Would you invest in something that you knew in advance would always lose 28% a year?
I’m pretty sure your answer will be no.
But what about consistently putting your money into something that would always cost you 3% a year? Does the smaller amount of consistent money loss change your answer?
It doesn’t for me, although I can picture a scenario where it might for some people.
But then…why is it that you’ll hear the opposite?
Why do people carry balances on high-interest credit cards, guaranteeing themselves a loss? Why do people say things like “I’m not in any hurry to pay off my student loans because they’re at such a low interest rate.” Or “It’s a bad idea to pay off your mortgage early because it’s tax deductible.”
The theory goes that it’s better to take the money you’d be sending to get out of debt faster and invest it instead.
Of course, it could be better to continue to owe many thousands of dollars (maybe even hundreds of thousands of dollars) IF you really are better off financially that way, and IF you’re comfortable with the additional risk that doing so brings.
Don’t blindly accept conventional wisdom
But don’t blindly accept conventional wisdom. Look at the reality of your own situation, and decide what’s best for you after examining the facts.
For example, if you’re keeping a student loan around, ARE you actually investing a ton of money each month? And more importantly, are you consistently making a greater annual return on that money than you’re losing on the loan? Or are you increasing your style of living instead?
And about those tax deductions
Sure, even student loan interest may be tax deductible. The key word there is “may”. The student loan tax deduction allows you to deduct up to “the lesser of $2,500 or the amount of interest you actually paid” — but only if your modified adjusted gross income is under a certain level and you meet various other criteria.
The same kind of considerations should be given to mortgage interest deductions. Take a look at your taxes. Did you itemize? If not, well, you’re not taking that mortgage interest deduction anyway. If you did, will you itemize again this year, or were you able to itemize last year due to some unusual events? If you’ve got a huge mortgage with a high interest rate, and you’re able to refinance, you could probably save more money that way than you’d save by reducing your taxable income.
Here’s a calculator that can help you look at whether or not deducting mortgage interest would save you any money. (If you can’t easily find the answers to the questions it asks, you probably don’t know as much as you should about your own financial situation.) I like the way Free Money Finance put it best though: the mortgage tax deduction is a consolation prize at best.
Personal finance is simple
Remember, when it comes right down to it, personal finance is simple.
Spend less than you earn, invest wisely, don’t use logic to justify emotional decisions after the fact, and don’t enter into complicated schemes designed to save you money. I can’t think of anything more complicated than the US tax code, myself. The best way to save money is to go ahead and save it from what you earn.
Of course, you’ve got to do whatever’s right for you in your situation. Just make sure you’ve examined it carefully, and gotten all the facts.Posted in Debt, Taxes on 12.30.11 with 18 comments.