Deciding between paying down debt and investing can feel like choosing between two good-but-confusing options. Here’s my simple breakdown to help you decide, based on your situation.
The 6% Rule of Thumb
If your debt has an interest rate of 6% or higher, focus on paying it off before investing extra money (with the exception being for retirement accounts with employer matches).
Why? High-interest debt — like credit cards — often costs you more in the long run than what you’d gain from investments. For example, if you’re paying 15% interest on a credit card, that’s like getting a guaranteed 15% “return” by paying it off, which beats most investments.
But there’s a caveat – this advice assumes:
- You’ve saved a small emergency fund (1–3 months of expenses).
- You’re contributing enough to your 401(k) to get your employer’s full match (this is free money!).
- You’re investing in tax-advantaged accounts (like a Roth IRA or 401(k)).
If your debt has an interest rate below 6%, investing might be smarter. Over time, the stock market historically averages about 7% annual returns after inflation, so your money could grow faster than your debt accrues interest.
Adjust for Your Comfort Zone
Keep in mind the 6% guideline is flexible. If you’re a conservative investor (which means your investments will be made of more bonds than stocks), aim to pay off debt with rates above 4–5%.
But if you’re comfortable with stock-heavy investments, you might tolerate debt up to 8%.
Prioritize These First
The 6% guideline is straightforward, but there are important nuances to consider before applying it. For instance, you’ll want to tackle a few key financial priorities first — like covering essentials and stabilizing your cash flow — before deciding between debt repayment and investing.
Why? Think of it as building a financial safety net. Before you even think about investing extra cash, make sure you’ve:
1. Paid at least the minimum on all debts. Skipping this can lead to late fees, penalty interest rates, or credit score damage.
2. Saved a small emergency fund (even $1,000–$2,000). This cushions you against unexpected expenses, so you don’t rack up more debt.
3. Cleared high-interest debt (like credit cards). These rates often outpace investment returns, making them a priority.
Why this order? It’s about stability first, growth second. A solid foundation keeps you prepared for life’s surprises and maximizes long-term wealth-building.
Once these are covered, use the “6% rule” to decide: Should you invest extra cash or pay down debt? If you have multiple debts at or above 6%, chip away at the highest-interest one first (the “avalanche method”), then move to the next.
Also, never skip your employer’s 401(k) match — it’s literally free money you’d otherwise leave on the table.
Why This Works
I like to think of paying debt as a guaranteed win — you’re avoiding interest, freeing up cash flow, and reducing stress.
Investing is riskier but can pay off long-term. By using the 6% threshold, you’re balancing safety and growth.
The Fine Print
Keep in mind that this strategy isn’t perfect. Future investment returns aren’t guaranteed, but paying debt always “returns” your interest rate. To play it safe, the 6% rule includes a 70% confidence level — meaning investing should outperform debt payoff 7 in 10 times.
Overall, start with high-interest debt, then save/invest in layers. If you’re still stuck, focus on what lets you sleep better at night.
After all, financial peace of mind matters and that’s something you can’t put a price on.
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