I received an email from a reader about whether it was a good idea to sell their non-registered portfolio to pay down debt. As always, my answer was “it depends”. It depends on the interest rate of the debt, how long the term is, the marginal tax rate of the debt holder and the capital gains built into the non-registered account.

As most of you already know, selling stock from a non-registered portfolio may result in a capital gains tax hit along with foregoing future growth. It could also trigger a capital loss which could be applied against capital gains for the year.

Holding high interest debt for the long term, on the other hand, can also be very costly. So which is more efficient? Keep the portfolio along with the debt? Or liquidate the portfolio and pay off the debt?

From what I have read, the general consensus is to not start a non-registered portfolio until all bad debts are paid off. But does that make sense all the time? Here is the readers situation:

  • Credit Card Balance: $20,000
  • Interest Rate: 18.50%
  • Minimum of 3% of Balance/month
  • Annualized Non-Registered Portfolio Growth after inflation: 5%
  • Portfolio Capital Gains: $5,000
  • Marginal Tax Rate: 40%
  • Portfolio is invested for capital gains only, no dividends or interest income.
Required Portfolio Withdrawal After Taxes: $21,000.00
5 10 15 20
Portfolio Gain after taxes: $4,641.53 $10,565.43 $18,125.99 $27,775.40
Loan Interest: $12,385.81 $17,515.82 $19,640.59 $20,520.64
Conclusion: Withdraw Withdraw Withdraw Do Not Withdraw

Even before doing the calculations, it’s pretty safe to assume that paying off a 18.5% credit card is better than staying invested in the markets. However, what’s interesting is that even at 5% return, it’s better to stay invested if planning to hold the debt for the long term(>15yrs). The reason being is because the investment growth is compounded, where the debt is slowly paid down with the minimum payments.

It’s important to note that the bulk of the interest is accumulated in the first 5 years, so if you have credit card debt in the high teens, it’s obviously in your best interest to pay that off as fast as possible.

For this unique situation, it seems that the “breaking” point for loan interest is around the 8% mark. At this interest rate, it would make more “financial” sense to keep the money in the portfolio assuming that the growth remains at 5% annually. This is shown in the table below.

5 10 15 20
After Tax Portfolio Gain: $4,641.53 $10,565.43 $18,125.99 $27,775.40
Loan Interest: $4,328.35 $5,378.14 $5,632.76 $5,694.51
Conclusion: Do Not Withdraw Do Not Withdraw Do Not Withdraw Do Not Withdraw

What stands out in this exercise is that it requires a higher debt interest rate to be equivalent to a lower growth rate portfolio. For those of you who want to do your own calculations, you can download the spreadsheet here.

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Very informative…thank you!

I don’t think the calculation is correct,

There’s an opportunity cost associated with not paying off the loan up front, namely the 3% each month you are paying off debts instead of investing. This can be quite massive after 20 years although it would diminish with less payment each month. If my calculation was correct, it would be $59,355.67 before tax (i.e., if you pay off your loan up front and invest the minimum payment each month, you would have $59,355.67 in your investment account after 20 years).

Or, if you were forced to withdraw the minimum payment each month from your portfolio, it would slowly bleed your portfolio. Actually, it’s not that slow. You would run out of money in less than 10 years even if there’s no taxes.

Above calculations were based on a 8% interest rate. With a 18.9% interest rate, you would run out of money in less than 5 years or end up with a $87,669 portfolio if you paid off the loan up front and invested the minimum payments for 20 years.

A good thing about keep debts is that the interest rate is before inflation. Therefore, in an high inflation environment, the real interest rate can be negative. For example, the inflation in China is 8% right now (probably much higher) whereas their mortgage rate is 5-6%. Therefore, there’s little reason to pay off that mortgage fast if the inflation keeps up and you have an investment that can beat inflation.

If you were in Zimbabwe. Definitely don’t pay off that debt. With an 11,200,000% inflation rate, I doubt the bank would bother going after you after a couple of months. :)

Mr. A: I agree with you on the opportunity cost issue. I made a similar comment on the Aug. 26 blog (comment #20):


What do you think FT? Should the opportunity costs be considered in scenarios like this?

Interesting article and an even more interesting comments. How about you sell the stock, and pay off the CC. After that you start contributing an amount equal to 3% of the original Credit Card balance to your investment account.

Having consumed $20,000 of investment funds, I would agree there is a strong incentive to ‘repay’ that loan from the investment account. I.m looking forward to an updated table containing the ideas expressed in these comments. FT?

DAvid (on the road)

I also don’t see the justification for only factoring inflation into the investment growth. In reality, the actual amount of money to pay down the outstanding debt is not impacted by inflation – it is what it is.

I don’t understand why the withdrawal of $21,000 AFTER taxes is necessary to pay down a $20,000 CC debt. If you meant that the stock ACB was $16,000 with a $5,000 Capital Gain, resulting in a total of $21,000 being withdrawn and $1,000 of Capital Gain taxes, then I understand.

I believe you meant to say $21,000 before taxes because my calculation shows after 5 years (inflation adjusted) that the after tax withdrawal of that original $16k investment would net the additional $4,641.53. However, with a 2.5% inflation factored into the return (thus giving 7.5% return) the net benefit would be $7,318.57 which is really what you would have to put down on that non-inflation-adjusted debt.


