So, you have debt. You also hope to retire someday and you want to start investing your money. Both require a commitment. Both require money. Which do you do first, pay off debt or invest?
Good Debt vs. Bad Debt
The first barrier to success in investing is bad debt. Yes, there’s good debt and bad debt. Good debt is money you borrow at a low rate of interest, with which you make a high rate of return.
An obvious example is the money you borrow to buy an apartment complex. The debt is covered by the rental income – or it will be in a few years.
Bad debt, by contrast, is consumer debt – money you borrow at a high interest rate to buy things that don’t produce income or grow in value. Things like cars, refrigerators, clothing and trips to Europe.
All of us have done it, and all of us have paid the price.
The Price of Bad Debt
The price of bad debt is the impact of compounding rates of return working against you instead of for you. If you have credit cards or bank loans costing you 18 percent or more a year, that’s 18 percent compounding against your retirement.
Since Rule #1 is all about not losing money, the first thing most of us must do to become successful Rule #1 investors is to pay off bad debt.
Don’t Lose Money By Paying Higher Interest Rates
Think about it: If your target rate of return is 15 percent and we have credit card debt we’re paying 18 percent on, essentially that means were borrowing money at 18 percent and making only 15 percent on it.
Even though we’re doing well as an investor, we’re going backward at a rate of 3 percent compounded per year. That’s a heck of a barrier to successful investing.
The only way you’ll get rich is to hit the lottery.
Otherwise, you’re going broke with great certainty. But notice that if we turn that around and take the money we were going to invest and instead pay off the 18-percent-interest-rate debt, then instead of losing 3 percent a year, now, even if we don’t have money left to invest, at least we’re breaking even and we’re not violating Rule #1.
Conclusion
Moral of the story, it’s better to pay off bad debt before you invest. While you pay off bad debt, practice investing using paper trading and when you’re finished paying off debt, then you can start to invest.
As long was you don’t violate Rule #1 and you keep on practicing, learning, and saving, you’re going to be rich one day.
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