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Ask a Fool: Should I Invest My Tax Refund or Pay Down Debt?

By Matthew Frankel, CFP® - Feb 16, 2018 at 11:00AM

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It depends on whether you have good debt or bad debt.

Q: I'm getting about $3,000 back from the IRS. I was considering using it to start investing, but I was wondering if it would be smarter to pay down some debt instead?

It depends on what type of debt we're talking about. If you have high-interest credit cards, payday loans, or any other type of "bad" debt, it's generally a good idea to pay it down before investing.

Here's why: Even great investors can only expect to achieve annualized returns of 10%-12% over the long run. If you're paying 15% or more on interest, choosing to invest is setting yourself up to lose money overall.

On the other hand, lower-interest debts such as mortgages, student loans, and auto loans are generally considered to be "good" debt, provided that they don't have excessive interest rates and you can handle the monthly payments.

Although many people aspire to pay their mortgage or car down faster, or to pay off their student loans as quickly as possible, from a long-term financial perspective, investing is generally a better move. For example, if you can borrow money to buy a house at 4% interest, and can achieve 9% investment returns over the long run (the stock market's historical average), the math works in your favor.

The main consideration is whether you can reasonably expect to earn more from your investments than the interest rate you're paying on your debt. If the answer is yes, investing your tax refund can be a wise financial move.

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