Managing money can seem a bit like walking a tightrope. Credit cards, student loans, car payments — you have debts on one side of the line that need attention. On the other side is yourself in the future, praying you have saved enough to retire comfortably. Hitting that sweet spot between closing the gap on what you owe and socking away more money for tomorrow is one of the most important financial skills you’ll ever master.
There is a perception among many that they can only have one, but not both. They think they should either be throwing every extra dollar at their debt or disregarding their loans altogether in order to begin investing sooner. The truth? They need a strategy that hits both at once. This article will explain in detail how to build that strategy, step by step, to help you sleep more soundly at night knowing that you’re making wise choices with your money.
Why This Balance Is More Important Than You Think
Before we dive into strategies, let’s review exactly why this balance is so important. Every year you wait to start investing is a year you’re not benefiting from compound interest, or that magical force that turns small sums into large fortunes over time. If you wait a decade to begin investing, you may have to save three times as much in order to reach the same retirement target.
But there are consequences to ignoring debt as well. High-interest debt compounds more quickly than the returns from most investment vehicles. If you pay 18% annual interest on a credit card while earning 8% back on investments, you’re losing out on that difference — 10 percentage points over the course of a year’s worth of debt. It’s similar to trying to fill a bathtub with the drain open.
The truth is, though, both debt and investing are fighting head to head over the same capital — your monthly income. There’s only one dollar at a time, you can only spend it once, so you need some kind of system for deciding who gets it.
The Interest Rate Rule: Your First Decision Making Instrument
Here’s an easy but effective rule of thumb that will shape most of your decisions: Compare interest rates.
Compare what you’re paying on your debts to what you could plausibly make by investing instead. Over the long term, the stock market has averaged a return of about 10% annually (but it fluctuates significantly on an annual basis). More conservative investments, such as bonds, might yield between 4-6%.
When to Prioritize Debt Payoff:
- Debt incurred with a credit card (typically 15-25% interest)
- Unsecured loans at high interest (over 8%)
- High interest payday loans (often 400%+)
- Any debt above 7-8% interest
When to Prioritize Investing:
- Mortgage debt (often 3-7%)
- Student loans (typically 4-7%)
- Low-interest car loans (2-5%)
- Any debt below 5% interest
The gray zone (4-7% interest): Here’s where the personal side of things comes most into play. Your decisions will be driven by your age, risk tolerance and financial situation.
Debt Priority Reference Table
| Debt Type | Average Interest Rate | Priority Level | What To Do About It |
|---|---|---|---|
| Credit Cards | 15-25% | High | Pay off flat out |
| Personal Loans | 8-15% | Medium-High | Pay off before most investing |
| Student Loans | 4-7% | Low-Medium | Split between debt and investing |
| Auto Loans | 3-6% | Low | Balanced |
| Mortgage | 3-7% | Very Low | Invest while paying minimum |
The Foundation: Emergency Fund First
Debt pay down or investing are pointless things to worry about when you don’t have a safety net. Financial advisers dub this an emergency fund, but you’re going to also want to think of this as your “life happens” money.
Strive to save $1,000 as fast as possible. This will get you through most small emergencies — a car repair, a broken phone, an emergency vet visit. Once you have that cushion, knocking out debt and investing becomes much easier.
By that point, you should have begun accumulating enough cash to support three to six months’ worth of essential spending. This may come with time, and that’s all right. You can be building this fund while tackling debt and investing, particularly if you’re receiving a match on your retirement contributions from an employer (more on that soon).
Why does this matter? Without an emergency fund, an unexpected expense becomes a crisis that puts you further into debt. You borrow more for emergencies and you can become trapped in a cycle.
The Free Money: The Employer Match
And if your employer has a retirement plan with matching contributions, all bets are off. Say your company matches 50% of what you contribute, up to 6% of your salary. Instead, if you make $50,000 and put in 6%, or $3,000, your employer puts in $1,500. That is an immediate 50 percent return on your money — you won’t ever have that option anywhere else.
The golden rule: Always contribute enough to get the full employer match, even if you have high-interest debt. This would seem to run counter to the interest rate rule, but the employer match is effectively free money. Anywhere can you get a guaranteed 50 or 100 percent return right away?
