Pay Off Debt or Invest?

May 13, 2019 by

Question markIf you have debt and you earn more than you spend, you’ve probably wondered: should I use my surplus income to pay off my debt faster or invest?

Then you read or hear a definitive answer from an “expert” (who, coincidentally, directly or indirectly makes money when people like you invest) that goes something like this:

Don’t be a sap! Your [fill-in-the-blank] debt has an interest rate of only 3.5%. Historically, stocks have returned an average of about 7% per year. And stocks have never posted a loss over any 20-year period in history! Of course you should invest! blah, blah, blah

Convinced? Most are, I think. Many of those who, like Ms. Money Counselor and me, are debt-free don’t find persuasive this argument. Are we saps? Well, you can make your own judgment about me, but I don’t feel like a sap. On the contrary, I feel like we’ve made shrewd, conservative, and mostly smart money choices, and those choices included paying off our 15-year mortgage nine years early in 2002.


First, let’s set the stage. You’ve been closely following Money Counselor 😉 so:

  • Your emergency fund is robust
  • You have no high-interest debt
  • You’re fully funding your retirement accounts
  • If you have kids, you’re putting at least a little money into 529s
  • You run a tight financial ship
  • You’ve got long-term debt (student loans, a mortgage) at 3.5%

And you’ve got some extra cash each month.

Buy Stocks or Pay Down Debt?

Should you:

A. Invest your cash surplus in stocks, or

B. Throw more than the minimum monthly payment at your debt?

You probably think I’m going to recommend B. I’m not. More on this at the end of this article, but I recommend that you consider doing a modified version of A and B combined. But, most importantly, you definitely should not do A alone. Since ‘put it all in stocks’ is the recommendation of probably a large majority of financial planner types, personal finance bloggers, self-appointed experts, etc., maybe I’m all wet. If I am, I find my damp environment quite comfortable and secure.

What’s Wrong With the Wall Street Argument for Stock Investing?

The CNBC shill / Wall Street marketing machine argument summarized in the grey block above is flimsy and misleading, yet has convinced millions to turn over their retirement savings to Wall Street money managers. Let’s entertain ourselves by throwing a few darts.

Speculative vs. Guaranteed Returns

Making a payment on a loan with a 3.5% interest rate is identical to making an investment with a guaranteed, risk-free return of 3.5%. If you think of paying debt as an investment opportunity, you’ll be debt-free a lot sooner.

The continually recited 7% historical stock return guarantees nothing and means next to nothing about the future. To what degree would you say the global and U.S. economy, stock market, and financial markets today resemble their counterparts of 80, 50, 30, or even 10 years ago? The answers of course are “not at all,” “not at all,” “almost not at all,” and “a little, but streaking toward ‘almost not at all’.” Why would you consider data from a period bearing, at best, very little resemblance to the future with respect to any characteristic relevant to stock investing useful in benchmarking future stock returns?

Would you use sales of the IBM PC, introduced in August 1981, to help you forecast next year’s sales of the iPad? You wouldn’t think of it, and why? Because everything about the technology market has changed since 1981.

Timing is Everything

U.S. stock values have twice crashed nearly 50% in just the past fifteen years. And a housing market that many said—based on decades of data from largely obsolete and so irrelevant market conditions—always goes up, instead melted down, effectively trapping millions in their homes and derailing the retirement plans of a big chunk of the Baby Boom generation.

The theory that all you need to do is invest for the long-term and then you’ll come out ahead is bogus. My friends, we don’t like to think of this, but we’re mortal. And most of us will either decline to work until death or ill health will preclude it. If the long-term over which stocks allegedly always produce unbeatable returns is reached after you want to or must retire, you’re screwed if you’ve trusted your retirement security to Wall Street. The older you are, the more this point matters.

Stocks Are Risky

In contrast to the guaranteed, risk-free return offered by debt payment, the potential return from any stock investment is speculative and could catastrophically be negative. Stocks are riskier than stock sellers would have you believe.


Unless your stock investments are in a Roth IRA, you’ll pay tax on any returns you earn, either next April 15 or when you withdraw money from your non-Roth retirement account. A 7% return becomes 5.95% if you’re in the 15% marginal tax bracket.

Unless the loan is a mortgage and you itemize deductions on your tax return, the 3.5% return you earn on making loan payments is an after-tax return. (This is why saving an extra dollar is worth more than earning an extra dollar. So far Uncle Sam hasn’t figured a way to tax reductions you make in household expenses like interest payments.)

Debt = Risk

When you’re debt free, you’re immune to a lot of costly and inconvenient ugliness that can befall those who owe money. For example, here’s a short list of costly events that never happen to the debt-free:

I know—none of these will ever happen to you. You’ll never lose your job, have a prolonged illness or become disabled, endure the failure of a sole proprietorship, get sick or injured and have big, uninsured medical costs, live through an economic depression or meltdown, lose your partner (and his/her income) to an early death or divorce, or watch helplessly as your home’s value drops by half. Never. Ah-huh.


