Many people in their 30s or even 40s have lived and worked their entire adult lives in a world of persistently very low interest rates. While a 40-year-old American was (barely) alive during Paul Volcker’s often double-digit interest rates during the 1980s, during their working life, rates have only exceeded 4% twice – once from 2006 to 2008, and again starting in late 2022. For much of the remaining time, rates have been well below 2%. This was, of course, a huge benefit to borrowers, allowing them to spend more on houses, cars and other goods, whether wisely or otherwise. At the same time, it amounted to a war on savers, many of whom were driven to take on more investment risk than they really wanted, since traditional low risk instruments likes GICs, bank deposits and bonds paid so little.
I have written before about how an investor can determine whether they are better off using cash for investment or for paying down existing debt. The calculation remains part mathematical, part emotional. On the mathematical side, the investor should estimate their expected return on their investment portfolio, and compare that to the interest rate on their debt. The difference between the two would be the expected “profit” (or loss) from investing compared to paying down debt. (There should also be a comparison of the tax efficiency of the investment, such as through an RSP, as well as that of paying down the debt, which can also carry tax consequences.)
On the emotional side, investors must consider their own appetite for carrying debt. Some investors loathe the idea of owing anything to another person or institution, and would be much happier paying debt down sooner, even if that may not be the financially optimal decision. Others are agnostic, and would simply prefer whichever one makes them better off in terms of dollars and cents.
Clearly, with much higher interest rates, this calculation has become relatively more skewed against investing. Long-term investors with a fixed-rate mortgage not due for a few more years may well be better off continuing to use available cash for investment. Conservative investors are unlikely to reach the same conclusion.
My view is that in many situations, in the current interest rate environment, the choice between investing available cash or using it to pay down debt is largely a distinction without a difference. The ultimate goal is to maximize a person’s net worth and retirement readiness for the long term. Investing available funds increases assets while allowing them to grow compounded over years and decades. Paying down debt reduces liabilities, increasing cash flow when the debt is exhausted and allowing for more saving down the road.
Personal finance is a marathon, not a sprint, and is about making smart choices consistently over a long period of time. While interest rate increases have greatly affected the short-term calculus surrounding investing versus paying down debt, it is a choice with two positive options. Investors should rest easy knowing that either choice improves their financial position for the long term.