After catching the entire match, aim any surplus cash at high-interest debt. After that’s gone, keep up your retirement contributions.
The Avalanche Method: Use Math to Crush Your Debt
The avalanche method prioritizes interest rates in order to save you the most money. List all of your debts, from the highest interest rate to the lowest. Pay the minimums on everything and put extra money toward the loan that has the highest interest rate.
Example:
- Credit Card A: $5,000 at 22% interest – Monthly minimum payment of $150
- Credit Card B: $3,000 at 18% – with a minimum payment of $90
- Student Loan: $15,000 at 5% interest — minimum payment of $175
- Total minimum payments: $415
If you’ve got $600 a month to contribute to debt, make minimum payments ($415) and throw the extra $185 at Credit Card A. Once Card A is banished, free up that $335 ($150 plus $185) to go after Credit Card B. When B is history, hey look! — You’ll have freed up a goodly $425 every month for a snowball attack on Student Loan.
This is the cheapest option, because you get rid of the highest interest charges first. The downside? It may take a little longer to see your first debt eliminated, which can be discouraging.
The Psychology of the Snowballing Debt Reduction Strategy
The snowball method disregards interest rates in favor of motivation. Order your debts from smallest balance to largest balance, regardless of the interest rate. Minimums for all but the smallest debt, to which you apply all available extra money.
Using the same example:
- Credit Card B – $3,000 @ 18% gets extra payment first
- Credit Card A: $5,000 @ 22% minimum for now
- Student Loan: $15K @ 5% – min for now
You’d knock out Credit Card B first, then proceed to Credit Card A and finally the student loan.
The advantage? Quick wins keep you motivated. Once that first debt is paid off, it feels good and gives you some momentum. You also see progress quickly, which helps to keep you on track. The disadvantage? You could end up paying marginally more in total interest.
Which method is better? The one you’ll actually follow. If you need to build motivation and gain some quick wins, opt for snowball. If you’re disciplined enough for this, and are looking to save the most money, opt for avalanche.
The Hybrid: Because Life Is Not an Either/Or Proposition
Some people work by blending one format with the other. Here’s how:
- Avalanche principle: Highest interest debt above 10% should be paid down first
- On lower-interest debts, pay off smallest balances first (snowball principle)
This number varies depending on your personal circumstances.
You could also pay off one small debt extremely quickly for motivation, then do the avalanche method to finish paying off your remaining debts. Personal finance is personal — the “right” answer is what works best for your brain and your situation.
Age and Time: Age Makes Everything Different
Your age very much determines how you should be confronting the debt-versus-investing conundrum. Time is an investor’s superpower because of the wonders of compounding.
In Your 20s and Into Your Early 30s
You have around 30-40 years until retirement. Invested money will multiply eventually. By age 65 (at an assumed average annual return of 7%), $5,000 invested at age 25 can grow to a value equal to about four and half times its original purchase price. That same $5,000 invested at age 50 may grow to just $15,000 by 65.
Strategy: Be aggressive with investing but also carry some moderate-interest debt. Max out that employer match, contribute to an IRA and consider taxable investment accounts once high-interest debt is tamed.
In Your 30s and 40s
It’s peak earning years, time is of the essence. Balance becomes more important.
Strategy: Get rid of high-interest debt as quickly as you can, and then divide your spending power between paying off other debts and investing. If you’re behind on retirement savings lean more toward investing when credit card debt leaves the scene.
In Your 50s and Over
There’s less time for investments to recover from market downturns. Living debt-free has even greater appeal as retirement looms.
Strategy: His top priority should be getting out of debt before he retires. If possible, pay off the mortgage. Continue investing, but favor stability at the expense of growth. You certainly don’t want to start your retirement years with loan payments that are gobbling up a fixed income.
Tax Breaks That Tip the Balance
Taxes throw another element into the debt-or-invest calculation. Tax benefits may make the true cost or return of some debts and investments more or less favorable.
Tax-Deductible Debt
You can tax deduct mortgage interest and in some cases student loan interest. If you belong to the 22% tax bracket and facing a 5% mortgage, your effective rate is roughly 3.9% (5% minus the tax benefit). That makes it more attractive to carry the debt than invest.
