How Can I Use My Investment Income to Pay Off Debt?

There really aren’t any special types of investing accounts or tax advantages.  It is just a matter of using investments to increase your income, and therefore have a larger shovel with which to clean up your debt.  Realize that stocks are a long-term investment — one cannot expect to get any particular return in any given year.  Bonds give a more predictable return, but that return is less than that of stocks over long periods of time.  Given how low interest rates currently are, it would be difficult to find bonds that are paying more than the 7% you reference without taking a lot of risk.  (Note you should also be able to get the home mortgage down below 5%, which would help some.)  Given this, there are some different ways to attack your debt.

1.  The Dave Ramsey method would be to pay the minimums on everything but the smallest debt.  Then, use all of your additional resources to attack that debt.  Once that one is gone, use the additional money you have from not paying interest and payments on the first one to attack the next biggest.  Go up the line this way.  Given that you have some savings already, it would make sense to keep an emergency fund (enough for 3-6 months of expenses) and apply the rest towards the debt. 

To make this work, it would help to cut your lifestyle back while you’re working to pay off debt.  For example, sell cars with big payments and get a cheap, paid-off car.  Avoid eating out.  Consider a second job delivering pizzas, bartending, or something similar – this is all extra cash that could go right towards the debt.  The more intensely you can attack the debt the faster it will be paid off and out of your life.

This method has the advantage of eliminating debts and therefore the interest payments as you go.  Also, you get the motivation of seeing your shovel – the amount of money you can pay each month – grow with each debt you slay.  The disadvantage is that if you hit some big misfortune, like losing a job and having trouble finding another one, you only have 3-6 month’s worth of cash as a cushion.

2.  A second method would be to pay the minimums, keep 3-6 month’s worth of expenses in cash, and put any extra towards investments (index funds or ETFs would be appropriate to lower risk).  Expect that the value will change daily, with rallys and drops in value.  Each time the investments equal the value of one of the debts, pay it off.  Then start putting the payment you were making toward that debt into investments. 

Because stocks fluctuate in price you will have some times when stocks rally and you’ll be able to retire debts quickly.  Other times the stocks will fall in price for  a while and you will just be paying the minimums for a while waiting for the stocks to recover.  The good news is that stocks rarely stay down for long, and because you’re investing regularly, you’ll be in even better shape than breaking even when they return to their former prices. 

The advantage of this method is that the investments will provide additional income that can be used to help retire the debt, albeit it at unpredictable times. You’ll also have some additional cushion from the investments should misfortune befall you, e.g., a job loss.   The disadvantage is that you’re taking a risk of taking even longer to pay off your debts if stocks drop substantially.  This risk decreases if the debt is large and will take a long time to pay anyway (for example, a house with a 30-year loan) since then you’d then be investing for a longer period of time, greatly increasing the chances of a good return.   Also note for very large debts (like a house), it would be worth it to sell some stocks and pay large portions of the debt after good years in the stock market (+25% returns or more) even if you can’t pay the whole debt since risk increases when the stock market goes up sharply. 

If it will take at least 10 years to pay off the debt, the second method might be a good strategy.  If you could work intensely and knock out the debts in a year or two, the first method would be more appropriate since a sudden drop in the stock market could occur and take a year or two to return to former levels, increasing the time it takes to pay off the debts.  In both cases, finding ways to increase your income and reduce your other monthly expenses will speed things along.

Note that which ever way you use, once the debts are gone try to take some of the money you were using in payments and begin to invest regularly.  If you avoid letting your expenses build up and consume all of your income, you can build a great portfolio that will greatly augment your income in 10-20 years.

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Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing

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