Debt Freedom: Why I Chose To Invest In My Financial Future

Investing in paying off debt is a good idea if you can earn more on your investments than your debts are costing you in interest. It is also a good idea if you have a low credit score, as paying off debt can improve your credit score, which is important if you want to buy a home or finance a vehicle.

Paying off high-interest debt will likely provide a better return on your money than almost any investment. Credit cards often carry the highest interest rates, so if you’re carrying a lot of credit card debt from month to month, you should focus on paying that off first. It is not uncommon for credit card interest rates to hover around 20%, an amount that far exceeds average returns in the market. So, unless you’re a brilliant investor, you will be losing more to interest payments than you would be gaining through investing.

Investing in stocks, bonds or mutual funds can grow your money over time

Investing in Stocks, Bonds, or Mutual Funds Can Grow Your Money Over Time

Investing in stocks, bonds, or mutual funds can be a powerful way to grow your wealth over time. Here's how each of these investment vehicles can help you achieve your financial goals:

Stocks:

Investing in stocks allows you to purchase ownership stakes in companies, benefiting from their growth and profitability. Stocks offer the potential for higher returns compared to other investments, but they also come with higher risks. When investing in stocks, it's important to have a long-term perspective and a well-diversified portfolio to mitigate risks.

Bonds:

Bonds are essentially loans made to governments or corporations in exchange for interest payments over a set period. They are considered a lower-risk investment option, providing steady income and diversification to your portfolio. The value of bonds can fluctuate, and they can be sold for a profit on the secondary market when interest rates fall or the issuer's credit rating improves.

Mutual Funds:

Mutual funds pool money from multiple investors to purchase a diversified portfolio of stocks, bonds, or other assets. They offer professional management, making it easier for individual investors to access a wide range of investments. Mutual funds provide the benefits of diversification, economies of scale, and the potential for long-term capital gains and dividend income.

When deciding whether to invest in stocks, bonds, or mutual funds, it's essential to consider your financial goals, risk tolerance, time horizon, and investment style. Each of these investment options has unique characteristics, and understanding them can help you make informed decisions about allocating your capital.

Paying off debt is another crucial aspect of financial management. While investing is important for growing your wealth, managing debt effectively is essential for maintaining financial stability. Here's why:

High-Interest Debt Reduces Your Overall Returns:

Debt, especially high-interest debt such as credit card debt, can significantly impact your financial well-being. The interest charged on these debts often exceeds the returns you could achieve through investing. By prioritising debt repayment, you can eliminate the burden of compounding interest and improve your overall financial position.

Improved Credit Score and Borrowing Power:

Paying off debt, particularly credit card debt, can have a positive impact on your credit score. A higher credit score enhances your borrowing power, making it easier to obtain loans with favourable terms for significant purchases such as a home or vehicle. It can also affect various aspects of your life, including insurance premiums, rental applications, and even employment opportunities.

Peace of Mind and Financial Stability:

Carrying a substantial amount of debt can cause stress and anxiety. Paying off your debts can provide peace of mind and improve your overall financial stability. It allows you to focus on investing and building wealth without the burden of high-interest payments.

In conclusion, investing in stocks, bonds, or mutual funds offers the potential for long-term wealth accumulation. At the same time, managing debt effectively by prioritising high-interest repayments improves your financial stability and overall economic well-being. Finding the right balance between investing and debt repayment is crucial for achieving your financial goals and maintaining a healthy financial outlook.

Investing early can take advantage of compounding interest

Compounding interest is the process of earning interest on both the initial amount invested and the interest accumulated over time. This means that your money grows exponentially, and the earlier you start, the more time your money has to grow. For example, if you invest £100,000 with an annual interest rate of 4% for 10 years, you would receive £4,000 in interest in the first year, £4,160 in the second year, and £5,693.24 in the tenth year, resulting in a total pot of £148,024.

The power of compounding interest is often referred to as the "magic" or "miracle" of compound interest. It is a long-term strategy that suits a conservative, long-term investing approach. The key to optimising compounding interest is to start saving or investing as early as possible and to avoid the temptation to delay. The more time your money has to grow, the more it will benefit from the effects of compounding.

Additionally, it's important to note that compound interest can work for or against you. When investing, compound interest helps your money grow. However, when you borrow money, such as through credit cards or loans, compound interest works against you, making it harder to pay off your debt.

Here's an example to illustrate the power of investing early:

Let's say a family invests £3,000 per year (approximately £250 per month) for their newborn daughter into a diversified equity portfolio. By the time she is 25, they will have invested around £75,000. If this portfolio achieves a 5% annual growth rate, and all dividends are reinvested, she will have received just over £75,000 from investment returns. At age 25, her total portfolio will be worth £150,340.

In summary, investing early and taking advantage of compounding interest can be a powerful way to build wealth over time. It's important to understand how compound interest works and to start investing as early as possible to maximise its benefits.

Investing in stocks can be volatile but has higher returns

Investing in stocks can be a great way to grow your wealth over time, but it's important to understand the risks involved.

