Invest or Pay Off Debt First?

A household with $500 a month spare and a 22.9% credit card ends ten years $6,840.89 better off clearing the card first. The same household with a 6.5% student loan ends $442.71 better off ignoring the loan and investing. Same money, same decade, opposite answers.

That is the whole decision, and the reason it feels harder than it is comes from arguing about it in general instead of at a rate. The rate settles it.

The comparison that actually decides it

Strip away everything else and it is one question: what does a dollar do in each place?

A dollar paid against a 22.9% balance stops 22.9% a year of interest. Permanently, from that day, with no uncertainty.

A dollar invested in a broad index fund earns whatever the market does, which we conventionally assume is about 7% a year over long periods, and which in any given year might be plus 24% or minus 18%.

So the crossover is exactly where the two rates meet. Run the model at a 7% assumed return and the break-even debt rate is 7.00%. Run it assuming 5% and the break-even is 5.00%. Run it at 9% and it is 9.00%. That is not a coincidence or a fitted result; it falls straight out of the arithmetic, because avoiding an x% cost and earning an x% return are the same thing to your net worth.

Which means the honest version of the rule is not a number at all. It is: pay the debt when its rate is above the return you expect, and invest when it is below.

Why the employer match sits outside the argument

Everything above compares a debt rate to an investment return. The match is neither.

Take a plan matching 50% of the first 6% of pay, on a $70,000 salary. Contribute $4,200 over the year and the employer adds $2,100. That is a 50% return before the money has been invested in anything, on the day it lands, and it happens again every year.

No consumer debt in existence charges 50%. So the order is not up for debate: capture the full match first, then have the argument on this page about everything above it. Over ten years at 7%, the employer's $2,100 a year alone compounds to $30,289.84, and it is the closest thing to free money household finance contains. The mechanics are in what the 401(k) match is actually worth.

Two things can make this wrong, and both are rare. A vesting schedule you will not survive, which is the arithmetic in vesting schedules and the cost of leaving early. And a debt where missing a payment this month costs you the car you drive to work, in which case the match can wait one month while you deal with that.

Three households, three answers

Each has $500 a month above its minimums, and ten years. Each either (a) throws the full $500 at the debt until it clears and then invests everything, or (b) pays only the minimum and invests the rest from day one. Returns assumed at 7%, and net worth is investments minus any debt left.

Three things in that table are worth more than the headline.

Household A's answer is nearly a tie. $442.71 over a decade is $3.69 a month. Anyone telling household A that they are making a serious mistake either way is overselling a rounding error. At 6.5%, do whichever you will actually keep doing.

Household B's answer is small too, and it goes the other way. $732.56 over ten years. Still worth taking, still not worth agonising over. The 8% to 11% band is where the maths says debt and the margin is thin.

Household C's answer is not close. $6,840.89 is more than a year of the contributions themselves. Above about 15% there is nothing to weigh up: the card is a guaranteed loss that compounds faster than anything you can reliably buy.

The rate bands, and the reasoning

Putting the model's output into something usable:

Notice that the band edges are a little above the 7% crossover rather than centred on it. That is deliberate, and it is the one place we are adding judgement to the arithmetic.

Why the two rates are not the same kind of number

The model treats 7% expected and 7% guaranteed as equal. They are not, and the difference runs in one direction.

The debt rate is contractual. It is on the statement, it does not vary with the news, and every dollar you pay removes exactly that much cost. The 7% is an average of a distribution that includes 2008 and 2022. You do not receive 7% a year. You receive a sequence, and over ten years the sequence you happen to get matters.

There is also a behaviour cost that sits on the investing side and never appears in a spreadsheet. A household carrying $9,000 at 22.9% while building a brokerage balance has to watch that balance fall 20% in a bad year and not sell it to clear the card. Some people manage that. Many do not, and selling at the bottom converts a paper loss into a real one.

So we would not put the line at 7.00% even though the arithmetic does. We would put it nearer 8%, and treat everything between 6% and 8% as a genuine coin toss where the deciding factor is which one you will stick with.

The behavioural case against the maths

There is one more argument, and it cuts against everything above.

Investing while carrying a card balance means running two plans at once. Debt payoff works because the money is committed before it can be spent, which is the mechanism in pay yourself first, and splitting $500 into $250 and $250 halves the visible progress on both. Household C's card takes 22 months to clear on the split and 12 months on the focused version, and the person who sees a balance falling by half as much each month is the person who stops.

Against that: a household that stops investing entirely for four years is a household that has to restart the habit, and restarting is harder than continuing. Contributing something, even $50 above the match, keeps the account open and the habit alive.

We come down on the side of focus above 10% and a split below it. But this is the part of the decision where the arithmetic genuinely does not have the last word, and pretending otherwise would be the hedging this publication exists to avoid in the other direction.

When this does not apply

If you have no emergency fund. Neither option comes first. One month of essential spending does, because without it the next $700 expense goes onto the card and undoes months of either plan. One month, not six, and then resume. Sizing the full fund is a later job.

If your debt is federal student loans on an income-driven plan. Extra payments can reduce a balance that was going to be forgiven, which turns a saving into a loss. Read your plan's terms before applying anything on this page to that loan, and keep it out of the comparison until you have.

If your income moves month to month. Both strategies here assume a reliable $500. On commission or self-employment, the right structure is a buffer first and lump sums afterwards, which is how to budget when your income changes every month. Committing to a fixed attack payment you miss twice a year teaches you that the plan failed, when it was the assumption that failed.

If the debt is at 0% on a promotion. Then its rate is 0% until a date, and after that date it is 22%. Invest the difference by all means, and reserve enough to clear the balance before the window closes. See balance transfers, when they help and when they hurt.

If you are within a few years of needing the money. The 7% assumption is an average over decades. Over three years it is close to meaningless, and the guaranteed saving from paying the debt wins on almost any rate.

Next steps

1. Find your plan's match formula and the contribution that captures all of it. Do this first and do it today.
2. List every debt with its rate, from a statement rather than memory.
3. Sort them against the bands above. Anything over 10% goes to the front; anything under 6% gets the minimum and nothing more.
4. For anything in the 6% to 8% band, pick the one you will keep doing and stop rereading articles about it.
5. If more than one debt is above the line, decide the order: avalanche or snowball, and what each one costs.