Today, I want to tell you about an exciting new investment opportunity.
It is virtually guaranteed to beat the market over the long run. Yet it is also completely risk-free with zero chance of loss. And unlike many of the world’s best investment opportunities, this one isn’t limited to Wall Street insiders and the super-wealthy.
Now, I know what you’re probably thinking: This opportunity sounds way too good to be true.
Well, let me assure you, it is real and available to millions of individual investors like you today. Except it isn’t new and isn’t actually an “investment” at all.
Instead, I’m referring to paying off credit-card and other high-interest-rate debt.
Let me explain…
Why Paying Off Your Credit Cards Is One of the Best ‘Investments’ You Can Make Right Now
There are generally few investments with a better risk-to-reward profile than paying off high-interest-rate debt.
When you pay off debt, you’re gaining an immediate return on your money equal to whatever the current rate on that debt is.
According to creditcards.com, the average interest rate on credit card balances in the U.S. was 17.48% as of late July 2022. That means the average American credit card holder could earn more than 17% on their money simply by paying off their debt today.
Meanwhile, over the past 100 years, the broad U.S. stock market has gained roughly 10% per year. That’s a solid return… but to earn it, investors were required to stomach significant volatility, including years — and sometimes decades — of very low or even negative returns.
In other words, by simply paying off your credit card debt today, you can potentially earn nearly double what you can expect to make in stocks over the long run. Yet you could do so with none of the risks of loss or drawdown you’d be required to take in stocks.
That is as close to a ”no-brainer” as you’re likely to find in investing. But I believe the relative benefits of paying down debt right now are even better than that comparison suggests. Given the recent combination of high inflation and historically high valuations, it’s quite likely stocks will underperform their historical average over the next few years at least.
We could even see something like the “lost decade” of the 1970s, where the overall market went nowhere for more than 10 years.
This likelihood of below-average market returns makes paying off high-interest-rate debt an even better opportunity than usual today.
In addition to the immediate risk-free return, paying down high-interest debt can also improve your credit score. And this, in turn, can save you even more money by reducing the rates you’ll have to pay on other debt, like a home mortgage. It can even reduce the premiums you’ll pay for home or auto insurance in some cases.
When in Doubt, Use the ‘Rule of 6%’
But what exactly is “high” when it comes to interest rates?
To answer this question, we’ll turn to research from Fidelity Investments.
In short, Fidelity found that 6% — rather than the 10% average market return I mentioned earlier — is what the average individual investor is likely to earn each year in a balanced, tax-advantaged retirement portfolio.
As a result, it generally makes sense for most folks to pay off any debt with an interest rate of 6% or greater before investing. If the interest rate on your debt is less than 6%, you could consider investing some of those funds instead.
Now, as a Money Talks reader, you’ve got a great chance to do better than the average investor over the long term — especially if you’re also a subscriber to our powerful TradeSmith tools. But I still think this “Rule of 6%” is a good, conservative guideline.
Two Proven Approaches to Tackling Your Debts
Once you’ve decided to pay off your debts, there are generally two good ways to start. These are known as the “avalanche method” and the “snowball method.”
The avalanche method prioritizes paying off your highest-interest-rate debts first.
To use this method, you’ll list your debts from highest to lowest by interest rate. You’ll then pay the minimum balance on each of them while dedicating the remainder of available funds to paying down the highest-interest-rate debt.
The avalanche method is technically the most efficient way to pay off debt, as it minimizes the total interest expense you’ll pay over time.
The snowball method instead prioritizes paying off your smallest debts first, regardless of interest rate.
To use this method, you’ll list your debts from smallest to largest. Again, you’ll pay the minimum balance required on each, but this time you’ll dedicate all remaining funds to paying down the smallest debt first.
While this one isn’t as efficient, it tends to be a favorite of financial advisers because it’s more motivating. Like a snowball rolling down a hill, you gain momentum as your smaller debts disappear more quickly.
So, which method should you choose?
There isn’t a “right” or “wrong” answer. Either method will work if you stick to it. Ultimately, it’s about choosing the best fit for your personality and circumstances.
The Harvard Business Review reported that the snowball method works best for most folks. But as I’ve mentioned before, my wife and I decided on the avalanche method because we liked the idea of paying down our debts as quickly as possible.
If you can’t decide, try both and choose the one that feels best.
As always, if you have any questions or comments on today’s editorial, I’d love to hear from you at [email protected]. I can’t respond to every email, but I promise to read them all.