Debt
When considering paying extra on debt, why should opportunity cost be considered?
When considering paying extra on debt, why should opportunity cost be considered?
What is the interest rate on the debt you are considering paying extra on and what is the expected return on the money if you save and/or invest it elsewhere? That is the key question here. If the interest rate is 3% on the debt and you would just stick the money in the bank earning .2%, then put the extra money on the debt. If you are going to invest it in a no-load stock index fund (Total Stock Market Index Fund at Vanguard would be a fine selection) and earn an expected 8% AFTER cost in a retirement account like a 401(k) or a Roth IRA, then you would go with the investment and only make a minimum payment on the debt.
Here is a a basic rule of thumb. If the debt interest rate is higher than 6%, put the extra savings that way. If it is under 6%, consider other options based on your ability to invest wisely while reducing the costs. Take your time and think through these issues carefully. Over long periods of time, the right decisions could be worth THOUSANDS of dollars. Inform yourself!
Isn’t debt in general a bad thing? I’m referring to home loans. In my area, our home loans gets renewed every 5 years. The current rate is 2.5%, which is pretty good. Do you think it’s best to hold off on aggressively paying off this debt?
Debt in general may not be good, Denny, but we always have to consider opportunity cost before paying extra on it. If I had a debt at 2.5%, I would not pay it off early. I would take that extra money and invest wisely using no-load index funds and/or ETFs, primarily in stocks. I would max out the retirement accounts first and then look outside of retirement if necessary. The wise and efficient investor can beat a 2.5% return! And that means YOU.