If you want to get rich, you'll eventually have to start investing. But before you put your savings to work in the stock market, there's one wealth-destroying mistake you simply can't afford to make: carrying a balance on your credit card.
While you might not think that a bit of credit card debt is that big a deal, for many people, there's no better investment than paying off that debt as soon as possible.
Nothing new, but getting worse
There's nothing revolutionary about just how bad credit card debt is. In contrast to "good" debt, like a home mortgage, debt on credit cards doesn't give you any sort of tax break. And even though rates on many mortgages have fallen below 5%, credit card rates have hardly budged, despite the Fed lowering short-term rates to near zero.
In fact, some banks seem to be targeting credit card holders and other credit-hungry customers for more revenue lately. According to the Wall Street Journal, Bank of America (NYSE:BAC) plans to hike rates on some credit cards to 14%, while imposing additional $10 fees on certain transactions. Meanwhile, Citigroup (NYSE:C) will offer consumer-finance loans with interest rates as high as 30%, and both US Bancorp (NYSE:USB) and Wells Fargo (NYSE:WFC) are making direct-deposit advance loans available to customers at effective annual rates of around 120%.
You can't afford it
If you're trying to get yourself into better financial shape, you might feel like you shouldn't wait to start investing. But if you have credit card balances or any other high-interest debt, it's worth it to wait.
Consider: to match the impact of paying off your outstanding balance on a typical credit card, you'll have to earn more than 14% on your money -- and that's before taxes. If you're paying 20% and are in a high tax bracket, you'd need to earn 30% or more just to break even.
Obviously, that's a tough nut to crack. For instance, these stocks are the only ones in the S&P 500 to break the 30% barrier over the past five years:
|
Stock |
5-Year Annual Return |
|---|---|
|
Southwestern Energy (NYSE:SWN) |
60.9% |
|
Apple |
53.3% |
|
Intuitive Surgical (NASDAQ:ISRG) |
52.5% |
|
Range Resources |
38.6% |
|
Monsanto (NYSE:MON) |
36.4% |
Source: Capital IQ, a division of Standard and Poor's.
And while a couple dozen stocks managed to do better than 20%, plenty have lost money over the same timeframe. While no stock is a sure thing, what is certain is how much you'll pay over time on a high-interest credit card balance.
Some better statistics
Recent news on the credit card front, though, has been unusually positive. Earlier this month, the Federal Reserve reported that the amount of credit card debt outstanding fell at the fastest pace since the 1970s. Combined with a rising savings rate, it appears that Americans have become more aware of the debt trap, and they're finally taking some long-awaited steps to free themselves from their debt burden.
That's a good sign, but the news isn't all good. Delinquency rates among credit card issuers are unusually high, which will increase pressure on card issuers to keep rates equally steep. Many card companies are also bringing down credit limits, squeezing the customers who rely on those cards the most.
So if you're trying to invest without getting your debt completely under control, my advice is simple: Don't do it. As important as it is to invest, put off buying stocks or funds until that debt is gone. Otherwise, you'll be trying to dig yourself out of a hole before you even start.
More on Foolish investing:
- 10 essential money lessons for everyone.
- Don't mess up your retirement.
- 3 investment myths you should avoid.
