself first" mentality. Every bit as silly. Every bit as costly.

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