Miya wrote me an email about her financial situation and was looking for an opinion.
I am a big fan of Million Dollar Journey and I learned a lot from here. I realized that if you don’t manage money, the money will manage you. Although I understand the fundamentals about finance management (I think I do), I’m still in a dilemma of choosing my priority between paying off debt, contribute to an RRSP or build a portfolio.
- I am married with a new born baby. Annual income of household is $75,000 before tax ($60k take home in BC).
- Annual expense budget which is quite practical is about $50,000 (Include: rent, car loan, cell phone, groceries, baby expense, credit card minimum payment, entertainment, etc.)
- Total credit card and line of credit: $45,000 (between 15-19.5% interest) note: from wedding expenses and over spending before baby was born
- Cash: $10,000
- RRSP: $15,000
- RESP: none
Our household after-tax income can basically cover the expenses. For the cash and other extra income, I don’t want to put them all against my debt, instead I would like to contribute to our RRSP or invest into stock market which I think is a good time to build a portfolio. I know it is crazy but I would like to see some rewards rather than fill the big debt hole.
I appreciate your advice.
So the question is, what does Miya do with their cash? To be blunt, it is crazy to consider investing in the market while holding credit card debt, especially when it’s upwards of almost 20%.
I think the biggest issue is that a lot of people feel that investing is sexier than paying down debt. The reason being is that investing can be more exciting and has the opportunity to grow your money, while paying down debt doesn’t have the same type of gratification.
There are times when I believe that investing should come before paying down debt. For example if the interest rates are extremely low, or if it’s a tax deductible loan (good debt). However, in Miya’s case, the debt is extremely high interest which would be extremely challenging to beat by putting the money in the market.
If the cash was invested in a non registered account, the market gains would have to be greater than 21% before tax to match the 18% debt on the credit cards. As paying down the high interest debt is a guaranteed return, the risk adjusted return required from investing would have to be even higher.
My suggestions? I’m not a financial advisor, but if it were me, I would:
- Take the cash savings and pay down the credit card debt (highest rate first) as soon as possible.
- Tighten that budget to squeeze every dollar possible to pay down debt.
- Consider pausing RRSP contributions (unless it’s employer matched) to put more towards the debt.
- After debt is repaid, invest by contributing to your RRSP or TFSA.
This scenario is similar to Paul and Melanie’s, but they’ve already paid down more than half their debt in 6 months since the post!
Those are my thoughts, what do you think?