3 Reasons You Should Pay Off Your Debt Before Investing

I love when people ask me whether they should pay down debt or get started investing. This means they are being intentional with their money and building wealth! In my opinion someone taking positive steps in any direction is better than nothing. For this reason, I would never shoot down someone’s plan. However, if they are asking for my personal advice I always recommend paying off the debt first. Once your debt is gone you will feel supercharged. You will be able to invest more money and have options as to what direction your personal life will go next.

3 Reasons To Pay Off Your Debt Before Investing

1. Free up your cash flow.

Once your debt is paid off you will have provided yourself with a permanent raise. Every month that you work moving forward you will be able to choose what you do with the money you earn. As of right now your debtors have a contract that tells you what to do with your paycheck. Regardless of if you stay employed or your investments keep providing returns your debtor will be waiting for their payment each month! Free yourself of this burden and keep the cash you make each month.

2. Take the risk-free win.

Many talk about using debt as leverage to get ahead. The idea is you take a loan at say 5% and invest and get a return at 8%. In this scenario you are making a 3% return using other people’s money, brilliant! Although in theory this is true it does not consider the amount of risk you are taking to earn your return. When you pay off your debt you are getting a guaranteed return, you will not pay any more interest on the loan value once it is repaid.

That is why it is so important to pay down any high interest-bearing debt. Don’t get fooled by “cheap money” either although rates are historically low today, values of assets are historically high. This means you are locking in a fat debt obligation regardless of if values revert to the mean over time. Make sure you take the easy win and lock in your guaranteed return when you are still in debt.

3. When a recession hits you will not regret having paid down debt.

It is starting to feel a bit nutty out here lately. I enjoyed Financial Samurai’s post that it is starting to feel like 2007 again. Personally in 2007 I was flying off to Australia with 5K in my pocket and not a care in the world or the realization that things were melting down around me. Therefore, I have no point of reference as to what it was like ahead of the downturn in the work and investing world.

Lately however it feels to me as though it might have before the last downturn. Over night people are becoming Bitcoin millionaires, housing is out of control, and the no one can lose mentality is back in full force. Those who are flying high taking risks today can be wiped out if they are not well positioned tomorrow. There is a reason companies with “clean balance sheets” or low debt obligations are more valuable than those that are loaded down with debt. Create your own “clean balance sheet” and make sure you can handle anything life throws at you.

Final Thoughts

Once you have paid off your debts you will be able to take more risks investing and swing for the fences. Until that point I think everyone should position themselves to succeed by ditching the debt. Don’t feel like you are missing out there will always be another investing opportunity.

What Are Your Thoughts?
  1. What types of debt do you hold today?
  2. If you are debt free do you regret it?
  3. What is your plan to pay off your debt?

Spread The Wealth!

30 Comments on “3 Reasons You Should Pay Off Your Debt Before Investing”

  1. Great points. On your questions:

    1. What types of debt do you hold today? – None. The only debt we intermittedly have is the balances on our credit card that we pay off in full each month.

    2. If you are debt free do you regret it? – Never. We’ve never had debt, but the one time that we came close there seemed to be a weight on us. Mrs. BD was going to grad school in New York. She had the option of NYU or Baruch (a state college in the city system). NYU is famous and top notch. Baruch is still a very good school, but didn’t have the “halo” effect some might get when thinking of NYU. In the end, Mrs. BD opted to go with Baruch because it costs probably ~$50-60k less than NYU.

    3. What is your plan to pay off your debt? – Never get into it in the first place. Understood that’s not always a possibility for some, but it’s important to try.

    1. Do you feel like Mrs. BD career was held back at all by not attending NYU? I think that weighing big college names and prices is something that millions of people face when choosing their education path. That is great you have stayed out of debt your whole life I am sure it has served you well and put you ahead financially.

      1. I don’t think so, but Mrs. BD initially did in terms of potential networking opportunities. No doubt, NYU is a fantastic school.

        As you mentioned, a lot of people do face a similar decision. While it can make a difference for a particular field or career, there is a balance of cost vs. perceived value (let alone actual value).

        1. Completely agree also once you get in a field the degree tends to not matter as much as the work you actually produce.

  2. Great post!

    Haha I admit I took the risk to invest in equity funds/stocks (as well as housing which means more leverage) before paying off student debt. Of course, luck played a role so far (knocking on wood)……..

    I honestly feel like I should just pay off my remaining student loan now because Canadian rates are going up. I admit that we’re more leveraged compared to most and if anything bad happens, we’re going to go downnnnn. Debt is a double edged sword! I won’t lie — I’ve been addicted to the bulls and it’s time to lower my expectations.

    1. I would say pay off your student debt for sure. It is a huge weight lifted off your shoulders and no one knows where things are headed. Today just so happened to be one of those days that reminds everyone that things can change oh so quickly in the markets.

    1. Agreed Steve, I think it sets you up to win down the road. Companies can use debt to grow the business, rental properties can use debt to leverage growth but as an individual you reward yourself with flexibility when you lower your monthly obligations.

  3. First, Josh at MoneyLifeWax, and now YOU? Man, I’ve gotta start thinking about paying off what’s left of our student loans I guess. They’re sitting at 2% interest, so it’s hard for me to justify paying more than the minimum payment. What’s an aspiring early retiree to do???

    1. Man 2% is a tough one to go after. It is not a one size fits all plan that is for sure. If you are comfortable carrying it then so be it. I have to say though the freedom that you have when you do not have to send off money each month is pretty fantastic feels like you can be more aggressive with your investing when you deploy money. I have a feeling you will be just fine either way!

