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Here’s a realistic personal finance conundrum: You have nagging debt collecting that you just can’t seem to get rid off, but, separately, funds are sitting and (ideally) growing in your investment accounts. What if you used that investment money to finally make a significant dent in your debt once and for all?
What may seem like a quick solution, however, has important financial implications to be aware of (hello, capital gains tax). When possible, experts generally suggest avoiding using your investments to pay down debt. However, there is one caveat to that rule: when you have high-interest debt.
Select, looks into the pros and cons of selling your investments to pay off debt.
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Selling investments to pay down high-interest debt
If you have high-interest debt like outstanding credit card balances, it’s smart to take every measure possible to take care of that debt, advises Tony Molina, a CPA and senior product specialist at robo-advisor investment platform Wealthfront.
“When looking at this from an interest rate perspective, if you’re paying 20% interest on credit card debt, you would need to make at least 20% on your investments to cover that interest cost,” Molina tells Select. “No one makes 20% year-over-year.”
Lynn Dunston, a CFP and partner at wealth management firm Moneta Group, agrees that you can quantify the best route to take when deciding whether to pay off debt off or stay invested, but his threshold rate is much lower. Dunston provides a “common industry rule of thumb,” explaining that once the debt’s interest rate is higher than 4%, it’s harder for your investment gains to overcome the cost of interest.
“At that point, we would typically recommend you pay debt down,” he says. “Of course, this is only a general rule and specific circumstances should always be taken into account when making important financial decisions.”
A good practice, Dunston adds, is to ask yourself what is the cost of the opportunity you’re giving up by withdrawing money from your portfolio to pay down debt? He wants you to consider what your investment money is earmarked for so you can weigh what might be jeopardized if you pay off the debt.
“Money invested will grow,” Dunston says. “If the debt in question has an interest …….