# Paying Debt vs Investing



## tygrus (Mar 13, 2012)

Its an age old question but I thought I would pose it again. 

I have a debt in my business (farm) and the rate is 4.5% over 25 years. The loan is not re-advancable meaning that as soon as I pay any portion of it, its discharged for good unlike something like a homeline which can be revolved indefinitely. If I wanted to borrow against the business again, I would have to re-qualify for everything again which is no small feat.

So I came into a chunk of money I was thinking of throwing against the debt but then I had second thoughts that if I ever wanted to get financing again, I would have to jump through hoops all over again. 

I was thinking instead of doing that, instead just investing it along side the business debt and have the investment dividend pay the interest on that equivalent portion of the outstanding debt. 

So I reason that this accomplished several things;

1. I have another asset appreciating alongside the main business and its paying a portion of the main business debt thus taking pressure off my income stream.
2. I hold a liquid asset along side so if I ever had an emergency or needed the funds quickly or just got tired of the debt, it could be sold in days and applied to the debt.
3. If I hold both long enough, I will have the main business paid along with a dividend bearing investment along side it which could make for a very nice income in 20-25 years.

Downside, I carry the debt longer than I wanted or needed too, but isn't this really the same thing as just paying it out?

Any thoughts on this approach?
thx


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## RBull (Jan 20, 2013)

I am a proponent of eliminating debt for the flexibility, peace of mind and guaranteed return it provides. 

However you have some reasonable rationale stated that still carries flexibility and good long term planning, and the shotgun financing clause isn't appealing. I also understand you are more of a risk taker. There would be investment risk with your windfall and the overall return may be less than the debt cost, even though dividends may cover the interest. Long term this risk has more upside than down of course.


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## My Own Advisor (Sep 24, 2012)

Here are my thoughts...do both:
http://www.milliondollarjourney.com/ending-the-mortgage-paydown-vs-investing-debate.htm


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## rikk (May 28, 2012)

Sounds like you're not into jumping through hoops again, just yet anyway ... a liquid dividends investment sounds like a plan ... even shopping around, a laddered GIC (ok, not so liquid) will (within the 25 years) get you close to the 4.5%.


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## Barwelle (Feb 23, 2011)

Young farmer here. I pay the required payment and nothing more. I do have extra cash from off-farm income, but I continue to contribute to my "retirement fund" couch potato portfolio, for much the same reasons you outline. The biggest one for me is that it increases the diversity of my assets. I don't like the idea of having the majority of my net worth in one single asset. You know the old saying about eggs and baskets. Like you say, if you were to go this way, then you end up with more liquidity, and you'll have more than one type of investment income which reduces your risk.

Later on, I'll be re-evaluating... when the term is up, if rates have shot up then I might cash in some of the portfolio. Just depends what the situation is.

Take into consideration that, presumably, that interest is tax-deductible, so the 'effective' interest rate from your point of view is probably somewhere around 3%.


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## realist (Apr 8, 2011)

If Barwelle is correct that your interest payments are deductible that makes leaving the debt as is a better proposition than say for a typical residential mortgage. That said I am still a big proponent of the "do both" attitude.


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## Guban (Jul 5, 2011)

The business loan should be tax deductible.
What you are doing would be the same as leveraging your investments. ie borrowing to invest. Could you get a loan rate less than 4.5%? If you can (for such a long fixed term), then you would be better off paying off the business loan, and getting the loan and investing. 
I will point out that your point #2 is good so long as the markets don't crash. Things would look a bit different if the value of your investments drop by 30-50%. 
Therefore, the answer to your question depends on your risk tolerance. If you are conservative, pay off your debts. If you are aggressive, keep the business loan. If you are even more aggressive, open an investment credit line, and buy even more.


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## Synergy (Mar 18, 2013)

I'd normally say kill the debt, but business debt is a different story. Looks like you'd be better off doing a bit of both (as MOA stated above) or pay the required monthly payments and nothing more (as Barwelle stated above). Do the math and / or discuss with your accountant to see what looks like the best option for you.


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## Barwelle (Feb 23, 2011)

Guban said:


> I will point out that your point #2 is good so long as the markets don't crash. Things would look a bit different if the value of your investments drop by 30-50%.


This could happen on either side. Well, tygrus didn't say what the loan was used for, but if it was used to purchase something like land or quota, these also could drop in value.


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## tygrus (Mar 13, 2012)

The loan is on the land so its an appreciating asset for the most part. All my depreciating assets like machines are paid off.

Its really a tough call because with the extra money I came into, it appears I could discharge the entire debt within 5 years. Debt free would be a nice place to be sometimes. With a business loan, the bank never leaves you alone. They are always looking for financials and projections and it would be a nice feeling to get them off my back.


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## Barwelle (Feb 23, 2011)

Then maybe doing both, as others have suggested, would be the best option for you. That way, you won't feel like you missed out entirely if one way or the other ends up being better.


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## amitdi (May 31, 2012)

What does do both mean? I read the blog, but didnt get it. Do you mean split the excess 50-50 and pay the debt with one part and invest with other?

In any case, my recommendation is invest and here are the reasons -
1) Since, the interest is tax deductible, your effective interest rate is 4.5 * (1-MTR). At 35% marginal tax rate (MTR), you are effectively paying less than 3%. So if your investments can beat 3%, you are effectively better off.
2) If you need to pay the loan down, you can sell your investments and pay off the loan BUT not the other way round.
Risk: Of course as others have pointed out, you may be 30-50% down at that point. So this is upto your personal risk tolerance and the investments you choose. (Remember 30-50% is extreme for stock index, dont have much experience with land)
If you really dont need the money for personal use, I would have a long term horizon so that the short term crash (if any) maybe evened out if there are big gains.


So, given the situation, my recommendation is to invest.


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## Barwelle (Feb 23, 2011)

Re: "both", yep, that's right. Instead of either a) putting it all towards debt, or b) investing all of it in the market, he can do c) some combination of both. Since he is conflicted as to whether a) and b) is better for him, I was saying that (as previous commenters have said) maybe he should go with c) both.

I lean the same way amitdi, but I can see how paying off debt is enticing.


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## Pluto (Sep 12, 2013)

If you don't pay the debt, and invest, what would you invest in? I surmise, but I could be mistaken, you would invest in dividend paying stocks. If that is the case, I'd say forget it. The stock market will not do as well over the next 3 to 5 years as it has done in the last 5 years. 

At some point in the next 3-5 years, there will be a serious bear market. I don't know, but get the intuition, it will be sooner rather than later. If you decide to keep the windfall, in lieu of paying off debt, my best advice is put your cash in some safe interest bearing type security until the market shows better value. Just look on it as a rainy day fund, then when it rains, that is when the market drops considerably, spend it on some good stock.


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## lonewolf (Jun 12, 2012)

Pluto said:


> If you don't pay the debt, and invest, what would you invest in?
> QUOTE]
> 
> XAU


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## lonewolf (Jun 12, 2012)

What about investing in an annuity. The death benefits & investment return would they out perform the drawdown from interest paid on the loan ??


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