Tax-Advantaged Investments
With a traditional 401(k) or individual retirement account, you get a tax break now. If you’re in a 22% tax bracket and can afford to do so, that allows you to save $220 in taxes today. Roth accounts don’t offer upfront tax breaks, but they grow tax-free for all time.
These tax advantages frequently make the case for investing over moderate-interest debt. A 5 percent student loan that’s tax deductible costs you less than 5 percent, for example; while an investment in a Roth IRA that receives tax-free growth is worth more than its stated rate of return.
Risk Tolerance: Comfort Zone and You
But the numbers tell only part of the story. Your emotional comfort matters too.
For some individuals, any level of debt, no matter the interest rate, causes sleepless nights. If a $10,000 student loan at 4 percent interest keeps you up at night, no mathematical “best” answer needs be computed. And the stress could be affecting your health, relationships and work performance. In such cases, the value of paying off the debt may be greater than whatever investment returns you’d otherwise have been making.
Others feel stressed out that they’re not contributing toward the future. They are more concerned about retirement poverty than about current debt. To them, the peace of mind that comes from savings is worth more than whatever money they would save on debt by paying it off faster.
Ask Yourself:
- How does my debt feel?
- Will I be more concerned about debt or not having a savings?
- Can I stand market volatility while holding debt?
- What would bring me the most peace of mind?
There’s no wrong answer. Personal finance is about more than maximizing numbers — it’s also about developing a life that enables you to sleep well at night and feel good about what your money does.
Creating Your Personal Game Plan
Now, let’s combine all of this into a step-by-step plan that you can use starting today.
Step 1: Take an inventory. Make a list of all your debts (and for each, the amount owed, interest rate and minimum payment) and all your investment accounts (as well as balance, how much you contribute). Be brutally honest and complete — you can’t solve problems you won’t admit.
Step 2: Build your starter emergency fund. Save up $1,000-$2,000 as quickly as you can. Sell stuff, clock some overtime, postpone spending — just get this cushion in there.
Step 3: Reel in free money. Make sure to save enough in your employer retirement plan to get the full match. This is non-negotiable.
Step 4: Crush toxic debt. Go after any debt over 8-10% interest with a fervor. These financial obligations are emergent and must be addressed expeditiously. Use the avalanche or snowball method, just make them gone.
Step 5: Establish your full emergency fund. Work to accumulate 3-6 months of expenses while making minimum payments on remaining debt. That’s what keeps you from sliding backward when life throws curveballs.
Step 6: Pick your split. Choose your split for other debts (mortgage, student loans, car loans) based on:
- Rates (use the matching rule)
- How old you are (if younger, invest more; if older, pay off debt more)
- Tax advantages (count deductions and benefits to retirement accounts)
- How comfortable you are (what gets you to sleep?)
A typical split is 60-70% toward the goal that prevails on interest rates, 30-40% toward the other goal. Adjust monthly as your circumstances shift.
Step 7: Gradually increase contributions. Whenever you receive a raise, bonus or tax refund, allocate it to both debt payoff and investing. Never let your lifestyle get to the point where all extra money is consumed—this is called lifestyle inflation and it’s wealth’s enemy.
Step 8: Automate it all. Establish automatic transfers for both debt payments (above your minimum) and investments. You take willpower out of the equation with automation. You can’t spend money that you never see in your checking account.
The Exceptions That Change the Rule
There are different ways to achieve the debt-and-investing compromise for different life situations.
Starting a Business
Business debt operates differently from personal debt. If the low-interest business loan is helping you make money, it may be worth your while to keep it while investing. The business is an investment in its own right. But don’t commingle business and personal funds, and definitely don’t ignore retirement savings altogether.
Prepping for a Home Purchase
If you expect to buy a house in three to five years, focus on saving for the down payment over debt pay down and long-term investing. The exception? Keep getting that employer match. Putting more down saves you thousands of dollars in interest, and it can help you avoid PMI (private mortgage insurance).
Anticipating Significant Life Changes
Thinking of having kids, going back to school or supporting aging parents? Prioritize building extra cash reserves, even if that slows debt payoff and investing. Variable and liquid begin to outweigh “most efficient” during transitory phase.
