The One Simple Reason to Kill Debt Before Investing

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It’s an age-old question: should you pay off debt or save/invest first?

At the end of last week, I read an interesting guest post about student loans and asset allocation written by The Physician Philosopher (“TPP”) for Physician on Fire‘s (“PoF”) blog.

In it TPP talked about the diversification his student loans provide for his investment portfolio because of the guaranteed return he gets as he pays them off.

He mentioned that he and his wife max all available retirement accounts before paying extra on his loans. He plans to be finished paying them off within two years after he finishes his fellowship training.

The argument for aggressively investing while paying off debt

TPP and I got into a heated debate quite civil discussion in the comments section about whether it’s better to pay off loans before investing or to invest as much as possible while paying off debt.

My understanding of his argument is (1) your savings rate is the strongest determining factor in your ability to reach financial independence/early retirement quickly, and (2) as high income earners, we can afford to do both.

He’s not alone. Others in the personal finance community also argue for investing as much as possible while paying off debt. Joshua Holt from The Biglaw Investor, for example, makes a similar argument (and is actually part of the reason we were maxing our accounts up until last year).

I get it, especially if you’ve refinanced your loans to a lower interest rate. Why pour money into paying down a loan at 3% interest when you could make 8-10% if you invested it instead? Basic math tells us that 8 or 10 is greater than 3.

Why that argument doesn’t work

This is about more than math. It’s also about risk.

If you turn the question around, you’ll see what I mean. Rather than “should I pay the minimum on this loan at 3% interest so I can invest and make 8-10%?” ask yourself “would I borrow money at 3% interest to invest and potentially make 8-10%?”


When you look at the question that way, the risk is more in-your-face.

The thing is, though, borrowing at 3% interest to invest is really no different from holding onto a loan at 3% interest to invest.

When you invest while you’re in debt, any losses in the market are magnified by the fact that you’re essentially buying on margin. Each dip in the market leads to a far greater effective loss to your portfolio.

In his commentary on TPP’s post, PoF gave an example that clearly illustrates the risks of such investments:

“[L]et’s say he’s got $110,000 invested in stocks and $100,000 remaining on his student loans. Leaving out other assets for the sake of simplicity, he’s got a net worth of $10,000 and $100,000 is invested in stocks. That’s like a 1,000% stock allocation. A 10% drop in the value of the stock market (like we had last month) would wipe out his entire net worth!”

Moreover, every dollar you pay in interest is a dollar that can’t work for you to help you reach your goals. Wouldn’t you rather be on the other side of this equation earning interest, rather than paying it out?

The sooner you pay off your debt, the sooner you can pour all of your extra income into your investments. To one of TPP’s points, your savings rate would be higher, as well, because you no longer have creditors claiming huge chunks of your money before it even hits your bank account.

I’ve got Warren Buffett and Mr. Money Mustache on my side

Warren Buffett, arguably the greatest investor of our time, strongly warns against using borrowed money to purchase investments in his latest letter to shareholders.

Quoting Rudyard Kipling’s “If,” he sagely advises against investing while burdened by debt so that you’re more likely to “keep your head when all about you are losing theirs” in a market downturn.

I don’t know about you, but I trust the Oracle’s judgment.

Another wise money man, Mr. Money Mustache, yelled at me and put me to shame through the interwebs about my huge, flaming debt emergency.

I’ll be the first to admit that “Mustachian” is not a word anyone would use to describe me…and not just because people who know me don’t know what “Mustachian” means. 🙂

Nevertheless, I can’t disagree with wisdom:

“If you still have a car loan, credit card, department store or even a student loan debt, you should destroy that as a prerequisite to beginning the more relaxed stage of saving for financial independence. At the later stages, you can start to take it easy, but right now is the time for some hard work.” — MMM

Well-said, MMM. Well-said.

The difference for us

As I mentioned, up until last year, we were maxing our retirement accounts and investing heavily. A few months into our debt payoff journey, we decided to back down the investments to focus on paying off our debt as quickly as possible.

Guys, backing down on investing has made a HUGE impact on our progress.

