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Should You Pay Off Debt or Invest in the Stock Market First?

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If you have debt, you may be wondering what to do first: pay off debt, or invest? Here's a little advice that will help.

Almost daily, two ideas swirl about the personal finance sphere – paying off debt as soon as possible and the importance of compound interest. Not always the most exciting of topics, I know, but both are very important and relevant at varying degrees for most of us. To a lesser extent though, we deal with what should be done if you have both debt (I am speaking of any non-mortgage debt here) and are balancing that with investing in the stock market.

In my previous life, I saw individuals on either end of the extreme and few that struck a balanced chord with the pay off debt vs. investing debate. As this can be an issue that many face, I’m including this in my how to invest in stocks series. If you ‘d like to check out some of the previous posts in this series, you can click on the links below:

 

The Case to Pay Off Debt First

 

I hate debt! Debt can be burdensome, taking years to pay off – especially when you’re dealing with credit card debt or student loans. When I reflect on my journey to pay off debt, I still get a bitter taste in my mouth thinking of all those years I made monthly payments towards my credit cards. It took me nearly five years to pay off the $25,000 I owed and several years more to pay off my student loans.

Sadly, I know that I am not the only one who has been in this situation of needing to pay off debt as I know many of us have been in this spot, or are still in it, and want to do all we can to pay it off. If you’re like me, you likely attacked the debt with all you had – looking for ways to cut expenses, earn extra money and throw all you had at the debt. In short, it’s a laser like focus that is often needed to pay off debt in order to achieve success.

Ultimately, when you’re struggling with debt, you’re not really “free” financially. You always have someone that you’re obligated to. Whether it be payments towards your credit card or towards student loans you’re held back from doing all or some of the things in life you want because you owe someone money. That being held back, and the potential thousands you can save in interest costs is a great reason to focus on paying off debt first.

 

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The Case to Invest in the Stock Market First

 

While the journey to pay off debt does generally take years to accomplish, the very same adage is true for investing in the stock market with an eye towards saving for retirement. Unless you wake up some morning swimming in a pool of cash, you’ll likely need years to invest in the stock market to build up a portfolio of any worth. A common argument for those in the “pay-off-debt-first” camp is that they can’t afford to invest. I’ll cede that, to a certain extent, as you need to be throwing as much as you can towards your obligations to make a considerable dent in the debt beast.

However, is that reason enough to give up investing in the stock market altogether? I think not. Let’s take a look at the easiest and best option at getting started at investing and saving for retirement – a 401(k). I’ve spoken with countless people who were in debt that would not even invest in their 401(k) plan because they felt that everything had to go towards the debt. The key here is to not cut off our nose to spite our face. In most 401k plans you’ll likely get a match of some sort. That’s FREE money people, I can’t think of any better form of money! Add to that its ability to lower your taxable income and 401(k) plans get a double bonus in my book.

If you have debt, you might be wondering if you should pay off debt first, or invest. Here's some advice on the matter.

Is There an Easy Answer?

 

Unfortunately when it comes to the issue of what you should do first – pay off debt or invest in the stock market, there generally is no easy answer; it really is a personal decision. Speaking for myself, I put so much focus on trying to get out of debt that being in the stock market went by the wayside for almost five years. Looking back, I still kick myself for handling it that way. Of course, hindsight is 20/20, but I see it as missing out on five years that I could’ve been growing my money, albeit in small amounts.

I know the argument can be made that I was growing my money by paying off debt first, but I was not actively saving for retirement. That lost time is not time I can get back. While I can do things like put more money away now, that will not make up for the time that I lost. As opposed to throwing everything I had at my debt, I wish that I would’ve taken a more balanced approach to the issue. While it would’ve likely added a number of months to my debt repayment, it also would’ve started my investing clock earlier.

Ultimately, though, there is no real easy answer in regards to paying off debt or investing and what should be done first. I would tend to say a balanced approach is best, though that is going to vary for each individual circumstance.

 

What’s your take? Would you pay off debt or invest first? Have you been in this situation and if so what did you do?

