When you finance credit card balances, your cost of financing will normally be much higher than the return you may receive on any market investments that you hold. You should always pay off any balance on credit cards before you invest funds anywhere else.
In general, avoid carrying a balance on your credit cards when you have the money to pay the balance. The likely return that you might earn from investing your money is usually less than the financing rate that you will be charged when you delay paying your credit card bills in full. Debit cards are a good alternative to credit cards because they offer the same convenience of not holding cash.
Some individuals use their money to invest in risky investments (such as stocks) rather than pay off their credit card bills. They apparently believe that their return from the investments will be higher than the cost of financing. Although some investments have generated large returns in specific years, it is difficult to earn returns that consistently exceed the high costs of financing with credit cards. If the thrill of a good return on your investment makes you think about delaying your credit card payment, consider the following logic. When you use money to pay your credit card bill immediately, you are preventing a charge of about 36% interest or more. Therefore, you have effectively increased your savings by 36% by using these funds to pay off the credit card debt.
Sonal just received a credit card bill for Rs 11,000. Assuming, the credit card issuing bank charges a 36% annual interest rate on the outstanding balance. Sonal has sufficient funds in her savings account to pay the credit card bill, but she is considering financing her payment. If she pays Rs 1,000 toward the credit card bill and finances the remaining Rs 10,000 for one year, she will incur interest expenses of:
Interest = Loan Amount * Interest Rate
=Rs 10,000 * 36%
= Rs 3,600
She could use the Rs 10,000 to invest in stocks or equity mutual fund scheme rather than pay off her credit card bill. After one year, the Rs 10,000 in stock market or an equity mutual fund scheme, may accumulate to Rs 11,200 based on a 12% annual return, as shown here:
Return Earned on Investment = Initial Investment * Expected Rate of Return
= Rs 10,000 * 12%
= Rs 1,200
Her interest owed on the credit card loan (Rs 3,600) exceeds the interest earned on the investment (Rs 1,200) in one year by Rs 2,400. Sonal, decides that she would be better off using her cash to pay off the credit card bill immediately. By using her money to cover the credit card bill, she gives up the opportunity to earn 12% on that money, but she also avoids the 36% rate charged on the credit card loan. Thus, her wealth is Rs 2,400 higher as a result of using funds to pay off the credit card bill rather than investing in stock market or equity mutual fund scheme.
Although she could have used the funds to invest in a high-risk investment that might achieve a greater return, paying off the credit card guarantees that she can avoid a 36% financing rate.
If your cash inflows are not sufficient to cover your credit card bill, you should pull funds from savings (if there is no penalty for withdrawal) to cover the payment.