Fluctuating Income
People who freelance, work on commission or are seasonal workers should have more saved (6-12 months) before attacking debt as earnestly/investing. Income volatility introduces risk that needs an additional cushion.
Common Mistakes That Derail Progress
There are some pitfalls that can still quash your best-laid plans. Considerable pitfalls to avoid:
Mistake 1: Waiting for the “Perfect” Moment
There is never a perfect moment to start. Markets will be volatile, unforeseen expenses will arise and you won’t ever feel 100 percent prepared. Begin anyway with whatever you can afford, even if it’s only $50 a month.
Mistake 2: Skipping Insurance
No financial plan can survive a sizeable, uninsured emergency. You don’t get to decide to have health insurance, disability insurance or life insurance (if others are dependent on your income). An ounce of financial protection is the inexpensive prevention that comes with solid insurance coverage.
Mistake 3: Trying to Time the Market
You can’t time market highs and lows. Don’t wait to invest, just because you believe that a crash is right around the corner. Dollar-cost averaging, investing a fixed amount regularly whether markets are good or bad — it’s worked well for investors over the decades.
Mistake 4: You Take On New Debt While Still Paying Off the Old One
If you’re diligently trying to pay off credit card debt but you’re financing new furniture, congratulations — you’re spinning your wheels. Pledge to take on no new debt — other than possibly the purchase of a mortgage — until those high-interest obligations are gone.
Mistake 5: Tuning Out Spouse/Partner Communication
Money fights can be fatal to relationships. If you pool money with someone, you need to agree on the debt-and-investing strategy jointly. Plan for monthly money meetings to keep track and make adjustments. Opposite money personalities can complement each other, if both partners feel heard and valued.
Mistake 6: Overlooking the Wins
Paying down debt and creating wealth is a long game. If you don’t celebrate milestones, you’ll get burned out. When you pay off a credit card, take yourself out to a little celebration. When your investment account crosses $10,000, $25,000, $50,000 — celebrate those milestones. Progress deserves recognition.
Tools and Items to Help You Stay Focused
You don’t need pricey software to keep track of this balance, though, some tools do help make the work easier:
Apps for budgeting: YNAB (You Need A Budget), Mint or EveryDollar can help keep spending in check and money divided up among various purposes. Being able to see the results even in a graphic helps keep you motivated!
Debt-payoff calculators: No-cost online calculators that spell out precisely when you’ll be debt-free and how much interest you’ll pay under different circumstances. These calculators show you the effect of extra payments.
Investment calculators: Compound interest calculators show how much you can potentially grow your investments. Watching that potential future balance can help keep you motivated to stay consistent.
Accountability partners: Find a friend, family member or online community that has the same struggle as you. Posting your progress (no, not the numbers if you want to keep it private) helps with accountability and keeps you encouraged.
When to Seek Professional Help
Sometimes DIY approaches aren’t enough. Consider consulting professionals when:
- Your debt is crushing (you’re spending over half of your income on debt payments)
- You’re not sure how to balance competing financial goals
- Taxes are tricky (more than one source of income, side business, inheritance)
- You’re close to retirement and want to maximize your approach
- You’ve attempted on more than one occasion to stick to a plan but you always manage to do off the rails
A fee-only financial planner (who doesn’t earn commissions on products) can give you customized advice free of conflicts. If you cannot afford ongoing advice, many advisers provide one-time planning sessions at a reasonable price.
The Flex Factor: Moderating Your Plan as Time Goes By
Your balance of debt and investing is not set in stone. Life happens, and your strategy has to adapt.
Revisit Your Plan Every Six Months:
- Has your income increased? Take raises to your money goals
- Have interest rates changed? Refinancing might make sense
- Are you on your goals, ahead of or behind them? Adjust percentages accordingly
- Has your family situation changed? Kids, marriage, divorce impact priorities
- Feeling anxious about the way you are approaching it? Rebalance for peace of mind
Flexibility is strength, not weakness. The best plan is the one that fits around your actual life and keeps you moving forward toward your real goals.
