Speaker 1:
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Brendan Freeman:
Welcome to the First Business Bank Podcast. I'm Brendan Freeman, and I lead our private wealth group at First Business Bank. Today, we're going to be talking about the pros and cons of paying off debt versus investing. With me today, I have Jessica Colby, wealth advisor, and Eric Engstrom, portfolio manager. I'm going to allow them to just introduce themselves. Jessica?
Jessica Colby:
Hi, Brendan. Thanks for having me today. My name's Jessica Colby, as he mentioned, vice president wealth advisor. And I've been in the banking industry for over 20 years. So thanks for having me.
Brendan Freeman:
Glad to have you. Eric?
Eric Engstrom:
Hi, Brendan. Thank you. And Jessica, nice to see you too. I'm Eric Engstrom, vice president portfolio management, and I've been doing investment management for the last six years.
Brendan Freeman:
Let's start at a very high level. Wondering, with this topic about the pros and cons of paying off debt versus investing, is it better to pay off debt or invest? I realize that's probably a pretty tough question. Let's take a step back and just look at that and consider all the elements of that question. Jessica, if you don't mind, could we start with you?
Jessica Colby:
Well, I would say that the overarching advice, or general rule if you will, regarding higher interest rates on your debt versus investing, is that if your interest rate debts are higher than your average returns, then it's common that you would focus on paying down your debts. However, the ability to accomplish both is an opportunity, where maybe if you have a good strategic plan in place around paying down those debts, but then also taking advantage of an employer 401(k) match, as an example, is still investing in your retirement. However, I'd also say that there's an element to consider the ability to pay off debt versus the willingness. And I'm sure, Eric, you can speak to that regarding personalities and opportunity costs.
Eric Engstrom:
Yeah, absolutely. I'd love to add onto that. First of all, great points, Jessica. But really the first thing that we want to look at is the interest rate that your debt is charging you versus the potential return that you could get on investments. So to add a little bit of historical context there, if we were to go all the way back to the 1950s, and you look at the S&P 500 specifically, you would earn about 10% annually over those 70-ish years, if you were invested only in the S&P 500. If you had a little fixed income or bonds in there, that might be closer to 6, 7, 8%. But if you're considering investing versus, let's say, paying off a mortgage, and in the last few years if you were able to lock in a 3% interest rate, something like that, on your mortgage, probably makes sense to go towards the investing route where you can get 6-plus percent depending on your allocation.
But if you're considering paying off something like credit card debt, that might be 25, 27% interest, it certainly makes logical sense to pay that section off first. However, as we know with money, you can have the logical answer, but there's always emotions that come into that as well. Some people just really hate having debt. And no matter what the interest rate or the projected rate of return are, they would rather not have debt than invest the money. Alternatively, some people could have a mountain of debt and really want to take a big swing and try to get that home run in the market. So part of what Jessica and I do is find that balance between the logical answer and the emotional answer for each individual person. That's the other thing is each one of these plans is going to be different, depending on who we're talking to and their comfort level. So that's really one of the things that we try to flesh out.
Brendan Freeman:
Well, that's great insight. Thank you, Jessica. And thank you, Eric. That certainly gives us an idea from a high level perspective. When you consider this dilemma for our listeners, where do they actually start? What would be some good advice in tackling this issue out of the gate? What should they consider right out of the gate, Eric?
Eric Engstrom:
Well, the first thing to recognize is that this is a good problem to have, because this means that you have a little bit of discretionary income on top of your daily, your weekly, your monthly expenses. But if you do have debt out there, it's still really important that you're paying that minimum monthly annual payment, because, if you don't, that affects your credit score, which negatively affects the entire financial situation. So that's really important. And then if you are still working, and your employer offers a 401(k) match, for example, it's still recommended that you maximize that match that your employer is giving you. So if I contribute 3%, and my employer contributes 3%, I want to maximize that free money from my employer before allocating any extra money somewhere else. So that's where I would start. Do you have any other thoughts, Jessica?
Jessica Colby:
I say don't forget to create that emergency savings account. I think the rule of thumb there is around six months. It depends on your industry and your level of expenses. But the last thing that you want to have happen, should something unexpected occur, is to make sure you've got a backup plan to cover those expenses, so you don't put yourself in a situation where you're racking up revolving debt to cover lifestyle and expenses, or potentially creating a situation where you have to liquidate securities, which can create further penalty and tax implications. So that's another thing to think about.
Brendan Freeman:
Well, Jessica, I'm going to throw a curveball at you here, and I'm going to say life happens a little bit. And sometimes, that can be a really positive thing. And sometimes, maybe that's not so positive. And so for our listeners that maybe have this challenge of paying off debt versus investing, and maybe they listened to your advice, and they kind of heard what you just said about the considerations and the things that you consider, what if they get an inheritance? What if they get a big bonus at work, as an example? Or on the contrary, what happens if they lose their job? Can you talk a little bit about both of those scenarios?
Jessica Colby:
Well, definitely the first two would be a positive thing. You just need to create a plan about whether and where you're going to apply it. It really just allows people to get ahead of their goal a little bit quicker when they've got this lift in assets, like an inheritance or a bonus to then decide, "Does it make the most sense to pay off something or do a little bit of both?" Further though, when it comes to the job loss, it goes back to having that emergency savings. And what are your resources? Because with the job loss, it may take some time to replace that income. And so again, having that backup plan is important.
