Email question: Should I cash out investments to pay off debt?

Hi Pete,

I am 25 and paying down about $2,000 in high interest credit card debt that I am trying to pay off as soon as possible. I currently have about $19,000 in mutual funds and I was wondering what the pros and cons of withdrawing money from that account to pay off my debt would be.

Thank you!

Darcy

Hi Darcy,

Thanks for the email. To everyone that's not Darcy, you can also email me and get the same personal advice I'm about to give. Just go to the contact tab to email me your question.

Anyway, back to you Darcy. This is a great question, but I don't have quite enough information to answer the question definitively so this answer will read like a choose your own adventure. Those were the best books anyway, so it'll be a good time.

Let's start with your net worth. Just to review, your net worth is assets minus liabilities. In your case Darcy, your assets are $19,000 and your liabilities are $2,000 leaving you with a positive net worth of $17,000.

If you liquidate $2,000 from your mutual funds and use the money to pay off your high interest credit card, your net worth actually stays exactly the same. Removing $2,000 from your mutual funds to pay off debt means your liabilities are gone, but your assets are now lower leaving you with a net worth of $17,000. There will be absolutely no change in your net worth if you pay off debt this way.

So is that a good thing or a bad thing? Well, it depends on how you look at it. You mentioned your credit card has high interest, but the thing about interest rates is they are subjective. Personally I think anything over 20% is high, although 15% and up is high-ish. And really interest is bad mostly because it often gets dragged out over a long period of time. So if you are able to pay off your card within six months, then the interest paid isn't enough to really worry about. I'm assuming your mutual funds are non-qualified, meaning they aren't retirement funds, which makes it a little simpler to withdraw from. Yet there are still taxes and fees to consider. For example, you may pay more in taxes and fees than you would in interest if you paid off your credit card in six months.

All the above is why I generally prefer for people to keep their assets intact and pay off their debt the old fashioned way a.k.a. paying off debt with your current income. Your income is a renewable asset. By using your current income to pay off debt you actually increase your net worth. Your assets stay at $19,000 and your liabilities go to zero, which leaves you with an increased net worth of $19,000. And not only does it increase your income, you will develop great habits. This is the true upside of having debt. Darcy, I don't know your current income or expenses, but whether you can spare $500 or $50 a month, you can pay off your credit card debt. What you'll learn by cutting expenses and living without the extra income for a few months or years is you don't need it.

Think of it this way: Your debt conundrum requires triage. The triage means you've got to prioritize your debt problem. You can either pay it off with assets or bust it for a few months and pay it off with your income. Either way your debt problem is solved. BUT what if you could solve the problem while increasing your net worth and learning a great financial habit? Well, then, the answer is obvious.

Darcy, I also answered your question on air, so if you want to hear me answer your question and talk about running without a shirt on, then you're in luck. Listen to this clip from The Pete the Planner Radio Show on WIBC.