Pay off debt while saving and investing?

Not personalized financial advice - your money, your choice

46%. That’s how many Americans have some form of revolving credit card debt.

It’s also the portion of Americans who will be diagnosed with some form of mental health condition in their lives - hopefully just a coincidence. 

Credit card debt can be especially tricky to pay off due to high interest rates. Debt like this tends to grow faster than mold fuzzes on fresh mozzarella - it accrues at an average of 22.28%. 

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That $100 of debt grows to nearly $125 after the first year. 

This gets exacerbated with more money. Add a 0 to each of those numbers so $100 >>> $1,000 and $125 >>> $1,250. 

Many people will also continue to spend when they already have credit card debt, so as their total debt grows, the interest accrues even faster.

This makes saving and investing even harder when there is rapidly growing high-interest debt. 

With the stock market, where the S&P 500 has returned 7% (inflation-adjusted) over the last 10 years, paying off debt that is growing at an estimated 19% (inflation-adjusted) is a higher priority.

I prefer the above method, where high-interest debt is prioritized over investing, especially if gains on funds invested won’t outpace the debt. 

If the situation were flipped and I had a student loan at 3% interest but knew my investments could return 7% then I’d favor investing first. 

Then, I’d take as much time as possible to pay off the student loans while investing the rest of my available funds.

Decision-making is hard if interest rates are more similar. For example, if I had a car loan at a 6.59% interest rate, should I pay that down first or invest first? 

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This is a situation where a mixed strategy may be helpful; investing doesn't need to stop, as it is still likely to outpace the growth of debt. 

The compounding effect of both debt and investment growth is similar, so I would decide to pay the car loan a bit faster (like paying off a car loan in 12 months vs 48 months).

Doing something like this would minimize interest paid while also allowing me to continue investing without stopping or selling investments.

If I prioritize paying off high-interest debt first, then investing, until the interest rates get below a certain amount.

Dave Ramsey takes a different approach. 

In the debt snowball method, he instructs people to pay off the smallest dollar amount of debt first, then the next biggest, and so on. The rationale is that it will feel good to get that piece of debt off your plate. 

While this doesn’t make the most sense for minimizing interest paid, it does play into the psychology of people & helps us reduce cognitive load by obliterating lines of credit. 

Getting rid of one piece of debt, then another, can feel like building momentum - or a snowball rolling down the hill.

Unfortunately, like the answer to many personal finance questions, the answer to how one should pay off debt largely depends on what is best for the individual.  

This is based on both their personal situation and their own psychology.

Some people feel that paying off the lower-interest debt on smaller loans first makes no sense. 

To others, this may make perfect sense. They just want to get ONE loan completely out of sight, then move on to the next one.

It can be hard to decide, but chances are one feels more ‘right’.

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