Eric Engstrom:
Yeah. And just to add on to that, if you have that inheritance or that bonus at work, that can really accelerate this plan, with that key word being the plan. Once you work with someone to figure out which options are best for you, and you start putting that plan in place, some sort of influx of cash might change that plan. So it could be important to sit down and reassess and figure out if that plan is still the best option for you. But this really emphasizes the importance of something like a savings account or an emergency fund, that if you were unfortunately to lose your job, being able to keep up that lifestyle until you're able to reenter the workforce is extremely important. So I'm glad that we mentioned that. Thank you, Jessica.
Brendan Freeman:
Eric, from your perspective, as we get to a period of higher interest rates, how does that play into this dilemma?
Eric Engstrom:
Well, there are a number of different types of debt out there. You can have your fixed debt, which higher interest rates might not really affect, if you were able to lock in, let's say, a 3% mortgage, as we mentioned before. But there's plenty of variable debt out there as well. And as interest rates go up, the amount that you owe to that creditor would also go up. And that's very typical in things like credit cards, for example. So if interest rates do continue to go up, and your debt obligation would therefore go up, again, that might change your plan. And you might consider paying off debt sooner rather than investing. And then as interest rates go up, it certainly affects what the market does and what different sectors of the market do, as a matter of fact. So that would be another opportunity to reassess your plan, reassess it with your portfolio manager and figure out if your current asset allocation is still appropriate.
Brendan Freeman:
Anything you'd add there, Jessica?
Jessica Colby:
Yeah, I would just say the plan is super important, even if it's a rising interest rate environment, hopefully with your advisor, you are building in those opportunities that could exist or come up. And so what is that specific plan? We have some clients today where leveraging a line of credit, because it's temporary to cover your short-term liquidity needs, knowing that later in the year that they're going to be able to pay down that debt, for example, if they get a surprise tax bill. But again, knowing that their income is sufficient but not consistent. And lastly, another opportunity that people borrow, even in high interest rate environments, is to add to their overall asset pool, like investment real estate. So their intent might be to purchase investment real estate and borrow, but they intend to flip it or add it to their overall investment portfolio, relative to real estate. And so it's another great long-term play, but just make sure that you have that plan because it's not for everyone.
Brendan Freeman:
Eric, I'm going to go back to you. Earlier you mentioned asset allocation. And our listeners are probably getting a gauge that, from an investment perspective, that's a lot of what you do every day. How does risk tolerance and how much willingness you might have to take on risk play into this debate?
Eric Engstrom:
Well, it's a huge part. Anytime we're talking about investing and asset allocation, we have to find a balance between the ability to take on risk and the willingness to take on risk. If you are just out of college, 25, 30 years old, something like that, and you have a long time horizon, you don't expect needing that money for 30-plus years, your ability to take on risk goes up, because you have a lot of time to ride the waves of the market. Theoretically, you won't be pulling out money at the wrong time. So taking on risk makes sense there. However, that individual might not like seeing their money go up and down in these huge amounts. So the price of peace of mind is something that we talk about, where if you just seeing your money go up incrementally over time, then your willingness to take on risk is probably lower. So finding the balance between how much time you have, how you can take on and how much risk you want to take on is a really interesting question and a fine balance that we work on with everybody.
Brendan Freeman:
Anything that you'd add to there, Jessica?
Jessica Colby:
I would just say that if your debt is in lower interest rates, and that's different for what lower interest rates means to everyone, then in theory you should sleep very well at night, and just trying to not let your emotions dictate or govern your decisions and be rational and intentional about the decisions you're making. Again, like Eric said, if you have assets for long-term investment purposes, perhaps don't be afraid of the volatility in the market. Be more afraid of the purchasing power that you could experience over time if you're not in the market.
Brendan Freeman:
Great perspectives. I think everyone's different, right? And so I think our listeners should try to figure out what's the strategy that's best for them, and obviously work with advisors like the two of you, to potentially solve some of these issues and work through what makes most most sense for them. Last question, there's been some recent news around the Secure Act, Secure 2.0, being signed, what impact does that have on this dilemma. Jessica, any perspective there?
Jessica Colby:
Sure. So the new update is that beginning in 2024, when you make your student loan payments, your employer may have the ability to match your student loan payment to your qualified retirement plan. So it's definitely going to be important when that time comes to check in with your employer and see if that is a benefit that you have available to you, to allow you to further weigh the ability to pay down your student loan payments, but yet still participate in contributing to your retirement plan.
Brendan Freeman:
Thank you. Jessica, anything else from your perspective that you'd like to leave our audience with today?
Jessica Colby:
You know me, Brendan. Anytime I'm so fortunate to be on a podcast with you, I always love to leave with a movie quote. And so from the movie Wall Street, "Money's only something you need if you don't die tomorrow." So the likelihood of any of us dying tomorrow is pretty unlikely, so I just think it's important that you do figure out a way to create a very strategic plan, work with your financial experts, so that they can help you map out your financial success.
Brendan Freeman:
Well, there you have it. Thank you, Jessica. I really appreciate you giving the audience something to think about as we close out our podcast today. I'd like to thank you, Jessica and Eric. I'd like to thank you for the wisdom, the knowledge that you shared with the audience. I'd also like to thank our audience members for listening in today. Hopefully, it was valuable to you, and it helps you assess your situation going forward. I would encourage you to use First Business as a resource. Visit us online at firstbusiness.bank. And if there's anything that we can do to help, please reach out to us. Thank you for listening today.
Speaker 1:
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