When you owe money, you limit your options. Being constrained from taking advantage of opportunity can cost you real money and, more importantly, make you unhappy and hurt your quality of life.

Hate your well paying, secure job? Suck it up honey—the debt bell tolls. Ache to put your heart and soul into starting that small business of which you’ve always dreamed? Sorry, you need consistent, reliable cash flow every month to keep the debt wolves at bay. Got an opportunity for that long sought dream job in a far away city? You’ll have to pass: your mortgage is underwater so you’re stuck in your home. Fantasize about telling your nasty boss where to go? Smile, hold your tongue, and take the stress home to vent to your spouse or you might find yourself on the receiving end of a debt collector’s campaign of intimidation, harassment, and humiliation.

What to Do With Surplus Income

First, with the assumptions outlined under Housekeeping above in mind, here are my suggestions:

  • Do not invest your entire surplus in stocks.
  • The principle of diversifying your investments is important and applies here. So don’t devote your entire surplus to pre-paying debt either.
  • In the context of your life plan, set a goal—a date—for paying off a particular debt. Figure the additional payments you’d need to make to reach that goal, and start making them.
  • For the remainder of your surplus, I won’t squawk if you want to invest some in stocks. But I’d urge you to consider the many alternatives to stocks—and there are many, if you tune out mainstream financial media, mouthpiece for the high-powered Wall Street marketing machine, and open your mind. I’ve written, and will continue to write, other Money Counselor posts on alternatives to stock investing. Check the Investing category in the left sidebar of Money Counselor’s homepage.

What Do You Do?

Do you choose not to pre-pay a debt because you consider the rate so low that you can do better investing your surplus cash elsewhere? Do you think of paying debt as an investment opportunity?

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  1. addvodka

    I take a balanced approach. I think both investing and paying off debt would be important. Luckily I have no debt so I’m full out investing now but when I had my car loan I did about 50/50.

  2. William_Drop_Dead_Money

    You’re absolutely right. There’s one more thing: when the economy turns down, you can cut most of your expenses, but you can’t cut those payments. Getting rid of them is the best survival tactic.

    And lest you think recessions are a thing of the past, here’s some math to consider: cycles last 7-10 years, and downturns typically start 2 years before the bottom. That means downturns typically start 5-8 years after the last bottom. The last bottom was in 2009. When is 5 years from then? Time’s coming when debt reduction will pay much better, and increase survivability…

    • Great point. Debt doesn’t seem like a big deal as long as everything is going along well. Then when something goes wrong–and it always does, for almost all of us–suddenly debt’s a big problem.

  3. Right now I have loan debt that is 6.55% so we’re throwing all the money at that. After that’s paid down in April of 2015, we’re going to do a combination of pay down the remainder of lower-interest student loan debt, save for short term, and invest in retirement. I agree that the balanced approach is the best for the long term so long as the interest rate isn’t crazy high on the debt.

    • Getting a 6.55% guaranteed, risk-free return on the investment you’re making in that debt has got to be the best investing opportunity you have right now, so good for you!

  4. Ryan @ Impersonal Finance

    If it’s a serious debt with a super high interest rate, I do everything I can to pay it down. But, emotions can also come into play, because I know a cheap mortgage at a great rate might be something I should hold onto, but part of me still really just wants to be rid of all debt.

    • When (not if) stock prices crash again, everyone who’d been paying down even low-rate mortgage instead of piling into stocks during the price run-up will be feeling pretty smug.

  5. We did pretty much exactly what you recommend with our mortgage. We put lots of extra money into saving and investing in both retirement and taxable accounts. But we also put extra toward our mortgage each month and paid it off in 9 years.

  6. I think you hit the nail on the head. Everyone’s situation is different and you should obviously start investing early but paying down debt is a must. You should tailor your percentage of investments vs debt accordingly based on your own personal decision.

  7. - ES4MI -

    Debt = Financial Slavery
    Here is a pretty easy equation for everyone to live by. If you bring home “$x” every month, but spend “$x + $1″ each month…you will go broke. Spend less than you bring home each month. It really is that easy. Stop spending on discretionary items until you have extra cash for such items. If you do use a credit card, pay it off in full each month. Becoming debt free (including one’s house) is so liberating!

    • Seems simple, but many appear not to grasp this logic. Why is that?

      • - ES4MI -

        I tend to place a lot of the blame on a complete lack of financial education and an overall lack of caring.

        1. Our education system should spend some time teaching children from middle school up through high school about sound money practices. As a tax payer, I’d be willing to toss some tax money at teaching kids that grow up to become adults how to properly evaluate financial matters. It would go a long way to solving some of the problems we currently are facing with financial illiteracy.

        2. Also, we need to adapt/create a societal mindset of caring about one’s finances. Some people out there just don’t care if they go into debt and they are lost in the financial mess they created. Others fall victim to undeserved circumstances, but they need to “brush the dirt off their shoulders,” get back up and restart the program of getting back into sound financial shape.


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