Rule of Thumb: Should I Pay Off Debt or Invest?

Factors to Consider Before Putting Your Money to Work

graphic showing two people on top of stack of books with a ruler and pencil. the words "financial rules of thumb" are in the middle

Joyce Chan / The Balance

If you’ve got debt, you’re not alone. Nationally, household non-housing debt is at the highest level in 16 years. Housing debt is a bit higher than it was in 2009, toward the end of the Great Recession. Should you strive to reduce your share of that credit card, student loan, and housing debt, or place your money in a retirement savings account or other investments? The answer is, you should do both. 

But let’s look at the factors that go into prioritizing investing versus debt payoff, with the help of two experts. 

Key Takeaways


  • Strive to invest and pay down debt simultaneously. 
  • Investing early in your life impacts your long-term retirement success.
  • Prioritize high-interest debts for payoff.
  • At a minimum, strive to earn any employer match for retirement contributions.

What Is the Rule of Thumb About Paying Debt vs. Investing?

In general, the rule of thumb is that you should both pay debts and invest. In fact, try to consistently contribute to three buckets—debt payoff, retirement, and an emergency fund—said Linda Davis Taylor, former CEO of Clifford Swan Investment Counselors in Pasadena, California, and host of the podcast Money Stories with LDT. Even if that means you can only contribute $10 or $20 per paycheck per month to retirement or savings in addition to debt payoff, it’s worth doing.

Martin Lynch, director of education at Cambridge Credit Counseling, a nonprofit located in Agawam, Massachusetts, agreed. “Both full debt repayment and adequate retirement planning are important, but it’s not an either-or situation,” he noted in an email to The Balance. 

If you overcommit to investing and only make minimum debt payments, you could wind up paying too much in interest over time, he pointed out, which can hamper your ability to buy a home or start a family. If you neglect investing entirely, however, you may fall short of your retirement goals.

Factors That Go Into the Decision   

Both investing and paying off debt are essential financial goals. Determining how to weight each goal can be complicated—Lynch points out that credit counseling sessions aren’t typically short. Here are a few to factors to consider: 

Debt Interest Rate

If you have high-interest-rate credit card debt, focus on paying it off first. "Interest rates on credit cards are so high that you can never get ahead," Taylor said. "Put yourself on a plan to eliminate your credit card debt, and be as disciplined as possible." 

The best way to illustrate this is to simply look at the numbers. Compare the rate of return on your investments to your credit card's annual percentage rate (APR). Historically, average rate of return for stock market investments is around 10%, while on average APR on credit cards is hovering north of 20% for a while.

So, if you are investing when you have credit card debt, you are likely paying a higher interest rate on your debt than you are earning via your investments. Unless you have a huge amount in investments, you end up losing money overall.

Faced with a high interest rate, Lynch suggests paying down the debt aggressively to free up money for investing, “but I'd never abandon retirement contributions entirely.” You want to be contributing to retirement early on because the money will earn interest, which then earns more interest, compounding over time.

Some debt interest rates tend to be lower, however, such as with student loans and mortgages. You don’t need to be as aggressive with those as with high-interest debts. 

When deciding which debts to tackle first, a good rule of thumb is to prioritize debts with an interest rate of 8% or higher that lack any tax advantages, according to the U.S. Securities and Exchange Commission (SEC). 

Debt Amount

Your credit utilization rate is also important to think about when deciding how aggressively to go after debts. "The higher your credit balances, the lower your credit scores. If you don't get your credit use back under control, you'll pay higher interest rates when you need to borrow again," Lynch observed.

If a card balance exceeds 25% of your available credit limit—and you can only afford the minimum payment on all debts—step back and review your budget, he suggested. Lowering your credit utilization rate (the proportion of your available credit that you’re using) and improving your credit score can make your life easier in a lot of ways. 

Time Until Retirement

In general, you should avoid carrying debt into retirement—but some debts are worse than others. “In a worst-case scenario, federal student loan collection can result in garnishment of Social Security income,” Lynch said. However, Social Security is typically exempt in bankruptcy proceedings.   

Of course, as Lynch noted above, he would also never advise abandoning retirement savings altogether, even for debt paydown, especially as you approach the end of your working life. 

If you’re nearing retirement age and you’re far from your financial target, you might have to work longer, cut spending, or make catchup contributions after age 50.

Tax Considerations 

Depending on your income, you may qualify for a tax return "Saver's Credit" of up to 50% of your eligible contributions to your Roth or traditional individual retirement account (IRA), a 401(k), and many other retirement plans, in addition to other tax benefits. According to the IRS, you benefit from saving now in some retirement plans such as a 401(k) by not paying taxes on contributions or investment growth until the profits are distributed back to you in retirement, sometimes decades later.