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I'm the founder of Frugal Rules, a Dad, husband and veteran of the financial services industry. I'm passionate about helping people learn from my mistakes so that they can enjoy the freedom that comes from living frugally. I'm also a freelance writer, and regularly contribute to GoBankingRates, Investopedia, Lending Tree and more. If you're wanting to learn how to monetize your blog, check out my blog coaching services to see how I can help you take your site to the next level.

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82 Comments

  • Pauline says:

    I have some debt with heavy penalties if you repay early and a low interest so would rather keep it and invest instead. For the peace of mind I’d like to be completely debt free but the numbers make more sense keeping the debt.

  • If you have card debt which is on high interest rates, then surely you should be paying these down as a matter of priority. Say you have a card at 25%+ then where can you get an investment return like that ? for me the stock market route is way to risky – what would you do if the market moves against you ? your just stuck in debt for longer.
    Suck it up – pay it off

    • John says:

      I would agree that if you do have a lot of credit card debt that you really need to be focusing on paying it off. That said, I think both can be done, even if it’s in a 401k. If the plan offers a match you get the free money, lower your taxable consequence, be able to invest and still pay off debt.

  • I am a cheerleader for prioritizing your debt. But it really depends on your personality. If you can commit to a plan to pay off your debt, while investing, then it’s a great way to get ahead. Even a tiny bit socked away will go a long way in a retirement account.

    • John says:

      I agree Taynia, I tend to prioritize debt as well. That said, I also agree that both can be done if you’re committed to it – which can be the difficult part.

  • I would say do both. I currently am paying down student loans but also contributing to my 401k. I don’t see why they can’t both be done at the same time.

    • John says:

      That’s exactly what I am talking about DC, both can be done. With the free money in a 401k match it just doesn’t make sense to pass it up.

  • I like to took at both as investing. When you think about it, paying off your debt really is investing in your future. Yes you aren’t seeing an asset appreciate in value, but you are investing in a better financial future by paying off your debt. Whatever your interest rate is on your debt, that is essentially your return. So if you pay off debt that carried an interest rate of 8%, then you received an 8% return on your money.

    As for which one to do first, for most people I would say to pay off the debt. Too many people wouldn’t follow through and invest the money on a recurring basis. They might for a month or two, buy then they would see something and buy it instead of investing.

    • John says:

      Those are all great points Jon and I agree about the return you’re getting from paying off the debt and many will not be committed enough to do both. That said, I think they still can be done if you go through a 401k. If you get the match then it just doesn’t make sense to pass up the free money in my book.

  • I’m of the same school of thought as Jon – paying off debt is essentially a risk free investment. If you pay off a debt with a 8% interest rate, you’ve essentially made 8% after tax on your money guaranteed. The only risk is that the interest rate might go down or you might miss out on another investment opportunity because of it. I’d pay off the debt, then start building investments

    • John says:

      Jon did have a good point and I agree about the return as well. That said, I think both can still be done if you have access to a 401k and they offer a match. It just doesn’t make any sense to me to turn down free money.

  • Matt Becker says:

    I think a balanced approach can definitely be beneficial, similar to Grayson’s argument for building an emergency fund while paying off debt. But I also agree with Jon’s point about viewing debt payoff as an investment. Investing for an 8% return while putting off your debt payments at 15% is not a good financial move, even if it might feel good to “get started” investing. There’s definitely a math involved and sometimes that will strongly argue for one over the other. But if the math puts them at a relatively equivalent place, then I think a balanced approach can work well.

    • John says:

      I agree Matt, that balance is crucial and you do have to look at the numbers. That said, I would still recommend contributing to a 401k (assuming you have access to one & they offer a match). Too many overlook that as an option and if they’re leaving free money on the table it just makes no sense in my book.