The Finish Line: What Success Means
Picture waking up and feeling good knowing you don’t have any credit card debt, your emergency fund is plump, and your investment accounts are ticking upwards. You may still have a mortgage or student loans, but they are manageable and do not dominate your life. You’re saving the recommended percentage for retirement, and you can actually track your future wealth accumulating.
This isn’t make-believe — this is entirely possible with consistent effort and a smart plan in place. It might take 3, 5 or even 10 years depending on where you start from, but every month that you continue sticking to your plan means that you’re getting nearer the end point.
The dynamic between debt and investing isn’t about perfection. It is about being thoughtful with your money, rather than allowing life to happen to you. It is the way to build both security and opportunity at the same time.
Frequently Asked Questions
Should I pay off my mortgage or invest the extra cash?
The answer to this question is reliant on your mortgage interest rate, age and risk tolerance. If your rate is less than 4 percent, and you are under 50 years old, investing typically makes more mathematical sense because of the historically higher returns in the stock market. But if you’re approaching retirement or seek the peace of mind that comes with owning your home outright, direct your attention to the mortgage. Others meet in the middle: invest for retirement while paying one more mortgage payment annually.
Can I begin investing with $50 a month?
Absolutely. Small sums grow dramatically over the long term through compound interest. Most brokerages now offer the ability to buy fractional shares, so you can invest in any amount. At a rate of 50 dollars per month compounded annually at an interest rate of 8%, that comes out to an overall gain of more than 37,000 over the course of thirty years. Begin with anything you can afford, no matter how little it is.
What if I can’t afford to both pay off my debt and invest?
If budget is extremely tight, prioritize in this way: get what employer match you can (it’s free money), then work on emergency savings ($1,000 minimum) and tackle high-interest debt (anything above 8%). After high-interest debt is erased, divide remaining funds between solidifying your full emergency fund and investing.
Should I quit investing altogether to get out of debt quicker?
If you have high-interest debt (credit cards, payday loans, personal loans above 10%) and no employer match to grab. Otherwise stick with at least some investing, particularly in tax-advantaged retirement accounts. Time in the market is crucial for long-term wealth accumulation.
How do I stay motivated when two goals feel so far in the distance?
Break huge aspirations down into smaller milestones. Rather than feel pressured to be 100% debt-free, celebrate the elimination of each individual debt. Instead of being hung up on a $1 million retirement number, celebrate the landmark of hitting $10,000 first and then increasing the target to $25,000 and finally to $50,000. You can chart your progress visually using a chart or an app. And always remember, consistency is in fact better than perfection — you don’t have to do everything perfectly, just consistently.
Should I contribute to a Roth IRA or pay extra toward my student loan?
This is a judgment call. The Roth IRA grows forever tax free, so that one is good. If you are younger (say, under 40), Roth is most likely the winner since you have decades ahead of you for tax-free growth. If you’re older or have a very low tolerance for debt, paying off the student loans may give you more peace of mind. Numerous people do both — contribute something to the Roth while also making extra student loan payments.
Do I save for my kids’ college or pay down my debt and invest in retirement?
Secure your own oxygen mask first. If you spend your retirement for the sake of your kids’ colleges, it’s conceivable that you become a financial burden for them later. Regaining financial control, even if that takes a while, will make life easier in the long run. Your children can borrow their way through school if need be, but you can’t finance retirement. Many financial advisers suggest this order: emergency fund, employer match, high-interest debt, retirement savings, college savings.
Final Thoughts
It’s not about having to pick one or the other when it comes to debt and investing — it’s all about finding the right mix that makes sense for you. Begin with the tactics that deliver you the most bang for your buck: emergency savings, employer matches and eradicating toxic high-interest debt. Then you can tailor your strategy according to your age, interest rates, tax situation and emotional comfort level.
And always keep in mind that it’s better to make progress than strive for perfection. The guy who’s putting $100 a month toward paying down debt while also investing will be way ahead of his counterpart lying on someone’s couch holding out for his best excuse to start. Hunt recommends this balanced approach, as he writes that someone who follows it won’t have to worry about making “perfect” financial decisions. Act now, course-correct as you go, and continue to progress. Your future self will be grateful for each and every one of those dollars that you used to build a solid financial foundation today.
