Should I Invest or Pay Down Debt?

By | 2016-08-01

Should I invest or pay down debt? I have had this question come in through a few emails and it always comes up in personal finance conversations.

Before we get to far into the question itself, I want to highlight that simply asking this question shows that you are on the right path. If you aren’t asking this question you are likely adding to your debt while simultaneously not investing. Even though the personal finance community is split on this question, we all agree that doing neither is 100% wrong.

What about savings? I purposefully chose the word invest over save for this title. Excluding our Emergency Fund, saving and investing are the same word in our house. We aren’t stockpiling cash at the moment so all of our savings are invested.

Read on if you want to see how I breakdown the “Invest or pay down debt” question.

Should I Invest or Pay Down Debt-

Benefits of Paying Down Debt

  • Emergency Planning – Less debt = More secure. As you drop your debt levels building your Emergency Fund and creating your Emergency Plan become a lot easier. The more mandatory payments you can chop off the less you need in your fund.
  • Interest – An obvious benefit is you wont be wasting more money on interest payments. Use an interest calculator to figure out how much interest you will pay over time (google “how much interest will I pay” if you aren’t familiar with these calculators). You can see the savings by paying extra by increasing the monthly payment.
  • Freedom – Since we still have a decent amount of debt, I can’t fully speak to how freeing being debt free is. But I know of other personal finance bloggers that have celebrated this milestone and will never go back to having debt.


Benefits of Investing

  • Financial Independence – Investing is the clearest way to Financial Independence. The younger you start, the longer your stockpile can grow. It is incredibly difficult (if not impossible) for the average person to reach F.I. without investing.
  • Money works for you – Putting your money to work for you is the biggest benefit of investing. Harnessing the power of compound interest is a must.
  • Freedom- Yep, this one goes under both. Being Debt free is freedom from lenders. Investing and building a net worth is freedom from work.
  • Passive Income – Depending how you deploy your capital, you could create passive income channels that make you even less dependent on a full time job.


How to break down your situation

When deciding to invest or pay down debt consider these factors:

Interest Rates – One of the biggest factors you need to take into account is your interest rate. Credit card debt is a killer, most interest rates are above 15%. Anything over 5% should be targeted for debt payoff at an accelerated rate.

Years to retirement – This is a tricky one because both of these options have distinct benefits as you approach retirement. The longer your investments work for you, the more cash you will have at retirement. If you are 100% debt free you need a lot less money when you are retired (think no home payments).

Emergency Fund – Before you get to far down the Invest or Pay of Debt path, make sure you have an Emergency Fund you are personally comfortable with. I decided to fund my Emergency Fund while simultaneously paying off debt and investing. We were able to get away with this since our jobs were very stable and thought the rewards of investing outweighed the risk.

Investment Decisions – One of the most important factors is how you are going to allocate your money. You are trying to compare your interest payment versus investment gains. Personally I use the average expected return when making this decision. Unless you are invested in guaranteed returns, you will not be able to definitively state what your returns will be. While this is unsettling to think about, if you are invested long term you can expect to be in the same ballpark as historical averages.

Thinking Ahead – You situation could change at any time. Do you have large purchases coming up? Are you going to have kids? Do you plan on changing careers? Depending on the answer to these questions you may tweak your investing/debt payoff ratio.

A.E. Approach – Invest or Pay Down Debt

Before I break down what the A.E. approach, I want to say this may not be the best path for you and your family. This post is to get you thinking about your priorities, not taking my approach and making it your own.

Our current situation:

  • 3 open debt channels – Mortgage (4% interest rate), Student Loans (4.075%) and Car Loan (.9%)
  • Our Emergency Fund is almost fully funded (by end of 2016)
  • At least 10 Years to official retirement (hope to be out of the corporate world a lot sooner, but not officially retired)
  • We plan on having kids in the next few years
  • Since we are both under 30, we are on the aggressive side of investment portfolios

Given the above variables, we have decided to focus more on investing than paying off debt. The ratio of investing to accelerated debt payoff is around 10 to 1. We pay an extra $200 a month on my student loans to get rid of them slightly faster (they are a black mark on my financial record, and I cant wait to get rid of them).

The reasons behind the 10 to 1 approach are pretty simple:

  • Our interest rates are low enough that we can do better investing (all well under 5%)
  • Our jobs are very stable, so the monthly payments aren’t that daunting (for now)
  • We will focus on paying off our mortgage after we have built a massive nest egg
  • We do not plan any large expenses outside of having children in the next 5 years*

*We may start paying off my student loans faster when our next salary increase goes through, at one point the $1,000 a month payments will become more of a liability.

Take Aways

I don’t think there is an 100% right answer to this question. My recommendation would be to kill any debt over 5% then start splitting your money between investing and debt payoff at a ratio that is comfortable for you.

One over looked approach to getting rid of debt over 5% is consolidation (especially for student loans). Prior to my refinance Student Loans interest would have been above the 5% interest barrier.

For anyone with a mortgage, it might be time to look at refinancing as an option. Rates are really low right now and I will be looking into a refinance over the next 2 weeks to see if it makes sense for us.

Don’t leave money on the table, if you get an employer match on 401K investing is a no brainer over paying down debt up to the match limit.

What is your approach? Do you invest or pay down debt first?

22 thoughts on “Should I Invest or Pay Down Debt?

  1. The Green Swan

    I think your takeaways apply to my situation as well. We have a mortgage and car loan with rates under 4% and 2% respectively. Since we expect long term returns from investments around 8% we continue to focus on investments.

    Thanks for the detailed walk through!