  • While it can be boring, paying off debt is one of the best investments that you can make for at least two very good reasons.
    First, when you pay off debt, your rate of return is guaranteed – it equals the interest rate you are paying on that debt. Plain and simple
    Second, when dealing with high rate interest debt (like many credit cards), the long term average rates of return on other investments pale in comparison.
    Where else can you get a guaranteed, very high rate of return? Nowhere. From a numbers perspective, paying off debt is normally a much better thing to do.

    • John says:

      I agree that it is often the best route to take (especially when credit cards are in question), but balance is also required. If you have access to a 401k and they offer a match it just makes no sense, in my opinion, to leave that on the table.

      • Good point, John. A matching 401(k) contribution would be irresistible under most any circumstance. I totally agree with you there. In Canada however, contribution matching to Registered Retirement Savings Plans (the equivalent of the 401k in the United States) is rather uncommon. Most employers opt for a defined contribution plan that is independent from your own contribution levels. If only …

        • John says:

          That’s interesting. I did not know that the RRSP is generally not matched. It would be tougher, in that case, to say definitely do both. Thanks for teaching me something new today. 🙂

  • We still invested when we were paying off debt. However, I definitely swing toward paying off debt first, especially high interest debt.

  • I think you should pay off debt first, just so you don’t have to worry on it the next time around. It can also help you give more time and focus on your investments.

    • John says:

      That’s the thing Mark, you’re actually losing time if you don’t invest. Why not still focus all you can on the debt payoff and contribute to your 401k, if you have access to one, and you can work on both.

  • Ouch. SOmeone doesn’t like Dave Ramsey! Either way, pay off debt. Period.

    • John says:

      Respectfully Tony, I did not say that at all. I said it depends on the situation and is personal. 🙂 Yes, if you’re wallowing in credit card debt then you need to be throwing all you can at it. However, I’d still take the 401k match every day of the week. 401k match = free money. You can do both, it just requires some balance.

  • AverageJoe says:

    I’m with you, John: look at all of the factors first, especially the cost of your goals. It probably makes the most sense to split somewhere down the middle, saving what you need for your long term goals while using the rest to mop up your debt.

    I just thought of this, but many people I’ve met look at this one of two ways:

    – Have fun today and pay off debt
    – Have fun today and invest

    There is a third way:

    – Invest today and pay off debt today. Have WAY more fun once you’re out of debt.

    • John says:

      Right on Joe! I think both can be done, in many cases, you just have to be committed to it. At the very least you can invest through your 401k which, if you get a match, gives you free money and lowers your taxable consequence.

  • I took on debt to invest. I will carry “debt” so long as I live. Technically speaking though, It’s quasi debt. I’m borrowing against my investments to buy more investments! So there is a negative cash balance in the account, but the market value is decidedly not. There are interest charges on the negative portion, just like a line of credit. If I liquidated everything, I could pay it off by the time the stock market opens.

    It’s all a function of what returns you can generate vs how much it costs to borrow. Quite simply, just a business expense.

    People may think I’m crazy, but many people out there do the same thing with houses. Houses will always be worth more right? Uhhhh… Detroit much?

    While my lifestyle ranges from “hair-pulling” up to “uncomfortable”, I’ve had very little work, yet my investment activities permit me to afford to feed, clothe, and house my family.

  • For me, its a purely financial and mathematical decision!

    Paying off debt equates to an investment at a risk-free rate of the percentage interest you pay on your debt. This should be compared to the expected returns from the market, which is a risk-inclusive rate.

    If the difference between these exceeds your risk adversity, then invest the money in the market.

    Usually, paying off debt would win. However, in these times of very low interest rates, then there could be an argument for investing before paying off very low interest mortgage or student loan debts. For me personally, these would currently have to be below 3% for me to be interested.

    You must also factor in the tax impact in saving in ISAs (UK) or 401k (US) or any other tax free equivalent and employee matches.

    Finally, I think that paying off the debt is probably also beneficial from a psychological perspective.

    • John says:

      I agree that math is a must with this decision and should be personal in nature in terms of what rate you’re comfortable with carrying in terms of debt. I also whole-heartedly agree that the mental impact of paying off debt, especially consumer debt, can be huge.

