Now Is A Great Time To Pay Off Debt
Invest In Debt When Stocks And Housing Are Expensive
Investing is about allocating your money to areas that make sense when they make sense for you. If you need to buy a house in the next few years, you wouldn't put all your money into an extremely risky stock. On the other hand, if you're a venture capitalist and have a lot of money to invest in a risky business, maybe you would take a chance on a high risk, high reward company.
In today's market, it's hard to find a bargain with stocks because they are expensive. Similarly, housing prices have bounced back and are 10-40% higher than before the housing crash in 2008.
When investments are expensive. Focus on investing in what you owe.
If in 10 years stocks and home values were cut in half would you rather have a paid off house or a bigger stock portfolio? How about if you lost your job?
Paying off debt gets you to financial freedom faster because when you can live on less you need less. For example, interest rates have been extremely low between 2009-2018, but most people will not stay in their house for 30 years. That means if and when they move they will have to buy a house at a new interest rate, likely something well above 4%. If you focus more on building your equity through paying off debt you'll be able to afford your next house in cash and be able to live off less while others are paying more in interest for their house.
How Expensive Are Stocks Right Now?
Stock values are the 3rd most expensive they've been in history. That's pretty expensive, so what does that mean for the average investor? Knowing that prices are high can be a strategic move to make sure you are investing appropriately to the market valuations. Chances are, we aren't going to see the kind of growth we've had in the last 8 years for the next 8 years.
In fact, the past would point us to the fact that we are likely due for a market correction fairly soon. In this Case-Shiller chart you can see that stock prices are as expensive as they've been since the dot-com bubble in 2000 and slightly less than the great depression of 1928.
Many banks and analysts are warning us that the market is expensive right now. Goldman Sachs warns markets haven't been this pricey since 1900. Does this mean you shouldn't be investing and sticking your money underneath a mattress? No way. But it does mean as investors we should consider where we are putting our money.
The market has crashed twice in 20 years.
Paying off debt is a safe, guaranteed return of what you were paying in interest.
It also hedges against future risk and most people will be better off with less debt than more savings if and when we have another recession.
The chart below shows the price of the S&P 500 since 1950. You can see that these stocks are as high as they've been since the 2000 bubble and the great recession in 2008. It's been 10 years since that bubble.
Housing Prices Are Sky High
Housing is also relatively expensive right now compared to historical prices. Many markets are priced higher than the 2008 bubble. In this chart you can see how prices fell from 2008 to 2012 but then have continued to climb up at a steep pace ever since.
So Where Should You Invest?
So what does this all mean? Honestly no one knows what the stock market or housing market will do. Stocks could continue to grow for a decade or more. Housing prices could also continue to grow for the same period. What we do know is that both asset categories are expensive right now. What this means is it's important to get creative with where you invest your money and how you spend it.
Invest By Paying Off Debt
Investing in debt reduction now will provide you with more money later when prices are likely more attractive. For example, lets say you are able to pay off all your debt in the next 5 or 10 years. In the meantime the stock market crashes. You're investments could be cut in half, but you will not be burdened by debt anymore. If you are fortunate enough that this aligns well with your debt payoff it means you'll have extra money to invest from what you were paying towards debt and you'll be buying assets at a more attractive price.
With your extra money that you were paying towards your debt, you can put that at stocks that are more favorably priced than they were 5 or 10 years ago. If the stock market doesn't crash and it continues to go up that's great! Doesn't change much for you. Sure you might have had a bit more net worth on paper, but you still would have had debt that you owe.
Who Benefits From You Carrying Debt?
When you talk or read about paying off your debts. The first argument you'll hear against it is opportunity cost. They aren't wrong. Opportunity costs is a real thing. However, most people don't have opportunities to make 15-20% knocking at their door. If you do, take it! Most people have to settle for investing in the market or investing in a business, like buying real estate. All of which takes significant time and risk.
When it comes to paying off debt or investing, ask yourself who benefits the most?
When I was deciding to pay off all my debts and live completely debt free, I read more articles about why not to pay for your house in cash than those that said I should. I found this odd. Most of these people weren't financial independent, but they pointed to strong cases on a spreadsheet in a 'perfect' world. Life isn't perfect and it sure as heck isn't lived on spreadsheet.
The idea around carrying debt and instead investing is we can earn more in the stock market than we can on the interest we save on our mortgage or other debts. That may be true. It's also true that the stock market could tank and I lose my job tomorrow.
Let's look at some of the reasons people may be steered towards keeping their debts.
Who benefits from When We Keep Our Debt and invest it elsewhere
The lender benefits - When you have a loan or mortgage you are paying the person who you borrowed money from in interest. That benefits the bank, the student loan holder, the government, the car company, whoever financed your loan.
Mortgage originators benefit - Loan origination fees cost anywhere from 500 to a few thousand dollars. Not taking out a mortgage avoids those costs if and when you can avoid it.
Realtors benefits - Typically, houses sell for more when there is a lender because people can afford a bigger house. We had to buy the house we bought because we chose to not take out a mortgage. That meant we could only afford a cheaper house than if we had only put 20% down. If we put a 20% down payment with what we paid for our house we could have bought a $1M home. That would have definitely benefited our realtor. When we got into the negotiation phase, our realtor knew what we had available to spend. There was no way to increase the sales price. We could only pay what we had available to pay.
The government benefits - When people chose to invest instead of pay off debt they end up paying taxes on their earning now unless they are in tax deferred funds. When you pay down debt, you don't have to pay taxes on the tax free gains you get from not paying interest. If you are fortunate to have enough to invest outside of your company match there is a cap on how much you can fund for retirement, $18,000 in 2018. So if I would have invested that money outside of a retirement account I would have been taxed at 15% on those earnings.
Who Benefits If I Pay Off My DEbt
1) The government- The government will get a little more of your income in taxes because of the lack of tax write offs. This could be student loan expenses, deductions or mortgage deductions; their are many write offs that can avoid taxes. However, I would never carry debt to avoid taxes. Not to mention that you can easily invest in tax deferred accounts once you've paid off your debt because you don't have a lot less expenses. The government will get a bit more in taxes when you reduce what you can write off but it's pennies in comparison to what you get to keep from not having that debt.
2) You - When you pay off your debt this will have the most direct impact on your lifestyle and what you can do with your money. As mentioned before, my wife and I focus on reducing our living expenses so we can afford to live off less because that brings us immediate financial freedom. We have found that it's easier to reduce our expenses than to be struggling to find a way to make more.
Other Ideas On Where to Invest In An Expensive Market
Don't buy a new house, improve the house you're in if you really need to. And if you really need to upgrade, pay cash. It is not recommended to use home equity from the currently inflated housing prices to take out a bigger loan to pay for improvements you can't afford. So if the choice is to take out a home equity loan or pay with cash. Use your extra cash now!
Save Up Cash
If you are fortunate to not have any debt or have extra money left over after paying towards your debt. Another potential option is to save up as much cash as you can. If you want to invest it, invest in low risk investments like municipal bonds or buy CD's. Then when the market lowers you'll be sitting on a pile of cash that you can start investing into the market when prices are much more attractive. Isn't this timing the market? Yeah kind of. It's not as much timing the market as it is value investing. When stocks are priced low buy more. When stocks are high accumulate more cash to purchase more stocks when they are cheaper.
In Conclusion - Why Focus On Paying Down Debt
Warren Buffett said it best:
“A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful.”
These are the strategies I have used and continue to use in a market that is expensive in regards to stocks and home prices. What about you?