Thursday, 15 May 2014

Want to earn a 20%+ return? Pay down that credit card debt!

Wanting to take control of your finances and start to invest your hard earned money is an admirable goal.  Congratulations if you have just started out on this journey and keep going if you have been on it for a while. The first step on any journey to financial freedom, whatever your goals are, should be to pay off your high cost debt.  Nothing is more efficient than this and I'll explain why in this post.

Pay off your high cost credit card debt before you start to invest

I know your goal is to start investing, to start making millions in the share market and to put your financial worries behind you...but the first step on this process is paying off your high cost debt.  Pay day loans and credit card debt will kill you over the long term if you don't deal with it first.  All your financial efforts should go to paying this down first.

The 'problem' with this is that it is not doesn't feel like your getting ahead financially.  But trust me when I say it is the best investment you can make.

Investment returns are rarely going to equal the effective return you get from paying off your credit card debt

Credit card debt is incredibly expensive.  At rates starting at 19% p.a. it is almost daylight robbery.  The fact is that there are very very few share market investments that will make you this kind of return consistently.  If you get a consistent 10 - 15% from the share market or other investments you are doing very well.  

Getting a 20%+ return on your money is unheard of...but this is
what you would be getting if you paid your credit card debt right down.  You can also get this 20% return straight away....just put every spare dollar into your credit card debt and you are getting that return from day 1.

Pay off your high cost debt before you pay off any other type of debt

When you have different types of debt, the temptation is to pay off your debt evenly...i.e. put some towards your student loans, put some towards your credit card debt and some into a savings account to feel like you are getting ahead on everything.  Although this may feel better...the better option is to pay the minimum amount on everything other than your loan / debt with the highest cost of interest.  Use all the spare cash you then have to pay down this debt

If you think about it in terms of what return you are getting it is much easier to see why you should do this.  Would you rather invest a little bit at 20%, a little bit at 10% and a little bit at 5% or the whole lot at 20% because as I mentioned above, paying down debt is the same as earning a return on your cash.

Only consolidate your debts if you can be disciplined enough to put the savings towards paying down your debt

Debt consolidation is actually a great way to save on your interest cost and to get ahead by paying down your debt faster.  The danger in this is that you spend the money you save by paying a lower interest rate rather than saving it and paying down your debt with it.

Only you know how disciplined you are.  If you only have to pay $1,000 a month instead of $2,000 what are you going to do with the other $1,000?  Are you going to spend a bit of it and pay down debt with a bit of it?  This is the worst thing you can do!  You will be amazed how easily you can spend this money.  If you are going to consolidate your debts make sure you use every single dollar to pay down debt.

Paying down this high cost of debt is your first step on the way to financial success.  Don't underestimate how important it is.   Once you have committed yourself to paying it down, commit yourself to never being in the same position again.  If you have to, cut up your credit cards.  In the coming weeks I'll do a post on how to keep your credit cards under control.

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  1. Yes completely agree, probably one of the best and simplest posts you've done :)

    This is a big one as it is very tough to find a return of more than 20% (risk free) as paying of your credit card generally is :)

    1. Thanks Jef! Appreciate the comment. I always debate with myself whether to put up these 'easy' posts but maybe I should be doing a few more...definitely something to think about

    2. Well for the everyday ready, this is the sort of thing that they might not know... We often forget that we know probably more than most (only about this and still not that much) by reading about and working in the industry..

    3. Agreed. You're right and I think I'm going to write a few more articles for people that are looking to take control of their financial lives (or those that are beginning on their investment journey)