      That said, I think if you do have access to the tax impact and free money of a 401k match, then you really do need to seriously look at that as you don’t watch to leave free money on the table.

  • Prioritizing debts and investments is soooo important. I can’t say I have any low interest debts where the interest paid would be less than what’s earned on an investment so, I’d have to pay off debts. However, I did start an investment account recently with a small amount just to get the ball rolling. Thanks for the great post!

  • I have a good amount of student loan debt but they are low interest. I strongly feel that even if you have somd debt, you should start investing, even a little bit. If you have a lot of high interest credit card debt, maybe that’s a different story. Otherwise, I think you can balance debt payoff and investing at the same time.

  • Michelle says:

    I think it all depends. If you have low interest debt, then you probably don’t need to pay it off. I hated having my student loans because most of them were above 6%, so I got rid of them as fast as I could.

  • The importance of establishing investment accounts (retirement or otherwise) early as possible cannot be overstated. Then again, neither can paying off debt. Therefore, my recommended approach in most situations is to do both, particularly if the individual currently does not have any investment accounts. I believe it makes perfect sense to open an investment account and make at least a nominal contribution to get started. I believe that provides an important psychological lift that the individual is finally being proactive with regards to investing/preparing for retirement. With that simple act accomplished, the person can continue to make small contributions $25, $30) on a monthly basis while they focus the rest of their efforts and money on the debt.

  • I think it’s important to do both. You might think you are going to pay off the debt first and won’t invest anything for only a short time, but I believe only a very small percentage of people actually throw everything toward the debt. The guy who paid off his Harvard student loans in a couple of years comes to mind. If you are going that route, I think it’s Ok to take a short while to pay off the debt and be done with it. Most of us, though, are going to go shopping or on a trip or out to eat, and that’s money you’ll never get back. At least invest if you get a match. Declining that is like saying you don’t want a raise. Not smart in almost all cases.

  • I’m a debt hawk, so in general I’d opt for paying off debt before buying stocks. Especially before buying stocks. 🙂 I see repaying debt as equivalent to making an investment with a risk-free, guaranteed after-tax return equal to the APR on the debt I’m repaying. That sort of investment can look mighty appealing in many investment environments, like the current one, in my opinion. And then there’s the freedom of paying off debt. It’s intangible, and of differing value to different people, but that freedom means a lot to me.

    • John says:

      Right on about the freedom that comes with paying off debt and the mental wins it can get you. That said, you can still invest and not be picking stocks. 🙂 If you have access to a 401k that has a match, you’d be foolish in almost all cases to not take the free money.

  • I’m in the camp of paying off debt first. I know it doesn’t always make the most sense numerically, but I believe that the psychological boost it provides makes up for the raw numbers. No joke, when I got out of debt my income started increasing rapidly and I started receiving random bonuses and lump sums from time to time. Call it karma or increased confidence, but I am a firm believer that good things happen when you get out of debt. 🙂

    • John says:

      That is a good point Nick and I agree that there does seem to be a mental boost to paying off debt. I remember that feeling myself! That said, would you give up investing in a 401k that included a match to pay off the debt. To me, that really is a huge part of the question as you really do not want to give up on free money.

      • Not only would I give up a 401k match, I actually did it. For two years while we were paying of debt I stopped my 401k contributions. Was that the right decision? I don’t know. But it helped me get out of debt faster, and now I am making up for it with increased contributions that used to be going towards debt payments.

        • John says:

          Thanks for sharing that Nick, I appreciate it. I can’t say that I would do it now, but that’s why personal finance is personal. 🙂

          You have to go with what works for you and making up for it with increased contributions is a great way to try and mitigate the lost time from not contributing. My issue is that you’re not the norm when it comes to it. Many don’t contribute to pay off the debt and once they pay it off (assuming they even do) they still don’t contribute – thus making it a continued problem.

          Speaking personally, I gave up contributing for almost five years and I still kick myself for that. Yes, I made up for it afterwards, but I still see the five years as lost time.

