Debts

Some debts can deal a killing blow to your investment plan especially those related to credit cards or those which have very high interest charges. It’s advisable to clear those off FIRST before you put your money elsewhere. For example, if your debt’s interest rate is like 4-5%, but your FD return is only 2%, it means you’re actually losing money than earning money. If you can pump money into both sides, then fine. Just be sure never to neglect the former for the latter. Focus on how to stop losing money, then only to how to earn more money.

Insurance

This is equally important. Life insurance and medical insurance are very very important. I can’t stress this enough. There are people who only focus on how to grow their money that they neglect these 2. And when they’re hit with some issues which don’t allow them to work, their dependents will suffer since there’s no income. Or, when they’re hit with some serious illnesses but do not have the money to pay for their medical bills. In the end, they need to take out all their personal savings in order to pay for the medical bills. Yes, growing your money is important, but thinking about your dependents and the ability to keep you healthy are even more important (especially if your company does not give you a medical card). Look into what kind of life insurance you should buy here – How much insurance do you need?

Once you’ve given thoughts (and actions) to these 2, you can start planning the second step of your investment journey. Always remember that your investment journey will be greatly jeopardized if you are not able to generate income, or something else is draining your income away. So do take note. These 2 should be the FIRST thing you should look into while planning for your investment journey.

Definition of balance transfer (source: CreditWeb):

A balance transfer is an option offered by many credit card issuers which enables the card holder to use their available credit from one card to pay off the balances due on one or more other cards. Usually the interest rate on the amount borrowed is lower than the rate of the cards that are being paid off by the balance transfer.

I actually rejected the offer since I don’t have any balance left in my credit card statement and I only have 1 credit card with that bank. So it kinda defeat the purpose of using a balance transfer. Also, it does not make much sense to use it if you know how to control your spending and spend within your limit. No late payment, no interest charges. You can choose to consider balance transfer if the other credit card offers zero annual fee… but in times like this, that’s pretty unlikely since you will most probably cancel off your unused credit cards…. and forced to pay the annual fees for the remaining 1 or 2. I’m sure in 2010, the banks will do their best to attract more credit card applicants and waiving the annual fees can be one of the best attractions

Anyway, I must be honest with you all that when it comes to balance transfer, I’m pretty bad with it since I’ve never used it. So far, I’ve been quite disciplined and managed to pay off my balance every month (not much anyway) so I rarely get hit by the interest rate… thus no point for balance transfer.

Yes, balance transfer has its advantages and disadvantages. But if you know how to control your spending and how to pay off the balance on time EVERY MONTH, then I really don’t see a need to use it. So in the end, it drills down to one thing – controlling your spending.

Anyhow, this does not change the fact that most people still want to eliminate or reduce their debts, myself included. So I went online and did some research, and realized that there are basically 2 types of approaches in eliminating debts.

• Eliminate the one with highest interest rate
• Eliminate the one with the smallest outstanding balance

Each has its pros and cons. Mathematically speaking, the first option which is to eliminate the one with the highest interest rate would be a better option in order to eliminate the total outstanding amount.

For example, if you have the following debts or loans (just estimations and the interest rates might not sound realistic to you):

• Car loan – RM 50000 at 3%
• Study loan – RM 60000 at 4%
• House loan – RM 200000 at 5%
• Credit card balance – RM 2000 at 10%
• Computer installment – RM 3000 at 2%

If you were to use the first option (eliminate highest interest rate first), it will appear like this.

• Credit card balance – RM 2000 at 10%
• House loan – RM 200000 at 5%
• Study loan – RM 60000 at 4%
• Car loan – RM 50000 at 3%
• Computer installment – RM 3000 at 2%

But if you are going for the lowest outstanding balance first, it will look like this

• Credit card balance – RM 2000 at 10%
• Computer installment – RM 3000 at 2%
• Car loan – RM 50000 at 3%
• Study loan – RM 60000 at 4%
• House loan – RM 200000 at 5%

If you are following the first option, one warning to you – you need to be a highly disciplined person and pay your loans on time EVERY TIME. Because if you don’t do that, you will incur more damages that you possibly wanted. And most importantly, you will start feeling demotivated because even with all the hard work and cost-saving things you’re doing, you are still unable to pay off anything completely. It is a very big psychological blow and it is the last thing you want while trying to clear your debts.

That’s why some experts recommend the second option and to remove the debts one by one COMPLETELY. Pay the minimum amount possible for all the other debts (in order to avoid getting extra interest charges), and pay more (whatever balance you can squeeze from your monthly income) to the one with the least amount. That way, you will feel more motivated especially if you can manage to remove 1 or 2 debts completely from the list. It is a very good psychological boost.

I am not sure whether this will work for everyone since it does force you to pay more than the traditional way of eliminating debts. But in a year when most experts are being pessimistic, having a shorter list of debts is always a good thing to have.

If you’re still unclear about what I’m explaining here, maybe the following link can help. After all, I did my research based on the link below.

Two Approaches to Debt Elimination

Hope it helps!