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Should You Sit On Debt?

When does it make sense to put "Pay off credit card" a little lower on the financial to-do list? Short answer: When the money you'd use to do so is working harder for you elsewhere.

Sounds obvious, but it's not always so cut-and-dry. For example, let's say you've set aside some extra cash for that just-in-case scenario -- just in case you or your spouse loses a job, breaks a leg, or accidentally sets fire to the neighbor's kitchen. It has taken you a long time to amass a comfortable sum. Cash it out or keep it?

If it's sitting in your checking account earning a paltry 0.08% interest, chances are it'd do your finances more good if you sent it to Mr. Visa. (The quick test is to compare interest rates, and with the average credit card charging 14% on outstanding balances, it's a clear winner.) How much of it to devote to debt payment is your call. If it is your emergency cash cushion, and you tend to be accident-prone, you may want to leave a little in your account for another emergency. Having cash at the ready can save you from future credit card debt.

For many people, though, having debt is an emergency. And getting rid of it is reason enough to liquidate their cash cushion. It's much easier to do if your cash is in an asset that is easy to get to -- say, in a checking account, money market account, or certificate of deposit (though you will probably have to pay a small penalty to get your hands on the greenbacks).

There are more consequences (financial and psychological) when that "extra" money is sitting in a brokerage account invested in stocks.

  • If your portfolio has gained value, you may be subject to capital gains taxes on your investments should you liquidate them.
  • If your investment is in a traditional IRA or other tax-advantaged account (such as a 401(k)), you'll have to pay an early withdrawal penalty, plus taxes, if you're younger than 59 and a half. (The Roth IRA allows you to withdraw your contributions at any time without penalty.)
  • There's a psychological cost to cashing out investments to pay off debt. Getting into the habit of saving is critical. Knowing that you are building something for the future -- even if you are paying for the past at the same time -- can do wonders for the psyche. Dipping into saved money can undermine that sense of accomplishment.
  • Even if the investments are not doing well, most of the time it pays to keep your mitts off the balance. Dipping into this money to pay off a depreciating asset -- a car, credit card debt -- is like robbing your future self.

Sometimes it pays to ignore the black-and-white numbers and do what feels right. While the calculations on the Excel spreadsheet build a strong case for holding off on investing and funneling extra cash towards debt, there are other, less tangible reasons to modify the plan.

For some, that means striking a balance by investing some of their extra cash and allotting a portion to paying down the debt, even if the investments are doing well and the debt carries a very low interest rate.

It's hard not to be enticed by low-interest offers. But there's something to be said for carrying little to no debt -- that feeling of outright ownership, and watching your investments truly add value to your bottom line. How you get there is your choice.

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