  • I’m with you John, paying off debt is the priority but don’t overlook the importance of investing either. I’m not saying invest aggressively but if you have a 401k plan with a company match, invest enough to earn the match. Then hit your debt hard. It seems like people are only looking at what the market might do in those few years when they are repaying their debt but the true potential of the market is not short-term. Time is your best friend or worst enemy when it comes to investing.

    • John says:

      I couldn’t have said it better myself Shannon! I really think balance is called for and time really can work either way for you with investing. I say take the 401k match for the max and then work hard on knocking down that debt.

  • I went with the balanced approached. I saw the importance of investing along with the importance of paying off debt. Why does everyone think it should be one or the other? Not everything has to be so cut and dry.

    • John says:

      You got me Grayson. 😉 I think some are so vigilant about debt that everything else goes out the window. I HATE debt, no doubt, but I also know that investing is also key and thus you can be balanced. To not take a 401k match, in almost every case, is just pure lunacy in my opinion…but that’s just me. 🙂

  • anna says:

    Like most things in life, I do an 80%/20% split with paying off debt and investing, respectively. I want to learn about investing, but do better when it’s hands on rather than reading about it, so that’s why I’m starting now while I still have debt. That’s just my personality, though, since it’s all theory to me until I put something into practice – that’s when it usually gels. 🙂

    • Great approach! I believe that getting into the market and letting your money work for you (taking advantage of compound interest), even it it is just a little bit, while you learn more and pay off debt is the way to go.

    • John says:

      I’d agree with James, I think that’s a great approach to take Anna! I think even if it’s through a 401k not only does it start your investing clock sooner, but it helps get more comfortable with investing.

  • Emotion says to pay off debt first but cold, hard arithmetic can say different. I would say it depends on what is the debt – we did pay off all our consumer debt but we are not that bothered about the mortgage. We calculated that if our five year plan even half works (e.g. we make £1.25 million rather than £2.5 million) the mortgage is an irrelevance that can be easily dealt with. At the moment for is important to accumulate capital to invest in big deals.

  • E.M. says:

    These are good points to consider. I’m currently in a situation where I am making my student loans a priority, but I am not offered a 401k at my job. It makes the thought of investing a bit more difficult, but I am determined to open up at least an IRA to get going. I think I will regret it if I don’t. My boyfriend is in the same situation with student loans, and when he joined a company that offered a 401k I told him he should contribute something. He doesn’t like getting less money in his paycheck every week, but I know it will pay off in the future.

    • John says:

      That is a little more difficult situation to be in E.M. I can relate to you’d regret not starting something. You also have on top of that if you want the tax benefit now or at retirement.

      In regards to your boyfriend, I understand that sentiment as I hear it a lot. One thing to remember is that while it is less take home, it is also lowers your taxable situation which is a double bonus (in my opinion) on top of the free money of the bonus.

  • jim says:

    I think it all depends on what stage of life you’re in. When you’re younger – I lean towards paying off debt – but NOT at the expense of not taking full advantage of your 401k match. Even when you’re young, broke and raising a family, ALWAYS contribute something towards your retirement – however meager it may be. When you’re older, you had damn well better have that debt kicked to the curb and investing BIG time so you can have a decent retirement. At any stage of life, remember what’s most important and savor every moment/experience you have.

  • My own experience: My debt knocked me down – almost. I am really crushed and balancing on the edge of a survival. Reason? I spent my reserves on paying the debt off which I allowed to overgrow me, my ability to comfortably pay it off.
    So, that said I had to cut off my investments savings and focus on the debt only. I would say, even if you have debt but you are able to manage it, you should invest as well as paying the debt off. If you see a danger of being unable to pay it off, stop investing and focus on the debt.

    • John says:

      Sorry to hear that Martin. I can all too well relate and am thankful to be past it now. I would tend to agree that is a solid way to handle it.

