Does it make sense to borrow money at an interest rate of 17% and then invest it in something that earns you a return of 8%?
This is not a trick question and so the answer is a simple “No.”
Unfortunately, without realizing it, this may be what you are doing right now.
If you are investing in shares and you also have a credit card balance that flops over from one month to the next because you don’t pay it off, then you are borrowing money to invest.
The good news is that you can do something about it that will accelerate your investment returns.
Before I explain how you can achieve this, it’s worth us looking at a few facts about credit cards first.
Most adults in the “developed world” have at least one credit card and I expect you do too?
Let me ask you a question…
What is the annual rate of interest for outstanding balances on your credit card?
My guess is that you don’t know without looking at your latest statement.
Before you read any more, I urge you to go and take a look.
Get your statement and check…
Having done that, what did you learn?
Is the rate higher or lower than you thought it was?
The chances are that the rate is higher than you expected.
Some credit card companies are sneaky and only publish a monthly interest rate such as 1.3% per month, to make it sound affordable.
Unfortunately, if you had a balance of $100 at the start of the year that increased 1.3% each month, by the end of the year the balance would have reached $116.76.
In other words, a monthly interest rate of 1.3% is equivalent to an annual interest rate of 16.76%.
Note that this is greater than 12 x 1.3%, which is 15.6%, because the monthly interest is compounding month on month if you don’t pay it off.
Credit Card Interest Rates
Bank interest rates are currently at the lowest they have been during our lifetime.
If you have a savings account you will only be earning a paltry rate of 2% to 3% on your money if you are lucky.
But it seems as though the credit card companies are living on a different planet to the rest of us.
If we borrow money from them on a credit card for long enough for it to flop over from one month to the next, then they charge us much higher rates of interest don’t they?
Their interest rates vary widely depending on the company, the type of card, your credit rating, etc.
I’ve been doing some research into this recently and I was shocked at what I found.
According to Index Credit Cards, the average consumer credit card rate in the USA is 16.94%, almost 17%.
In the UK, the average credit card rate is slightly higher at 17.3% according to the Bank Of England in its report in March 2012.
In Australia, the average is 17.44%, slightly higher again, according to the Reserve Bank of Australia.
How does this compare with your credit card(s)?
I have three:
- Card number 1 charges me 21.44% interest on outstanding balances
- Card number 2 charges me 1.313% per month i.e. 16.78% per year
- Card number 3 charges me 16.9% per year
So mine are more or less in line with the average, what about yours?
And that means that any credit card balance that I carry over from one month to the next is going to cost me 16.78% to 21.44% to maintain.
If that is not an incentive to reduce and eradicate credit card balances, I don’t know what is.
Time To FLIP The Discussion!
So far, I’ve been talking about credit card interest rates as a cost.
That’s because this is interest that you PAY a bank instead of EARNING interest from a bank.
But what if you were to reduce your credit card debt balance so that you did not have any outstanding balance from month to month.
Every $100 that you pay off will save you circa 17% of interest every year.
That is like having a bank account that PAYS YOU 17% interest on your savings.
In other words, every $100 that you pay off your credit card balance will create another $17 every year that you can invest properly into stocks and shares.
And as your balance falls, month on month, it will cost you less to maintain.
Which means that you will be able to pay off more and more each month.
Which means that your debt reduction will accelerate.
Which means that the money you free up to buy shares with will accelerate.
Which means that your share portfolio and returns from it will accelerate.
This is compounding working for you now rather than against you as it was before.
Keep it up and you will soon become a Debt-Free Investor.
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