First lets set the environment… Mr. x has debts of $20k. Its not mentioned how much his investment is, but I don’t think it matters. To make sure he covers the debt and the capital gain for the withdrawal he will have to have $25k in investments. I am not sure where you got the $21k number to withdraw from the investment account, because my math says that he would need to withdraw $25k ($25k = $20k for debt + $5k for capital gains assuming the 40% tax bracket, which translates into a 20% capital gain tax on the withdrawal). Lastly, its assumed that Mr. x can afford to make the debt payment, which will be $600/mo (3% of $20k). If he can afford the $600/mo in month 1, then he can afford the $600/mo throughout the model… so the monthly payment will remain constant, even though 3% of the outstanding balance would mean the debt payment would decrease over time if only paying the minimum on the credit card. Note, keeping the payment at $600/mo means the debt will be paid off in 48 months; and lets face it… nobody should keep credit card debt longer than necessary.

Scenario 1, keep investment and pay down the debt monthly.
As already mentioned, at an interest rate (compounded monthly) of 18.5% and with a payment of $600, the $20k debt would get expired in 48 months, with a final payment of $89.34 in the 48th month, leaving a positive balance of $510.66. The investment of $25k over the same 48 months with an annual return of 5% (compounded monthly) grows to $30522. Add the two together for a total net of $31033 after 48 months.

Scenario 2, pay debt with investment start new monthly investment.
Here we are keeping things equal in that $600/mo is required for the investment. With this scenario there is no debt to pay off over time, because it was paid off at day 1. So we start an investment where we put in $600/mo for 48 months with an annual return of 5% (compounded monthly). An investment of this nature would grow to $31808 after 48 months.

Conclusion, Scenario 2 results are better by about $800. Growth after 48 months is moot because future growth for both scenarios is the same (5% growth per year). Since we know the value of each model when they converge to be identical models (after 48 months), we can know the better model by only calculating each model up to 48 months.

knightmastery: The thing to remember is that capital gains tax is only paid on the redemption value minus the adjusted cost base. The portfolio capital gains were only $5k so it was just assumed that you’d pay all of it with a 40% MTR or just a 20% of the total capital gain, which is $1k. Of course, it would depend how big the actual portfolio is, because it would depend how much of those $5k of captial gains you had to realize to withdraw the right amount, but I think FT was making a worst case assumption, give a lack of all of the details.

FT: Yes, the 3% that would have been paid on the CC should be rolled back into the investment account. There’s a few ways to model it. One would be as knightmastery did by assuming a constant $600 per month payment available. The other would be to assume a decreasing payment, for whatever reason. Regardless of the choice of model, withdrawing funds from the investment account frees up some monthly cash flow that wouldn’t have been present without the withdrawal. So it is only fair to put those funds back into investment account.

The only problem with these assumptions is that you have to have the discipline to actually make those payments back to the investment account. It might be pretty tempting to just use the increased monthly cash flow to raise the standard of living.


That is an interesting point, I will look into it. Are you saying that the 3% paid on the credit card, should be added to the investment portfolio to make things equal?


I think that the 3% should be added to the investment portfolio after the credit card is paid off from the investment portfolio. I also think that there is another clause which is the risk of losing your sleep. Stock market returns are generally variable while the credit card interest is mostly less variable. So if our investor could sell the stocks, pay off the debt and start fresh, he/she would live a long and happy life.

I would recommend the approach stated by the Dividend Growth Investor. First pay your debt and than start investing the 3%.
Don’t forget that the debt interest is sure thing whereas the return on your investment is not.
I also agree that in high-inflationary economy you better have debt as I have seen this with my eyes a decade ago in Eastern Europe, where the credit millionaires had to return pennies to the banks.

Yet another choice would be to consolidate the debt with a lower interest rate loan. If our borrower can get a secured loan (4.8%) using equity (stocks or dwelling) as collateral, the $20,000 debt would be paid in 36 months, at a cost of $1,507; total repaid is $21,507. The $21,000 currently invested should grow to $24,391 in that same 3 year period, a difference of about $2,880 to the borrower’s advantage.

or redeem the investment, pay the credit card then take out an investment loan to reacquire the investment!

( I just don’t understand why people carry credit card debt!!! )

DAvid (on the road)

One other thing to consider is that paying off the credit card earns you a guaranteed rate of return. You know exactly what that card is costing you and how much you will save.

While for the investing scenario, you are estimating what your portfolio will be growing at. You are hoping 5%, but it could turn out that the portfolio loses 20%.

In knightmastery’s example (and I didn’t verify the numbers), the difference is $800. But one of the options is guaranteed while the other isn’t.

Paying off the credit card is the sure bet. Of course, that assumes that the person won’t rack up their bills again in the future!

I can’t help but think that perhaps the value could be slightly offset not only by the increased cashflow for either investing or simply for yaknow… having..

But the piece of mind of knowing you have nothing to worry about as well.

Retirement is a long way off, and planning for it is obviously important, but not being miserable today will always top it in my books.

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