Invest for the future vs. Debt reduction

September 29, 2008 6:32 PM

Investing 201: Given the economic news of late, If the value of my mutual funds drop and the interest rate of my debts go up would it be prudent to liquidate the mutual funds to pay off my debts or should I "stay the course" despite this? Financial details inside...

OK so I have about $15000 in Mutual Funds (Canadian RRSPs to be exact - these are like 401Ks, I think, where the money invested is for retirement and is not taxed until withdrawn).

I also have about $30,000 in debt that I am paying off.
Half of it is a line of credit at 9%; the other half is credit card debt at about 12%.

Until now, my strategy was to leave my investment money where it is, and allow it to grow despite the temptation to use it to pay off the debt.

Now, if the economy goes to hell, I am assuming that the credit card companies and banks will jack up the interest rates (is this a safe assumption?) and that the value of my investments will plummet (which is expected).

I'm not so concerned about the investments - I normally would have "stayed the course" considering that I am a far way off from retirement, however but I am concerned about the debt - if the interest rates rise, it might become difficult to pay these off in a timely fashion.

So here are my options:
1) Stay the course, watch the value of my funds drop (temporarily at least) and risk paying more interest on my debts and extend this already long and painful course of financial redemption (at the risk of my happiness, health and marriage).

2) Liquidate the mutual funds, pay the up-front tax, pay the income tax on the money I am cashing out, and reduce my debt by 1/3, for the sole purpose of having a smaller debt in the event that interest rates go up.

Given this assumption, do you think it would be a better idea to liquidate the mutual fund, pay the up-front taxes, pay the income tax.

I'm still thinking Door #1 (stay the course). But I am curious to know what the hive mind thinks!

posted by anonymous to work & money (8 comments total)

ur unlikely to beat your funding costs on the investment returns so pay the debt
posted by jeb at 6:57 PM on September 29, 2008

My understanding on credit card debt is that they can't arbitrarily raise your interest rate unless you agree to it. Continuing to use the card would constitute agreement, but if they try to jack your rate way up, and you decline the rate increase within the time limit, all they can do is close the account to new transactions. You continue to pay your old debts at your old rate.

This, however, is legal advice from someone on the internet, based on things that someone read on the internet, so take it with an entire box of kosher salt.
posted by jacquilynne at 9:07 PM on September 29, 2008

I'm not an investment guru, but I can't see why you haven't already chosen option 2. What fund could beat 12% interest on a debt?
posted by StrikeTheViol at 9:32 PM on September 29, 2008

You're going to have to do ALL the math on this one -- when you sell the stocks now, the tax and transaction fees will eat into that number. As well, you're certainly selling at or near the bottom of the market (unless we're on our way to bartering, civil wars, and conflagration of society, in which case whatever choice you make doesn't matter) so that'll also impact the value. That being said, the debt is actually 'negative' investment -- unless your investments will end up making more money than the cost of the debt, you're still losing money. That's what you need to do the math to figure out.

Right now, you're essentially investing in the stock market with other people's money. That works if you're making more than you're paying for the money (that's why businesses borrow money, because they can invest it in their company, grow their business, and then pay it back, having made a profit greater than their cost of the money), but that doesn't work in your current situation.

Hate to tell you, but this isn't Investing 201 -- this is Investing 101. NEVER invest money if you have debt, unless the debt is serviceable at a lower rate than your investment profit. But also keep in mind that debt cost is generally predictable while investment profit rarely is. Notice how I said the same thing five times? Sell the stock.
posted by incessant at 10:45 PM on September 29, 2008

wouldn't you save money if you converted the 100% of the credit card debt to line of credit debt? the interest rate is lower and you'd pay less interest. Maybe the bank will also give you a loan at a fixed rate if you asked them. (maybe have this discussion w/ them?)

usually the strategy towards retirement RRSPs is to stay the course, over several decades, and not react to fluctuations in the market. My own bank reminded me of this yesterday after I asked a very similar question to yours (should I rebalance my RRSP/change funds I'm invested in etc. in light of the economic situation).

I digress but my bank also told me, the failure to pass the bail out was a calculated ploy by the US Gov't to see how the market would react. If the reaction was severe enough they'd go back and pass the bailout.

Otherwise the debt vs. RRSP is another question, but the present circumstance is not a good time to pull your money out ...
posted by thermonuclear.jive.turkey at 12:17 AM on September 30, 2008

oh and P.S. - think about cutting up your credit cards. I don't know your circumstances, but IMHO if you're racking up >$15,000 worth of credit card debt, maybe you have a spending issue?
posted by thermonuclear.jive.turkey at 12:21 AM on September 30, 2008

Look here for withdrawal issues. If you are in Quebec, you pay 30% to take your $15,000. So you end up with $10,500. That won't even pay the half of you debt you're carrying at 9%. And you lose the benefits of the RRSP. And you can't re-contribute that money.

Focus on using your income to pay down your debts. Strip out all of the unnecessary things and pay as much as you can towards your debts every month. Call your creditors and ask for a reduction in your interest rate. Do you have a hobby you can monetize? I infer that you're already on this course but it's kind of stressful. Do what you need to do to preserve health, happiness, and marriage along the way.

Check my math, and my sources of info, and keep in mind that I'm only an expert (sort of) in my own finances, which aren't even Canadian.
posted by KAS at 9:02 AM on September 30, 2008

If you're far from retirement, let the money stay. I don't know how those accounts work in Canada or how much the penalty is but stay the course. If you do anything, contribute less and put that new money towards debts.
posted by wangarific at 11:31 AM on September 30, 2008