Last year, we paid off a little under $50,000. In the first two months of this year, we’ve already paid off over $21,000! (See our January and February updates for more details.)

Our decision to decrease our investments is not the only factor in our increased payoff this year, but that decision jump-started our journey and has been a major factor in our progress.

Once we pay off our debt, we’ll be able to invest to our heart’s content to reach our financial goals without worrying about debt dragging our income down.

At the end of the day, personal finance is personal, so neither argument is truly wrong.

But as I told TPP, one is definitely more right than the other. 🙂

What do you think: pay off debt or save/invest first? Why?

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The Physician Philosopher

Love it! And you are pulling at my heart strings, too. The poem you mentioned (If by Rudyard Kipling) is hands down my favorite poem of all time! I feel bad saying anything contrarian to what you have said now! But I still will 🙂

I think that there is probably a break point where you argument is more right than mine. If your debt to income ratio has crept to the point where your debt either A) causes you to lose sleep at night, or B) will require you to make payments for longer than 3-4 years after finishing school/training then it is probably worth scrimping a little on the investment side of things to pay off more debt.

The problem for me is this, if your debt is in that situation you also likely fit into the “Should have done PSLF” group. In which case, you are trying to make the minimum payments in order to be forgiven at ten years/120 payments. I recommend that anyone who has a debt to income ratio of 1 or higher (i.e. $200,000 in debt and makes $200,000 in income) to consider PSLF. If its greater than or equal to 2…then you really should have done PSLF. If, for whatever reason, you are not pursuing PSLF in that situation, then I 100% absolutely whole-heartedly agree that you need to be hammering away at your debt.

I would say that not investing at all (not at least getting your employer match for example) is just wrong. No opinion needed. It doesn’t sound like you do that, though. You’ve just cut back to put more money into debt. I can’t argue with that.

I appreciate your thoughtful post and your line of thought! That’s one thing I love about this personal finance community. We can have very reasonable people on both sides of the fight. As I always say, as long as you are making an intentional decision that makes both your head and your heart happy, you will not find me in disagreement!

Thanks for your comment, TPP. Thorough, as always.

With respect to your comment on PSLF, remember that not everyone can take advantage of that program. To your credit, I think you were specifically thinking about doctors, but I’ve got a number of friends from law school who have an amount in student loans equal to their Biglaw salaries. Mine wasn’t quite 1:1, but it was close. The government is not forgiving that no matter how much we ask. 🙂

That being said, D is in the PSLF program, but we don’t plan on letting his loans hang around for 10 years. We’ve got a 5 year plan to be completely finished with our student loans and our mortgage.

I agree that at our income levels, we should invest at least something while paying off debt, especially given our (my husband’s and my) timeline for paying ours off. I think it would be difficult to make progress either way if we made less and were trying to do both, though. In that situation, if the person could pay off the debt within a year or 2, I actually would recommend holding off on investing to focus on paying off the debt. Paying more money than the original cost is what really gets me. I want to minimize the additional amount paid as much as possible.

Completely agree about our community being the best. I love seeing how others think about these issues, and even if I don’t agree, I can usually understand their position.

Biglaw Investor

J – I need to re-read my post! Ironically, I’m actually in your camp when it comes to paying off debt and often use that same argument (i.e. would you borrow money at 3% to invest in the market and get an expected 8% return? The answer is almost always no because as Warren Buffett would say, “Investing on margin is dumb.”). I’ve had the good fortune of interacting with dozens of lawyer millionaires and it’s a rare case where they’re still holding onto low-interest student loan debt. Most pay it off quickly in their careers.

The lesson I tried to impart in my post is that I spent the first three years of practice skipping my 401(k) contributions because I wanted to get rid of the debt ASAP. Keep in mind that I wasn’t able to refinance my loans, so the rates were 6-8% and much higher than someone would have to pay today. In hindsight, I’ve realized that I wish I would have maxed out my 401(k) AND paid aggressively toward debt. With a Biglaw salary, I had enough money to do both and from a behavioral finance perspective I think it would have encouraged me to save even more money (the 401(k) would have been automatic and each month I would have been motivated to throw as much as I could toward the debt, since getting out of debt was a driving force).

