First off, congratulations on getting $1,000 together. That’s a meaningful financial milestone. But before you put that money into the stock market, there’s an important question to answer: Would your $1,000 work harder by reducing your debt?
For most Canadians, the answer depends largely on the interest rate attached to that debt. As a general rule, paying off high-interest debt should come before investing because the savings are effectively a guaranteed return, while investment returns are never guaranteed.
Source: Getty Images
High-interest debt usually comes first
Credit-card debt is a clear example. Canadian credit cards can carry interest rates ranging from roughly 9% to 26%, with many standard cards charging around 20% to 24%.
Consider what that means. A 9% long-term investment return would be considered a solid result. Consistently earning more than 20% would put you in the company of some of the world’s most successful investors. Yet paying down a credit-card balance charging 20% effectively saves you that 20% interest expense, without taking stock-market risk.
That makes the choice straightforward: if you’re carrying expensive credit-card debt, using your $1,000 to reduce it is the more attractive financial decision.
What about lower-interest debt?
The calculation becomes less obvious when your debt carries a much lower interest rate. If you’ve already paid off your credit cards and have a relatively inexpensive mortgage, student loan, or other debt, investing at the same time can make sense.
There is also a psychological benefit to reducing debt. Even affordable debt remains an obligation, and eliminating it can improve your financial flexibility and reduce the amount of interest you’ll pay over time.
I’d also give serious consideration to paying down loans on depreciating assets such as vehicles. A car generally loses value as it ages, so carrying a large loan for it can work against your overall net worth.
If you invest, choose quality
If your high-interest debt is under control and you decide to invest the $1,000, focus on quality rather than chasing the hottest stocks.
For example, Enbridge (TSX: ENB) is the type of blue-chip dividend stock Canadian investors may want to research. The North American energy infrastructure giant has a long history of returning cash to shareholders, including more than 70 years of dividends and roughly three decades of consecutive dividend increases.
Its dividend yield has also become more attractive following the stock’s roughly 16% pullback from its recent highs. Enbridge targets a distributable cash flow payout ratio of approximately 60% to 70%, while its year-to-date payout ratio is about 65%, representing a sustainable dividend.
That doesn’t make Enbridge risk-free, nor does it guarantee future returns. But for an investor seeking income and an established business, it illustrates why quality can be more important than simply buying whatever stock has fallen the most.
At the quotation of $65.65 per share at writing, the analyst consensus price target represents a discount of about 17%. On top of this valuation upside potential, as Enbridge targets distributable cash flow per share growth of about 5% per year, steady price appreciation is also in the cards.
The bottom line
If your $1,000 is competing with high-interest debt, paying down the debt is a guaranteed win. Once expensive debt is gone, however, a combination of debt reduction, cash savings, and long-term investing can be a solid way to go. The goal isn’t simply to invest your money — it’s to put each dollar where it can improve your financial position the most.
First off, congratulations on getting $1,000 together. That’s a meaningful financial milestone. But before you put that money into the stock market, there’s an important question to answer: Would your $1,000 work harder by reducing your debt?
For most Canadians, the answer depends largely on the interest rate attached to that debt. As a general rule, paying off high-interest debt should come before investing because the savings are effectively a guaranteed return, while investment returns are never guaranteed.
Source: Getty Images
High-interest debt usually comes first
Credit-card debt is a clear example. Canadian credit cards can carry interest rates ranging from roughly 9% to 26%, with many standard cards charging around 20% to 24%.
Consider what that means. A 9% long-term investment return would be considered a solid result. Consistently earning more than 20% would put you in the company of some of the world’s most successful investors. Yet paying down a credit-card balance charging 20% effectively saves you that 20% interest expense, without taking stock-market risk.
That makes the choice straightforward: if you’re carrying expensive credit-card debt, using your $1,000 to reduce it is the more attractive financial decision.
What about lower-interest debt?
The calculation becomes less obvious when your debt carries a much lower interest rate. If you’ve already paid off your credit cards and have a relatively inexpensive mortgage, student loan, or other debt, investing at the same time can make sense.
There is also a psychological benefit to reducing debt. Even affordable debt remains an obligation, and eliminating it can improve your financial flexibility and reduce the amount of interest you’ll pay over time.
I’d also give serious consideration to paying down loans on depreciating assets such as vehicles. A car generally loses value as it ages, so carrying a large loan for it can work against your overall net worth.
If you invest, choose quality
If your high-interest debt is under control and you decide to invest the $1,000, focus on quality rather than chasing the hottest stocks.
For example, Enbridge (TSX: ENB) is the type of blue-chip dividend stock Canadian investors may want to research. The North American energy infrastructure giant has a long history of returning cash to shareholders, including more than 70 years of dividends and roughly three decades of consecutive dividend increases.
Its dividend yield has also become more attractive following the stock’s roughly 16% pullback from its recent highs. Enbridge targets a distributable cash flow payout ratio of approximately 60% to 70%, while its year-to-date payout ratio is about 65%, representing a sustainable dividend.
That doesn’t make Enbridge risk-free, nor does it guarantee future returns. But for an investor seeking income and an established business, it illustrates why quality can be more important than simply buying whatever stock has fallen the most.
At the quotation of $65.65 per share at writing, the analyst consensus price target represents a discount of about 17%. On top of this valuation upside potential, as Enbridge targets distributable cash flow per share growth of about 5% per year, steady price appreciation is also in the cards.
The bottom line
If your $1,000 is competing with high-interest debt, paying down the debt is a guaranteed win. Once expensive debt is gone, however, a combination of debt reduction, cash savings, and long-term investing can be a solid way to go. The goal isn’t simply to invest your money — it’s to put each dollar where it can improve your financial position the most.