    1. Apathy Ends Post author

      No problem Mr Swan – Same approach, I must be doing something right!

  2. Preston @thedrunkmillionaire

    Great discussion on a very popular question. Your right that there’s really not a correct answer for everyone’s situation. We focused entirely on debt after building the emergency fund and now invest a larger proportion of our incomes. Having a 4% interest rate on the mortgage certainty makes the decision harder!

    1. Apathy Ends Post author

      Yea, 4% isn’t a bad rate at all but you can get a better one right now if you are willing to refinance. Record lows!

  3. FinanceSuperhero

    Believe it or not, I go back and forth with regard to my thoughts on the investing/saving vs. paying down debt debate. Even when my wife and I opted to wipe out my student loan debt with an all-out, two month assault, part of me really wanted to invest the funds instead. In the long run, I’m happy with the choice we made, and as you said, doing what is in your perceived best interest is important.

    We still have a very small car loan floating around at a similar interest rate to yours, and I’m OK with that for now. Since I don’t get a company match, per se, because I participate in a teacher pension program, I’m trying to focus upon other tax-advantaged investment vehicles at this time. Once we have matched out those options for the year, I might get a little anxious to wipe out the car loan. We shall see.

    1. Apathy Ends Post author

      I remember when you wiped them out!

      Sometimes I think wiping out debt really quickly makes sense – just can’t get over the thought of missing out on market run (especially the one we just saw)

  4. Dividends Down Under

    Hey AE, I completely agree with your thought process behind how you came to your decision. When interest rates are so low, why pay more than you need to at this point?

    Your investments could pay for your interest, I’d make that same choice!


    1. Apathy Ends Post author

      Thanks Tristan – Starting to think the PF community might be leaning more towards investing instead of debt payoff based on these comments

  5. Mr. PIE

    Oh my, we have gone back and forth on this one!!

    We paid off our vacation home last year and the simple reason is that it is going to be our FIRE home in 2 years. Starting our new life with no mortgage is going to be that awesome feel good feeling come 2018. Nothing fancier than that.

    I can also say we took advantage of multiple refinances on our primary home over the years. Often with very low to zero closing costs.

    1. Apathy Ends Post author

      Do you have a post on your refinance experience with any tips?? I am new to the process

      paying off a FIRE home makes a lot of sense to me, as we get closer to FIRE we will be looking to cut as many payments as possible

  6. Jon @ Be Net Worthy

    AE, good thought process above. It really is a different decision based on everyone’s situation and preferences. I would just recommend that people take tax considerations into account.

    If you put some money into a 401k or IRA, even without a company match, you’re automatically making a 20% or 28% return the first year since you are not paying taxes (insert your marginal tax rate). That could make a big difference in building your net worth over time.

    1. Apathy Ends Post author

      Very good point Jon,

      Tax considerations are often overlooked and since we actually ended up with a tax bill last year we have increased our pre tax contributions considerably.

      Appreciate the advice!

  7. Dollar Engineer

    Nice breakdown here AE, and in many instances this decision just comes down to the math and your tolerance for the risk of your investments. Awesome job so far and sounds like you are well on track!

    1. Apathy Ends Post author

      Thanks Dollar Engineer – appreciate the comment

      Risk tolerance plays a lot into this, if you aren’t willing to invest the bulk of your money in the stock market or comparable risk investments, the interest rate percentage drops

  8. DW @ GreatPassiveIncomeIdeas

    I’m totally with you on killing debt over 5%. Anything less than that I can live with because I’m likely making more than that with my investments over the long haul average. I’m always amazed at how many people do not look into debt consolidation for their higher expenses. It’s not too hard to qualify and it can save literally thousands off your total expense.

  9. Z
    ZJ Thorne

    I like your 10:1 approach for debts under 5%. I definitely chose to start investing last year even though many of my debts are over 5%, because I needed to start somewhere. Seeing my investments grow is psychologically helpful in a way that seeing my debts decrease isn’t. Now that I at least got my investments started, I’m back to focusing on debts, because that is sensible in my situation.

  10. Gail

    I’ve always struggled with answering that question myself. With $40,000 dollars worth of school debt, and a burning desire to save for retirement, I try my best to do both. I’m only 26 so I know that by starting now, my money will have more time to grow so it’s important that I at least invest SOMETHING. I also can’t wait to get rid of the school debt as quickly as possible, but I think investing is worth slowing my progress down at least a bit. Thanks for the great post AE!

  11. Abandoned Cubicle

    I have a 5-1 ARM at 2.625%, allowing us to let the mortgage marinate while we purchase investment properties. In 2020, the fixed rate ends, so we’re planning to pay off the mortgage then.

  12. Roadrunner

    Our mortgage is currently 1.9%, fixed for nearly 10 more years, so for me it’s no question that I rather invest. What you should also consider is the condition of your mortgage. If you can pay it off without any or much penalty, that’s another extra reason for investing. Should you ever change your mind, you can always use your investments to kill your mortgage.

  13. JT Smith

    The main benefit to paying off your house is cash flow. Even though your house might only have a 3% interest rate, it locks up a significant portion of your cash flow. Let’s say you pay $1,000 a month in your house and after making all other mandatory payments your free cash flow is only $1,000. Paying off that house means you double your free cash flow, which makes you a flexible machine and allows you to handle any expense or unique investment opportunity that comes your way.

    1. Apathy Ends Post author

      That is a fair point on the cash flow, but it also locks up the bulk of your money in an illiquid asset.

      We will tackle our mortgage as we get closer to retirement – but right now I prefer to build an investment portfolio


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