At the end of each year when bonuses are deposited, many workers face the recurring dilemma: Should they use this money to invest or to fully pay off their debts?
Many rely on feelings or comfort to decide, but financially, there is no single formula. Instead, there is a logical principle using the "accounting break-even point" to compare the interest you must pay against the expected profits to make the decision.
The “accounting break-even point” is a straightforward financial measure focusing on actual money received and paid. In managing a special lump sum, it’s the point where the "interest saved by paying off debt" equals the "returns earned from investing."
Therefore, setting aside emotions about which choice feels better, the core decision boils down to comparing two numbers: the investment return and the debt interest cost.
Paying off debt guarantees a return equal to the interest you avoid paying to the bank. Investing, however, offers uncertain returns that might be higher but also carries the risk of losing principal.
The decision formula hinges on comparing the “interest you must pay” against the “net returns from investment” as follows:
However, relying solely on the accounting break-even point risks overlooking the crucial factor of "risk," since investment returns are uncertain and principal can decline.
Kanya Siriwaradorn from the Government Pension Fund shared an article through the Stock Exchange of Thailand (SET Investnow). She stated that deciding to use money to pay off debt or invest should first consider one’s financial health, such as having sufficient emergency savings. Then, weigh the pros and cons of each choice to maximize benefits.
If your debt has a reducing balance interest rate and the rate is too high to beat with investment returns, you should use the lump sum to pay down debt. But if you’re confident you can earn investment returns higher than your debt interest, investing that money makes sense.
To clarify and provide better decision data, it’s important to classify debt, as each debt has a different “cost.”
: Krungsri Bank (Bank of Ayudhya) Public Company Limited has categorized debt by urgency level to help prioritize and manage debt more effectively, with the following recommendations:
1. High-interest debt (red zone) such as credit cards, personal loans, and cash cards. These are typically short-term debts under 5 years but come with penalties up to 16% interest if unpaid. Therefore, paying off these debts first is advised.
2. Medium-interest debt (yellow zone) such as student loans and business loans. These are usually medium-term debts. Paying these off early reduces interest burden, freeing up monthly cash for other uses.
3. Low-interest debt (green zone) such as home equity loans, which have low interest and long repayment terms up to 30 years. You can use lump sums to pay off other debts to increase liquidity, and if money remains, invest further.
Thus, if you have green zone debts like mortgages with low interest and long terms, you might allocate some money to pay off other debts to improve liquidity and invest the remainder.
But if your debts fall in the red or yellow zones, you should prioritize clearing them first because of their high interest. Paying off these debts reduces monthly expenses and prepares you to invest more confidently in the future.
Follow personal finance and financial planning news with Thairath Money to help you achieve “Good Finances, Good Life.”https://www.thairath.co.th/money/personal_finance
Follow the Facebook page: Thairath Money at the link below.https://www.facebook.com/ThairathMoney