Last week we spoke about the opportunity cost of money.
If we are not careful, we will lose substantial growth in important areas if we are NOT paying attention to this principle.
Today, let’s take a look at how we should weigh our options in regard to how we deploy our monies.
Weigh Your Options
We have to consider both growing our money but also limiting loss.
To best do this, we need to look at both interest we earn and interest we pay.
If you currently have debt, one of your main priorities should be limiting what you give away in the form of interest.
If your debt is in control or at zero, gaining interest should be your focus.
Let’s look at both.
If You Have Debt
If we are paying interest to others, we are giving up that interest potential for ourselves – this is the opportunity cost we talked about last week.
Debt also has an adverse effect on our cash flow - unless it is productive debt.
When you are trying to figure out which debts to pay off first, you must weigh both the interest rate and the payment (cash flow impact).
There are many schools of thought around which debts to pay off first.
First look at interest rates - not all debt is created equal.
Debts like credit cards, payday loans, and subprime auto loans; are all debts that carry high interest and are what I consider toxic debt.
These debts must be a priority and should be paid off first.
Once these have been eliminated you can then focus on your “reasonable” debts.
These are debts with lower interest rates.
My first focus on these reasonable debts would be cash flow.
If you have two debts with similar balances, you may want to pay off the one that has the largest payment.
This will allow you to compound your effect as you can now plow that extra savings back into other debts or investing.
Once you have knocked out the highest interest and largest cash flow saving debts, you can then continue to use the extra money to get rid of the next highest impact debt.
Remember, opportunity cost tells us that once money is spent in one area, we then forego using it for other options.
When we pay interest, we are unable to earn interest for ourselves.
I don’t believe we should pay off all debt before we invest, but those toxic debts must be eliminated quickly.
I also do not necessarily believe paying off a mortgage early is always the best use of money – but this is specific to each situation.
The main goal is to get our debts under control so it is not counterproductive to our money growth.
There are some financial influences who propose getting rid of all debt before investing substantially.
I believe this approach has a large cost when it comes to money growth.
Be cautious when heading this advice.
Investing Your Money
How do we weight investing options from the lens of opportunity cost?
Risk versus reward is what we are concerned with.
While it is not always true, when we take more risk, we can expect a higher return – as well as higher potential losses.
Any great investor will tell you that limiting loss is as equally important as your return.
Next week we will talk more about why this is the case.
As we weigh these options, we need to take into account things like: where taxes will be in the future, risk, access to money, etc.
For many, an employer 401(k) is an obvious first step.
Because you get their match, this is one of the highest returns you can see.
If you invest $50, and they match that with $50, you have already realized a 100% return.
That is hard to beat.
Once you have contributed what is needed to get this full match, you must weigh other potential options.
Maybe you have an eye for real estate.
If done correctly, this can give you a steady return on your money.
I know many individuals who use all of their extra money to put in to whole life insurance.
They do this at a lower rate of return, but it gives them access to money without having to wait until retirement.
Through this insurance, they are able to lend to themselves so they can invest in things like property, business, etc.
For me, I find immense value in starting businesses.
As I have mentioned in prior emails, it’s very realistic for most people to grow a sizable retirement through a 401(k) or other qualified retirement accounts.
The issue though, is that it may be at the expense of your lifestyle leading up to retirement.
Being self-employed is – in my opinion – a very practical way to not only save for retirement, but to also have the money to live the life you desire along the way.
When we work for someone else, there is always going to be a limit on what we can make.
The only way to truly maximize income growth is to own your own business.
Even though this is not for everyone, it is something I believe everyone should at least consider.
This list is not an exhaustive list, but should give some guidance on how to weight options for how to allocate your money.
Your situation is unique and should be viewed under that lens – this is not investment advice.
The important aspect is getting in a routine of making sure that you are allocating your money to its most beneficial source.
Money that is left idle will not go to work on its own.
Be proactive with your money and you will see a much more specific result.
Thanks for Reading,
Founder of 1911 Apparel