The value of paying down debt ASAP

In The Smart Debt Coach by Talbot Stevens, he illustrates in laymen's terms why paying down a high interest debt of at least 20% can translate to a guaranteed return of 25% or more on an investment.

Which given that investment returns tend to hover between 5-10% over a long, long period of time (if you're smart and don't choose a poor investment strategy), if there was an actual investment or an actual stock out there that could and would guarantee a 25% return on your investment, people would be trampling each other in the rush to go all in on it. Because a 25% return is impossibly large.

If there was such a thing as a guaranteed 25% return on investment,
everyone would be like this.

But how can debt be equated to an impossibly lucrative investment? Well it all relates back to an individual's net worth.

Your net worth is probably the simplest math available in personal finance; what you own minus what you owe. So count up all your investments minus the debt you have and there's your net worth, a number that is solidly in the red for me. But he takes the net worth discussion a step further by pointing out that a gain of $200 and avoiding the loss of $200 is essentially the same thing to your net worth. Either option results in a positive impact on your net worth.

When you pay over the minimum payment on your credit card, or even pay off the balance completely, you are not just paying down the debt you owe against your net worth, you are also avoiding the interest fee that you would have accumulated if not for paying down your balance.

For instance say you owed $2,000 on a credit card that charges an annual interest rate of 20%. That means that every month that you owe $2000 on the card, you will pay $33.33 in interest alone. That's $33 extra you owe every month and $33 against your net worth every month.

But say you have $2,000 and you use it to pay off your debt. Suddenly, you not only owe $2,000 less against your net worth, you also save $33 in interest costs, therefore the return on your net worth is actually $2033, which is basically an immediate $33 return on investment.

But say you can't pay down the $2000 right away. Say you can only pay half of it one month and the other half the following month. What's the return like then?

If you pay down half of the $2,000 in the first month, you will save $16.66 in possible interest costs but also get charged $16.66 on the $1,000 you didn't pay down, basically your net worth has not been impacted, positively or negatively, which is great given how badly debt and interest can impact your net worth.

The longer it takes for you to pay down a debt the more time you allow for interest to creep in to negatively impact your money.

By paying down the debt as quickly as possible, you not only positively increase your net worth by owing less, but in the long view, you also positively increase your overall net worth by not having to pay whatever extra interest you would have otherwise have paid.

Nowhere is this more exemplified than when I calculate my interest costs on my student loans. Not only does paying an extra $50 a month shave off the number of years in which I'll be paying down my loans by almost a year, but it will also save me up to $850 in additional interest costs as a result which is still way more than any amount of money I would get back from the government in the form of a tax credit on the interest I would have paid otherwise.

That right there is a massively positive increase on my net worth and a hugely positive investment to my future self.

Now granted, my student loan interest is a 5.5% compounded daily annual interest rate, which may justify putting more of my money towards investing due to higher returns on some investments in the stock market. Plus, my interest payments comes with a tax credit from the government, standing to reason that my loan interest costs are even lower still than even a small return on investing year-over-year.

And that's justified reasoning. However, my student loan payments offers a guaranteed return within the next five years whereas most investments do not. In fact, investments can be quite volatile within that timeframe.

Though it may be boring... and may not equal the best returns on your money, it is the safest means of guaranteeing a return on any money you can and will make.