Ultimately, personal finance is personal and you certainly can’t be faulted for throwing all the money toward your debt. Good things will come!


Thanks so much for your comment, Josh! Our views are very similar, but the difference is that you believe it’s better to max out your 401(k) while paying off debt aggressively if you have the income to do that. I would rather pay off debt even more aggressively by not maxing and use that extra to get out of debt faster.

As you said, personal finance is personal. As long as we’re moving in the right direction (i.e., not going into debt), I think we’re all doing it right. 🙂

Megan Nichole | The LaziMILLENNIAL Movement

Awesome post! I recently shifted my strategy from TPP’s to Warren Buffett’s/Mr. Money Mustache’s after realizing that government contractors don’t (automatically) qualify for PSLF :-(.

It’ll be a long road for me either way!

Thanks, Megan! It will be a long road for us, too, but it will be so worth it in the end. Identify why you’re doing it, and that will help keep you motivated. For us, it’s that we don’t want to miss out on our kid growing up because we have to work so much.

You can do it! Just don’t quit. 🙂 I’m happy to help in any way I can.

To me, the answer is to invest in the 401(k) (and HSA) before extra loan paydown. In the case of investing in tax-sheltered accounts, I think to say “would I borrow money at 3% interest to invest and potentially make 8-10%?” oversimplifies the choice.

Our remaining loans are just under 3% fixed and the interest is not tax deductible at our income level. Therefore, in our case I view the question as: “Would I rather invest $18,500 in a tax sheltered account and potentially make 8-10% annually or pay down ~$12,000 (after taxes) of my loan balance at 3%?”

We have the cash flow to handle investing while paying down debt. So, I want to put as much of my income to use as possible. Investing in a pre-tax account allows me to do that. Add in any possible employer match, and that’s icing on the cake.

Thanks, DA! I agree that an employer match is icing on the cake. We invest up to my husband’s match to get that free money. We’re putting the same amount in my 401(k), although my employer doesn’t offer a match.

It’s great that you have a plan that’s working for you. I wish you all the best in reaching your financial goals (but I still disagree with your strategy) 🙂

A very good topic and a serious one at that. Serious in that the ramifications are very significant. And there are many good arguments to be made on both sides.

I am of the “Both but not equally” school of thought.

I think that when there is a high level of debt, then a overwhelming majority of funds should go to paying off debt. No question about it.

If debt is small and manageable (what kind of debt really is?), then IMHO most money should go to debt.

In both cases, some funds for investment. In a situation of large debt, something very small like 5% or even less. Where debt is small and manageable, then a little more, like 10-15%. Why do I say this?

If you put 100% towards debt, then when you reach 0% and have paid off all debt, you are then starting investing from basically zero.

If you have some initial leverage (namely, a little investments under your belt), then you are not starting from scratch in the investment world when your debt reaches zero. With even small investments along the way when paying off debt, you have dollar cost averaged into investing with even the small percentages. So you have something to show for all the struggle. And if you have some income from your investments, namely dividends accrued, you are doing that much better.

That’s my view.

Thanks for your comment! I agree with a lot of your viewpoint with the caveat that, for me, much of the decision to invest while paying off debt is tied to income. If you make enough to significantly pay on your debt while investing a little bit, by all means go for it. If it’s going to take you a while to pay your debt off (say longer than 2-3 years), I’d also go for it. We’re investing in retirement enough to get the match from my husband’s employer because (1) we make enough to still aggressively pay down our debt, and (2) it’s going to take us a while. 🙂

If your debt is small, such that it won’t take very long to pay off, I say regardless of income, focus on paying off the debt. I agree that you’ll be starting investing at zero, but you’ll be able to invest a much larger percentage of your income, and your investment gains won’t be offset by all the interest you’re paying on your debt.

In all cases, I recommend having at least a month’s worth of expenses saved in case of emergency (the exact amount depends on your situation), but I wouldn’t go so far as to fully fund an emergency fund.

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