Should You Pay Off Debt or Invest Your Money? Let’s Compare Both Options…

Disclosure: Our content isn't financial advice. Do your due diligence and speak to your financial advisor before making any investment decision. We may earn money from products reviewed. (Learn more)

You have some extra money and wonder if you should use it to pay off debt or invest? Perhaps you want to invest in stocks, crypto, gold or perhaps you want to use your money to finance a new business like a new construction company, a gym, or a clinic. All these are viable options with their own pros and cons. Now, in this post, let’s take a closer look at whether you should invest or pay off debt. I’ll walk you through the thought process step-by-step, and we’ll focus on practical, real-world considerations to help you make the best decision for your situation.

Start With the Basics: Compare Interest Rates

Here’s the deal: the interest rate on your debt versus the potential return on your investments is the biggest factor in this decision.

• If your debt has high interest rates (10% or more), like credit card debt or payday loans, focus on paying that off first. Why? Because paying off a 20% credit card is like earning a guaranteed 20% return—something most investments can’t match.
• If your debt has a low interest rate (under 5%), like a mortgage or student loan, it’s worth considering investing instead. For example, if the stock market averages 7-10% annually, you could potentially earn more by investing than you’d save by paying off that debt early.

Bottom line: If your debt’s interest rate is higher than the return you could reasonably expect from investing, pay off the debt first, without question. If it’s lower, you might lean toward investing, but think carefully…

Check Your Financial Foundation

Before deciding, take a look at the bigger picture of your financial health. Ask yourself:

1. Do I have an emergency fund?
   Life is unpredictable, and having 3-6 months of living expenses set aside is a must. If you don’t have this cushion, make building your emergency fund priority number one. Paying off debt or investing won’t help if you end up needing a loan for an emergency.
2. How’s my cash flow?
   If money feels tight every month, paying off debt can give you breathing room. Fewer bills mean more flexibility. On the flip side, if you’re already comfortable, investing might be the smarter long-term play.
3. Do I have any expertise in what I’m about to invest in? In other words, don’t invest in something you know nothing about, as that’s a guaranteed recipe to lose your money.

Think About Emotional Benefits

Let’s be honest: money decisions aren’t always about numbers—they’re emotional, too.

• The Peace of Mind Factor: Debt can feel like a huge weight on your shoulders. Even if it’s low-interest, some people find being debt-free is worth more than any potential investment return. If clearing your debt would help you sleep better at night, that’s a valid reason to prioritize it.
• The Confidence Factor: Are you comfortable with investing? If the thought of navigating the stock market or managing investment risks feels intimidating, it might make more sense to focus on paying down your debt first.

Don’t Forget Taxes

Taxes play a role here, too:

• Some types of debt, like mortgages and student loans, have tax benefits that reduce the effective interest rate. For example, if your student loan rate is 5% but you can deduct the interest, your real cost might be closer to 3-4%. That makes the debt less urgent to pay off.
• Investments are often taxable, so keep that in mind. If you’re earning 7% from investments but paying 20% in taxes on those gains, your net return is lower than it looks.

Why Not Do Both?

Here’s an option many people overlook: you don’t have to choose one or the other. You can split your extra money between paying down debt and investing.

For example:

• Put half your extra cash toward paying off debt faster, reducing the interest you owe.
• Invest the other half, letting your money start growing for the future.

This way, you’re making progress on both goals without feeling like you’re sacrificing one for the other.

When Paying Off Debt Might Be Better

Focus on debt repayment if:

• You’re carrying high-interest debt (e.g., credit cards, payday loans).
• You don’t have a solid emergency fund yet.
• You’re stressed about the idea of owing money.
• Your debt payments are eating up too much of your income, limiting your ability to save or invest.

When Investing Might Be Better

Lean toward investing if:

• Your debts have low interest rates (under 5%).
• You already have an emergency fund and manageable monthly expenses.
• You have access to investments with solid potential returns (e.g., an employer-matching 401(k) or low-cost index funds).
• You want to take advantage of compound growth, which is most effective the earlier you start investing.

Practical Example: Balancing Both

Let’s say you have $10,000 in extra cash this year. You owe $5,000 on a credit card at 18% interest, and you’re considering investing in a retirement fund that might earn 8% annually.

1. Start by paying off the credit card in full. That 18% interest is a guaranteed cost you’d otherwise keep paying.
2. Use the remaining $5,000 to start investing. You’ve now freed up cash from the debt payments, and you’re setting yourself up for growth.

The Final Decision

There’s no one-size-fits-all answer. It all depends on your goals, the type of debt you have, and where you stand financially. The key is to weigh the numbers, consider the emotional impact, and choose what aligns best with your long-term plan.

Remember: whether you’re paying off debt or investing, you’re making a smart decision to improve your financial future. And that’s something to be proud of!

All in all, you never go wrong by paying off your debt, as you can always borrow money from the bank later on if you want to invest in a business, or in anything else. When you have a lot of debt, it’s difficult to get any form of loan or financing from banks.