  • Liquid says:

    That’s right, there’s no easy answer unfortunately. I don’t know what it feels like to be $25,000 in credit card debt, but I do have a lot of other consumer debts. As a general rule I tend to invest more when interest rates are low like in recent times, and prioritize on paying back debt when rates are high, like in the early 90s for example. Broken down however, each debt will need to be scrutinized individually. I’ve kept a $5,000 credit card balance at 1.9% for a couple months now, but when the courtesy rate expires in November, I’m going to pay it all off 🙂

    • John says:

      That’s a great point Liquid! I think you do a very good job of leveraging the two for your advantage. Many do not have the stomach for that and I think you’re proof that it can be done if you know what you’re doing.

  • The Warrior says:

    I don’t even have to think twice on this one. I definitely would pay debt down first.

    Only way I would invest first is to meet a retirement account annual contribution limit that couldn’t be added to in following years.

    The Warrior
    NetWorthWarrior.com

  • Ankit | Getting Money Wise says:

    I am not too familiar with 401k but to me, it is impossible to isolate risk from stock market investments. So, a chance loss in the stock market with existing debt sounds like a double whammy and I would rather pay off the debt first

    • John says:

      Very true Ankit, you’re not really able to separate risk from being in the market – it’s unavoidable. That said, I believe you can accomplish both investing and paying off debt.

  • A couple of ideas: First know the difference between good debt and bad debt. The difference? Is it possible tax deductible? Mortgages, mortgage related loans and student loans=good. Pretty much everything else=bad. Then for me it is about managing debt service like a business. Do I have enough to pay my bills (and something more than just the minimum payment) and invest. By not investing early you do lose the compounding effect over time. However, psychologically it does feel good not to have those credit card payments go out every month. In the end, it is personal preference and balancing act.

  • There is a difference between funding your 401(k) and investing in the stock market. The tax and match benefits alone will surpass debt payments.

    When considering just taking a fixed sum and applying it to a traditional brokerage account rather than a debt repayment that is a separate discussion, and one that I would say is easy to side on paying down the debt first.

    • John says:

      I agree Matt, the tax and match benefits are well worth it. That said, I would disagree that investing in the market and funding a 401k are different as you’re investing in the market through the 401k. At the end of the day, you’re still investing in the market. The problem is that too many people, I saw it every day for years, would forego putting money in their 401k to pay off debt – overlooking the benefits the 401k offered them.

  • Been a long time since I stepped into your site, John.

    Personally I feel that only when you have cleared your debts, you will feel more comfortable to put your money into the stock markets because you have no more liabilities. If you wish to invest and clear your debts at the same time, either the apportioning comes in at your own comfortable levels or you have to be a really good investor.

    • John says:

      I agree Janice, it’s largely a personal decision and one you need to be comfortable with, also knowing the risks you’re taking on either way.

  • Adam Kamerer says:

    John, I’m curious to know how your opinion changes if you take 401k off the table. My wife’s employer doesn’t offer one, so right now we’re focusing our efforts on paying down debt. If someone else isn’t paying extra money into your investment (as with an employer match), are there still investment opportunities that you feel are worth pursuing in lieu of (or at the same time as) paying down debt?

    • John says:

      That’s an good question Adam. I would say it depends largely on how much of debt you have and what kind of debt it is. If it’s consumer debt and it’ll be some time before you’ll be able to pay if off I’d say you might want to start with a little each month into an IRA and put it into some low cost index funds.

      If we’re talking a short amount of time to get the debt repaid, I’d probably focus on that and then work on the saving for retirement. That said, I think there are opportunities you could take, but depends on the amount and type of debt and your personal preference of course. 🙂 Thanks for stopping by Adam!

  • Ikonz says:

    Like you, I hate debt, but at the same time, my investment strategy requires specific investments every month.

    I’m paying down debt on a slow but regular basis, whilst still maintaining my aggressive regular investments.

  • Nick says:

    Like many said, its both a matter of math and comfort level. We have aggressively paid off auto loans, credit card debt, and some higher rate student loan debt all while doing a little investing. That being said, we’re just going to ‘ride out’ our lower rate (tax deductible too!) student loan debt as well as a 0% loan I took from my parents.

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