One of the most common questions facing young professionals is whether they should focus on paying off debt before they start investing, and unfortunately the answer is not as simple as choosing one over the other. Debt and investments operate on opposite sides of the financial equation, where debt creates a contractual cost that you must pay, while investments offer an uncertain future return. The right decision therefore depends largely on the type and cost of the debt, the expected return from the investment, your time horizon and your overall financial position.
The first distinction to make is between expensive and relatively inexpensive debt. Credit-card debt is generally one of the strongest reasons to prioritise repayment before investing. If you are carrying a balance from month to month and paying a high interest rate, achieving an investment return that reliably exceeds that cost becomes extremely difficult. Paying off the debt effectively provides a guaranteed return equal to the interest you would otherwise have paid, whereas investment returns are never guaranteed.
For example, if you are paying 20% or more in interest on outstanding consumer debt, an investment would have to generate a return greater than that after considering fees and taxes simply to put you in a better financial position. This is a particularly difficult hurdle to clear consistently. Paying off high-interest debt can therefore be viewed as a form of risk-free financial improvement, because the interest saving is certain.
Vehicle finance requires a more nuanced approach. A vehicle is generally a depreciating asset, and the total cost of ownership extends well beyond the instalment. Interest, insurance, fuel, maintenance and depreciation can make a vehicle significantly more expensive than its purchase price. However, paying additional amounts into a relatively low-cost vehicle loan may not always be the best use of available cash if the investor has a long-term horizon and could otherwise build a diversified investment portfolio. The important question is not simply whether you have a vehicle loan, but what interest rate you are paying and how that compares with your other financial priorities.
Home loans are different again because a mortgage can carry a considerably lower interest rate than unsecured consumer debt and is attached to an asset that may appreciate over time. For this reason, many investors choose to invest while continuing to pay their mortgage according to its original schedule. However, making additional payments into a home loan provides a relatively predictable benefit by reducing future interest costs and shortening the repayment period. Whether this is preferable to investing depends on the interest rate, expected investment returns, tax considerations, liquidity needs and the investor’s tolerance for market risk.
Student debt also needs to be considered according to its specific terms. Not all student loans have the same interest rates, repayment structures or consequences for early repayment. If the debt is relatively inexpensive and the qualification significantly increases future earning potential, aggressively repaying it may not necessarily be the highest-priority use of every additional rand. On the other hand, expensive private education debt should be treated more cautiously.
Another important consideration that is often overlooked is time. A young investor who waits until every rand of debt has been repaid before investing could lose valuable years of compound growth. Investing R2,000 a month from an early age can ultimately be more powerful than investing a much larger amount later in life. This does not mean that investors should ignore expensive debt in the pursuit of compound returns, but it does mean that the decision does not have to be entirely binary.
A sensible strategy can therefore involve doing several things simultaneously. Establishing a basic emergency fund, paying down high-interest debt aggressively and making at least some long-term retirement or investment contributions can provide a more balanced financial foundation. Employer retirement contributions or other benefits that effectively provide additional value should also be considered before deciding to suspend investing completely.
Investors should also be careful when comparing a guaranteed interest saving with an expected investment return. If your home loan costs 10%, for example, paying an additional rand towards the loan effectively saves interest at that rate. An investment might historically have produced returns above 10%, but there is no guarantee that it will do so over your particular investment period. The investment could fall substantially just when you need the money, while the interest saving from reducing debt is certain.
Ultimately, the question should not be whether investing while in debt is always right or wrong, but rgather about prioritising the highest-cost financial obligations while making sensible use of the long-term advantage of time. Credit-card debt and other expensive unsecured debt will often deserve priority, while lower-cost debt such as a mortgage can potentially coexist with long-term investing.
The strongest financial strategy is therefore not necessarily to become completely debt-free as quickly as possible. It is to understand the cost of each debt, maintain sufficient liquidity, invest according to your long-term objectives and allocate additional money where it is likely to have the greatest impact on your overall financial position.