Inflation Protection: Pay Off Variable Interest Debts!
This is much more personal finance strategy than investment strategy, but I came to this realization recently and thought it good to share it. I'm sure many of us struggle with whether we should pay off debts or invest. Most of us are not filthy rich, so we must often choose whether to pay down debts or invest the little extra free cash flow that we have.
If you've seen any money supply charts recently, the recent money expansion is disgusting. We have yet to see those effects, but the potential is there. Just as recently as 2007, when inflation wasn't crazy, I had one private student loan in particular that was as high as 8.75%. It's currently sitting at 3.25%, but even modest inflation would push it way higher again.
I look at TIP, which currently yields 3.84%. This is not much higher than my student loan. TIP would obviously yield more if inflation went up, but my student loan rate would also go way up. For now, I'm going to assume that the tax disadvantages of TIP (capital gains!) and tax disadvantages of paying off a student loan early somewhat cancel out.
What is the allure of TIPS? It's mainly the idea of guaranteed yield, right? Even if inflation goes up, you do get a degree of protection as the interest rate gets readjusted periodically. I believe that paying off any variable interest debt is more appealing. Even with my currently low private student loan, paying it off is like inflation protection. The rate will go way up if inflation hits, so any money sent there is sorta like buying TIPS, except that you get the added psychological bonus of paying off debts.
The choice is much more obvious with my 7.9% Bank of America card. It was a fixed rate for a long time until a few months ago, when Bank of America finally screwed me by making the rate variable (No, I wasn't surprised). Until recently, I was content investing extra cash flow instead of sending it to my 7.9% card, since I believe I can beat 7.9% with my investments. Now that the rate has turned variable, I will strongly consider sending a chunk of extra FCF to this particular debt instead.
Basically, here's my new investment/debt repayment pecking order:
1. Invest in tax-deferred investment accounts
2. Pay off variable interest debt
3. Invest in taxable accounts
4. Pay off fixed interest debt
Thoughts? I'm sure some of you do this already.