Should You Invest or Pay Down Debt?

October 2, 2015

Should You Invest or Pay Down Debt

When you’re young and burdened by debt, making the decision between debt repaying versus investing may seem impossible. How can you invest if all of your extra money goes to debt repayment?

While deciding what to do with any extra savings can be tough, it is possible to manage competing financial priorities. Here’s what to consider when answering the question of investing or paying down debt.

All Debt Is Not Created Equal

Having debt keeps you tied to monthly payment, and that can hamper your ability to use money to achieve other goals. But not all debt is created equal.

Take a look at these different types of debt:

  • Car loans
  • Credit card debt
  • Student loan debt 
  • Health-care related debt 
  • Home mortgage or home equity loan

You need to evaluate what type of debt you have, your debts’ interest rates, if any repayment plans are available, and what can and can’t be discharged in bankruptcy to help you make an informed decision on what to focus on.

What to Consider When Creating a Balanced Plan

Once you have a clear picture of your debt situation, you can start working on a plan to balance repayment with investing. You also want to think about:

  • How much you owe: If you owe over $20,000, it may not make sense to target your extra money strictly to debt repayment. Depending on your salary, it could take a long time to repay debt. If you’re only focusing on this debt, you’ll miss out on a lot of time and opportunity to build wealth by investing.
  • Interest rate: Credit card debt usually has the highest interest rates out of any other debt. If your interest rate is any higher than 10%, consider aggressively trying to pay off that debt first. While all of your debt will accrue interest, a 27% interest rate on $5,000 worth of debt is alarming compared to 4% interest on a $10,000 debt.
  • Any programs to help you repay debt: Student loan debt in particular has a variety of programs to help you repay debt in a manageable way. If you’re struggling to pay off your student loan debt, work in public service or as a teacher in a low-income area, you may qualify for several different government repayment programs. Check out Income Based Repayment, Pay-As-You-Earn, the Public Service Loan Forgiveness program, and the Teacher Loan Forgiveness program.

How to Incorporate Investing into Your Financial Priorities

If you have significant debt, you may feel like repaying your debt will take forever and at the expense of other priorities. It doesn’t have to be that way! 

One strategy for paying off debt while still investing is to allocate different percentages of your income to different goals. This strategy allows you to pay for essentials, address your need to invest for the future, and make progress toward debt. Here’s an example of how this could break down:

  • 50% of your take-home pay can go to essential expenses, like housing, utilities, transportation, and groceries.
  • 20% of your take-home pay can go to discretionary spending and cash savings.
  • 15% of your take-home pay can go toward investments.
  • 15% of your take-home pay can go toward debt repayment.

This rule is just one way to look at how you can manage both investing and debt repayment. Breaking down your income and allocating it this way allows you to make progress on paying down your debt while also building wealth via investing. 

It’s important to find ways to balance both these financial priorities. While debt isn’t ideal and you may feel pressured to get rid of it as soon as possible, you don’t want to get stuck “racing to zero.” This means focusing only on getting out of the red — and ignoring the need to build up assets.

You Should Invest Strategically

One more thing to think about: when you’re trying to manage both investing and debt repayment, it’s important that you’re making the most of your investment dollars since it comes at the cost of paying off debt. If you can take advantage of a 401(k), make sure you do so. Contribute at least enough to get your company match if one is available.

A 401(k) is a good tool for investing because your contributions are tax deferred. That means you pay taxes when you withdraw the money, and not in the year you make the contribution. The tax savings may allow you to save more each year.

(Self-employed? Try using a SEP IRA or Solo 401(k) to reap similar benefits.)

Investing vs. Repaying Debt Doesn’t Have to Be an End-All, Be-All Choice

Tackling debt is incredibly important, but you can manage multiple goals at once. If you feel like you just can’t divert a little income to investing, remember the power of compound interest. Rather than focusing on racing to $0 debt, you can and should consider investing while repaying debt. By thinking strategically, you can pursue multiple financial priorities at once.

If you enjoyed this post, you’ll love free access to more content from The Money Guys. Click here to learn more and join the community!



Most Recent Episodes

How to Recover From 4 HORRIBLE Financial Mistakes!

In our nearly four decades of combined experience managing money, we’ve seen some horrible financial mistakes - here are the four worst we’ve seen first-hand and what you can do to avoid making a similar mistake. In this episode, you’ll learn: The worst financial...

Why Americans Are Actually Broke! (2023 Edition)

Americans might be bad with money, but you don’t have to be. In this episode, we discuss the underlying reason why Americans are so bad with money and how you can do it better. In this episode, you’ll learn: Common financial pitfalls you should avoid Practical steps...

Build Wealth With the 3 Bucket Strategy! (By Age) 2023 Edition

We believe there are three distinct taxable buckets you have the option of investing in for retirement. We’ll talk about how to balance those buckets by age and show a case study by age that shows what your buckets may look like! In this episode, you’ll learn: The...

Debt Ceiling Crisis: World’s Financial System at Risk?

Should you be worried about the debt ceiling crisis? Although political leaders have so far been unable to come to an agreement, we'll tell you what history says will happen and what it means for your finances. For more information, check out our free resources...

Financial Advisors React to INSANE Money Advice on TikTok!

Is financial advice on TikTok all bad or is there some good advice out there? Check out our brand new TikTok react show where Brian and Bo give their honest reactions to trending financial advice. Enjoy the Show? Sign up for the Financial Order of Operation (FOO)...

How to Save Thousands of Dollars in Taxes in 2024

Tax season is over for most of us, but that doesn’t mean it’s time to stop thinking about your taxes! Planning out your tax strategy in advance can save you time and money on your taxes. In this Q&A, we’ll discuss the line items on your return to pay attention to...

Average 401(k) Balance by Age (2023 Edition)

Are you doing better than the average American at saving in your 401(k)? We'll talk about basics of a 401(k), including new limits, employer matches, and vesting schedules, how many millionaires are created by 401(k)s, and of course the average 401(k) balance by age....

TikTok Products That Are Actually Worth the Money!

TikTok has become not only a popular social media platform, but a popular place to find trending new products. Are any of them actually worth it? Let’s find out!   For more information on how to make the most out of your financial life, check out our free...

The Dark Side of Being an American Millionaire! (2023 Edition)

Being a millionaire isn't always sunshine and rainbows in 2023. In this episode, we'll discuss some common pitfalls and traps millionaires fall into, shock-and-awe stats, and how you can handle your money even better than a millionaire. In this episode, you’ll learn:...