Stocks, or equities, are known for their volatility, meaning their prices can fluctuate significantly over time. This volatility is what attracts many investors, as it provides the opportunity for significant gains. However, it's important to remember that what goes up can also come down, and stock prices can also drop just as quickly.

When investing in stocks, it's crucial to take a long-term view. Historically, stock markets have trended upward over time, and the impact of volatility tends to decrease over longer periods. For example, since 1980, the Canadian stock market has never posted a single negative return during any 10, 20, or 30-year rolling period. So, while short-term volatility can be unnerving, staying invested for the long term can smooth out those fluctuations and increase the likelihood of positive returns.

Another benefit of investing in stocks is the potential for higher returns compared to other investment options. While there are less volatile investments, such as cash or fixed-income options like bonds, these typically offer lower returns. Stocks, on the other hand, have the potential to deliver superior returns over time, making them attractive to investors seeking to grow their wealth.

It's also worth noting that not all stocks are equally volatile. Diversifying your portfolio across different stocks and asset classes can help reduce overall risk while still allowing you to take advantage of the higher return potential of stocks.

However, investing in stocks does come with risks. In the short term, stock prices can be unpredictable, and it's possible to lose money if you're not careful. It's important to do your research, understand the companies you're investing in, and ensure that you're comfortable with the level of risk you're taking.

Additionally, it's crucial to manage your overall financial situation wisely. While investing in stocks can be lucrative, it's generally recommended to prioritize paying off high-interest debt before investing. Credit card debt, for example, often carries high interest rates that can quickly outweigh any potential stock market gains.

In summary, investing in stocks can be a volatile but potentially rewarding endeavour. By taking a long-term view, diversifying your portfolio, and managing your overall financial situation wisely, you can increase your chances of achieving positive returns while mitigating some of the risks associated with stock market investing.

Paying off debt improves your credit score

Paying off debt can be hard work, so it can be disheartening to see your credit score drop after you've repaid some debt. However, this is not always the case and paying off debt often improves your credit score. Here are some reasons why your credit score may have dropped after paying off debt, and why it will likely improve in the long run.

Credit Utilization Ratio

Your credit utilization ratio is the amount of available credit you're using at any given time. For example, if you have a credit card with a $2,000 limit and a balance of $1,000, your credit utilization rate is 50%how much of your available credit you're using both on individual cards and across all of your accounts. A credit utilization above 30% can drag down your credit score. When you pay off a credit card balance and keep the account open, you're improving your credit utilization ratio, which can boost your credit score.

Average Credit Account Age

Lenders like to see a track record of responsible credit usage, which includes the length of time you've been using credit. The longer your average credit account age, the better. Closing a long-standing card will lower the length of your credit history, which can cause your score to drop.

Credit Mix

Creditors like to see that you can manage different types of debt. Your credit mix includes loans, credit cards, mortgages, and other types of credit accounts. If you pay off your only installment loan, such as a mortgage, it could negatively impact your credit scores by decreasing the diversity of your credit mix.

Lag in Credit Reporting

Creditors don't always report credit events to the bureaus right away, and it can take 30 to 45 days for a payment to be reported. If you've recently paid off a debt, it may take more than a month to see any changes in your credit score.

Other Factors

There are many other factors that can impact your credit score, including payment history, length of credit history, newer lines of credit, and new credit. Making on-time payments helps your payment history, which accounts for 35% of your credit score. The longer your credit history, the better, as this makes up 15% of your score. Newer lines of credit and new credit inquiries can negatively impact your score, as these factors account for 10% each.

Improving Your Credit Score

Even if you're working on paying off debt, there are ways to improve your credit score during that process. Making timely payments, keeping your accounts open, and not opening too many new accounts can all help boost your credit score. While building or repairing credit won't happen overnight, consistency is key, and your credit score will likely improve over time.

Paying off debt reduces stress and anxiety

Debt can have a significant impact on mental health and is linked to a number of mental health issues, including denial, anger, depression, and anxiety. It can also lead to low self-esteem and impaired cognitive functioning, making it difficult to learn, remember, focus, or solve problems.

Financial stress can affect physical health by interfering with sleep, causing anxiety and panic, and increasing the release of stress hormones like cortisol and adrenaline, which can compromise immune system functions.

Paying off debt can help reduce stress and anxiety by eliminating the fear and worry associated with owing money. It can also improve overall health and quality of life, leading to increased self-confidence and freedom to pursue other life goals. Additionally, it can strengthen relationships and improve communication with loved ones.

Tips for paying off debt:

• Understand your debt: The first step is to acknowledge and confront the amount of debt you have.
• Make a plan: Seek professional help or create a sustainable plan to pay off your debt.
• Recognize it takes time: Repaying debt is a journey, and it's important to be patient and stick to your plan.
• Practice gratitude: Try to focus on the positive aspects of your debt, such as the opportunities it has afforded you.
• Manage your thoughts: Allocate specific times to think about your debt and actively work on being present and enjoying the moment.

Frequently asked questions