On the other hand, some forms of debt come with tax benefits, as well. For example, interest paid on student loans and some mortgage interest payments are deductible. Check with your tax professional for more details.

Handling a Windfall 

If you receive a windfall such as an inheritance or a bonus at work, Lynch suggests first shoring up an emergency fund with 10 months’ worth of living expenses, as it may take that long to find a new job paying equivalent income to one that’s been lost. Other experts suggest dividing your annual salary by $10,000 and saving up that many months’ worth of expenses in your emergency fund. For example, if you make $60,000, you’d save six months’ worth of expenses. 

For modest windfalls, consider splitting cash between debt (60%) and investment (40%). Lynch said he’d encourage someone who is struggling financially to put enough of the windfall toward debt to get the monthly payment down, so the overall balance can be paid off in months rather than years. 

For significant windfalls, Taylor suggested considering consulting with a financial advisor on how to use the money in a way that aligns with your goals.

Options to Refinance or Use a 0% Balance Transfer

If you have the opportunity to refinance at a lower rate or take advantage of a 0% balance transfer promotion, that may impact your decision. Either strategy will reduce your interest rate costs, which reduces your monthly debt payments and allows you to increase your savings rate. This improves your financial world today, as well as in the mid-term and long-term.

The risky part with this strategy is resisting the temptation to continue spending on the old card (or cards) that you're paying off. But, if you're disciplined, it can allow for a much cheaper servicing of debt. It also allows for earlier and more substantial investment into retirement and non-retirement accounts.

Why Focusing on Retirement Generally Works

Retirement plans and emergency savings are both critical pieces of your overall financial puzzle, and retirement should be a major priority, as a rule of thumb. “Dollars invested early on can have an exponential impact on retirement earnings,” Lynch said, due to compound interest and market gains over time. 

Calculate how much your current and any additional savings could be worth by retirement age with the U.S. Department of Labor’s Lifetime Income Calculator

401(k) Employer Matches

If offered, strive to at least meet your employer's match amount or percentage for a work-based 401(k)—it’s free money, after all. "If your company matches contributions and you can't get to that point because your debt payments are too high, that's a time to stop and look at your budget," Lynch said. 

 Reach out to your creditors to request an interest-rate reduction or ask for help from a nonprofit credit counselor. Many interest-rate reduction requests are being granted during the pandemic, he noted.

Roth IRAs

If an employer doesn't match your retirement savings, Lynch suggested looking into a Roth IRA because investment growth isn't taxed when you withdraw your funds. Although you can only contribute to a Roth with after-tax earnings, putting funds in a Roth account now may mean you can avoid higher tax rates on withdrawals in the future, Taylor said. Check with your plan administrator for details.

When investing in a workplace retirement account, your plan administrator can help you understand the tax rules and implications of your contribution. Questions to ask: How much can I contribute? What is the workplace match? At what age or under which circumstances can I take money out of the account in the future?

Other Investments

Playing the stock market with apps may look fun, but tread carefully. Don't invest more in the stock market than you could afford to lose overnight, Lynch said. "The best way is to play it safe," he said. Ensure you meet your monthly minimum credit card payments (and more) first. 

If you can stay under 20% of credit limits and can reduce that by 3 or 4 percentage points every month, you "might be able to keep a hand in on Wall Street," he said.

Once you’ve paid off a credit card, you could transfer the equivalent of that monthly payment into your brokerage account to build longer-term wealth.

Grain of Salt

Rules of thumb are guidelines and there will always be exceptions. Take this one with a grain of salt if it doesn’t exactly fit your circumstances. 

Virtually no investment can provide a reliable return of 18% or more that’s comparable to your high-interest credit card fees, points out the SEC. If you’re dealing with extremely high-interest debt, focus on that first—specifically the highest-rate card or loan.  Taylor said credit card balances are “the biggest risk to gaining long-term financial health.” Super-high-interest loans such as payday loans should take even higher priority for paydown in your budget.

But the average person should always make monthly progress on both retirement and paying off debt, in Lynch’s opinion. “Too many people freeze up because they routinely use credit and feel they can't afford to invest because their credit accounts aren't paid in full,” he said, which leads to a “troublingly high” percentage of people who don’t save for enough for retirement. 

“In truth, they can't afford not to invest for their retirement. Consumers need to find a way to do both. There are no scholarships for retirees,” he said.