Rate comparison
Debt payoff vs. investing: how to think about the tradeoff
When debt interest exceeds expected investment returns (typically 7-8% real), pay debt first; below that, invest. Always capture employer 401(k) match before any other goal — it's an instant 50-100% return. High-interest debt (credit cards, payday loans) almost always loses to debt payoff. Behavioural factors matter too: paying off debt feels permanent, while market gains can vanish in a downturn.
Level
Try calculatorKey takeaways
04 · ideas- The math centers on comparing after-tax debt rate to expected after-tax investment return
- High-rate debt (credit cards, payday loans) typically has a clear mathematical case
- Tax-advantaged investing (401k match, Roth IRA) changes the comparison
- Risk tolerance and behavioral factors matter alongside the numbers
When you have surplus income each month, two common uses are paying down debt faster or investing. The decision involves comparing the guaranteed cost of debt (the interest rate you pay) with the uncertain return from investing.
The basic framework:- The "return" from paying down debt equals the interest rate on that debt — it is guaranteed and risk-free
- Investment returns are uncertain and vary over time
A 7% mortgage rate means extra payments provide a guaranteed 7% "return" (interest savings). A stock portfolio has historically averaged 7-10% annually, but with significant year-to-year variability.
High-interest debt: When debt carries a rate significantly above typical investment returns, the mathematical case for prioritizing payoff is more straightforward. Credit card rates of 20-25% represent a very high guaranteed return from payoff.