Should I Pay off my Debt or Invest?

Do you find yourself with a little bit of excess cash? Confused whether you should pay down debt or make an investment. Sadly, there is no one size fits all answer to this question, but very generally speaking you should make investments/pay debts as follows:

• Pay off credit card and any other very higher interest rate debt.

• RRSP and/or TFSA

• RESP or Real Estate

• Other Lower interest loans (car loans)

• Student Loans (depending on interest rate)

• Non Registered Investment Accounts.

When thinking about this for your own person situation you can also consider the interest rate of your investments, accounting for the tax implications. For example, let's say you have $5,000 dollars available and can either make an investment into the stock market or pay down a 6% car loan. If we assume the investment in the market would yield a return of 7%, your first impulse might be to make the market investment. But considering the tax rate on this incremental income will likely be 30-40%, the net investment return would be 7% X 70% (1-30)= 5%, making paying down the debt a better investment. But comparing that same car loan to an RRSP investment (again assuming a 7% return), then you’d make the RRSP investment since you get both tax deferral (pay tax later, likely at a lower rate) plus a reduction in this year’s taxes since your overall taxable income is reduced. So, the RRSP investment actually returns MORE than 7% (although the actual return would vary based on many factors) so the RRSP investment should come before the car loan pay down. And if your company provides a match then it isn’t even close – that’s why we are such big fans of the RRSP.