Financial management is an essential aspect of being a successful and wealthy person in Australia. In most cases, many individuals find themselves in a situation where they have enough money in their savings and need to choose whether to settle outstanding debts or invest in shares. While this decision may seem simple to some people, many financial advisors give contradicting suggestions.
This guide will help you understand how to choose which debts to tackle first and how to invest in shares effectively. By doing this, you will learn how to handle different financial issues to build a strong financial foundation in the future.
Table of Contents
Good Debts and Bad Debts
Not all debts can be termed the same since some are useful in building a long-term investment portfolio. For instance, a mortgage and HECS-HELP in Australia fall under good debts since they provide the opportunity to make significant wealth in the future. The interest rates are also relatively low compared to other financial products.
On the other hand, bad debts refer to borrowing from different sources for depreciated assets and basic expenditures. Such financial products include credit cards, personal loans, and online car loans from ING and others. It is easier to lose money when dealing with such financial products since the interest rates increase much faster than any potential gains.
As a rule of thumb, one should always pay off their bad debts before starting to invest. For example, paying off credit cards with interest rates of eighteen percent would guarantee you an eighteen percent profit in the process. There is no way of making this type of gain from traditional investments in Australia.
Long-Term Investments and Compounding Returns
After sorting your debts, the next important thing would be to begin investing. Most investors know how important long-term investing is due to compounding returns. Essentially, when the investments make profits, the earnings are automatically invested to generate additional gains. After several years, the initial capital becomes very valuable.
Waiting until you are debt-free to start investing might be costly. If you invest all resources to settle a low-interest mortgage for twenty years, you might lose their opportunity to benefit from the market during this period. Small amounts can become a significant fortune after several decades when invested wisely.
Balancing Your Assets and Liabilities
It might be challenging to balance the liabilities and assets effectively. However, it is possible to do so by prioritising settling debts whose interest rates exceed the expected gains from the market. For instance, if you anticipate making seven percent returns from the share market, then the best decision would be to clear any loan above the seven percent mark.
When the interest rates are lower than expected gains, the next course of action would be to allocate funds towards both activities. One could settle a portion of the debt and invest the remaining amount in the market to generate extra cash. This way, the individual will not only reduce the liabilities but also allow the gains to compound.
How to Become Financially Independent
Dealing with financial resources does not mean that one has to sacrifice something to enjoy the benefits in the future. Individuals can take measures to actively reduce their liabilities while increasing their investment portfolios. For instance, one could examine their current interest rates, determine their risk tolerance levels, and plan their actions accordingly.