  4. This is really great advice. Yes it is always great to have your debt paid off first. I’ve never been one to be able to handle debt so I have always made sure it was paid off. Even having side jobs at times to make sure I was able to pay it off. Debt is just a bit too hard for me to handle.

    1. You did handle it! Congratulations on being conscious and responsible, hopefully it has put you in a position where you are able to invest for your future.

  5. I have to disagree with you here. A few years back I advocated for investing even while in debt and it got a lot of comments. Of ~50 comments, only 3 were supportive. Then I did a couple of posts showing mathematically how much money you are leaving on the table if you pay off low-interest debt instead of invest, and not a single person disagreed, and they admitted what I was hoping they would: paying off low interest debt isn’t mathematically correct, but for some the psychological gains outweighed them.

    With my company’s stock alone going up 45% (it’s in the DOW, so not a high growth speculative stock), I’m really glad I didn’t sell stocks to pay off debt. Yes, that’s just a 1-year sample, but if you look at 5, 7, 10, 15, etc. years you will see that it simply doesn’t make sense to wait until all your debt is gone before investing.

    1. Solid point! I am happy to hear that it worked out in your favor.

      I don’t think that it is a one size fits all answer. While I understand and agree that mathematically if you carry a low interest loan and invest wisely on average you “should” come out ahead I don’t think that takes into account the whole financial picture.

      For example for many young millennials who are starting to invest now they will be investing into assets that are at historically high multiples. I would hate to see someone invest like crazy for the next 18 months in stocks holding student loan debt and then experience a 50% pull back (not out of the question). New investors could get spooked out of the market and sell at losses and then still be stuck with the student loans.

      Additionally, I think having no debt obligations gives the confidence needed to make moves in your career. For most young people increasing income is going to be so important to be able to even get to a point where they can put it away. Under a scenario where they are carrying large amounts of debt I think it would make many second guess taking that leap of faith because they need their current income to pay the bills.

      Everyone has to ultimately do what works for them, great input.

      1. I would actually say having an emergency fund is even more important as long as you can keep up with minimum payments. That will give you the extra insurance needed to pursue a strategy like YAM suggests above. To your point on markets being at high multiples, that holds true irrespective of whether you are in debt or not. Just that the risk for someone in debt is higher. Another reason, why I believe an emergency fund is mandatory

  6. You’re right, it does feel a bit nutty around here. The bitcoin madness is mind boggling.

    I have some mortgage debt and can pay it off technically if I wanted to. It will be going down to 5 figures soon, hopefully! My plan is to continue to be ‘slow and steady’ with the mortgage pay down and continue with the investment contributions. I’d rather be more diversified than just have 100% real estate, know what I mean?

    1. Absolutely, I am not in the group of paying off the mortgage ahead of investing. I am speaking more so to the consumer debt side of things including student loans which you can’t even shake off if you were to fall into bankruptcy.

    1. I think that is a pretty awesome way of positioning yourself. Taking advantage of the tax benefits is a controllable easy win for your retirement accounts. If you love the home you are in I think working towards paying it off is also a very smart way to retiring early. I would not feel comfortable carrying a mortgage and retiring at say 40, personally for me having the house paid off is a part of my plan before I would retire.

  7. Counterarguments as follows:

    1) Frees up cash flow – paying off debt does free up cash flow in the sense that you don’t have to make the monthly payments anymore. But that isn’t relevant to the debate of to invest or to pay off debt. The very heart of the question implies that you have excess cash flow beyond your basic needs, it’s a question of what to do with it.

    Besides, being in debt also happens to free up cash flow because you can spread out the cash expense of a big ticket item over time. We just bought a new car (I know, I know…*gasp*, *the horror!* etc.). I got 0% financing for 48 months. We could have paid cash, but why would we when we can keep it and spread out our payments over four years?

    Remember: investing in growing assets or income producing assets also gives you a “permanent raise”.

    2) Risk-free win – not so fast. There is no free lunch and there’s no such thing as a “risk-free” investment…and make no mistake that paying down debt is an INVESTMENT. So maybe my 0% car loan was an extreme example. Our home loan is a bit more nuanced since we actually have to pay interest on that.

    We have a 4% mortgage on our house. If I pay down the principal I lock-in a 4% return by eliminating future interest, right?

    Not exactly. I know that I’ve definitely eliminated 4% in interest, but who knows what will happen to the underlying asset. It’s not really a “risk-free” 4%, I’m just investing in a very specific piece of real estate. Hopefully the house appreciates or at least holds its real value relative to inflation, but that’s far from guaranteed.

    3) No regrets – meh maybe. Who knows what the next recession will look like, but it would not necessarily be a surprise if it includes high inflation rates. Let’s circle back to Econ101. In a high inflation environment, is it better to be a debtor or a saver?

    When a fiat currency loses value the saver doesn’t have as much and the debtor doesn’t owe as much.

    If the dollar is spiraling, I would DEEPLY regret having made a bunch of extra principal payments with more valuable dollars, when I could have just let inflation wipe the debt out for me.

    And now to answer your questions:
    1) We are far from debt free. We are about 60% leveraged if you include the iliquid value of our real assets in our net worth. We are looking to buy more property which will mean more debt.

    2) I regret not using leverage more strategically earlier in my investing career. I used to be debt-free but I wasn’t building wealth either. I mostly drank a lot of beer.

    3) Property #1 is currently being paid off by tenants. Property #2 (our current house) will eventually be put into the same program. We already have the cash to pay off the car, we’re just not doing it yet because 0% interest. Maybe tenants pay off the debt in full or we liquidate the assets. We’ll have to see how it plays out.

    Anyway, sorry to poop in your listicle punch bowl. I don’t mean to minimize the value of paying down debt. It’s an important thing to consider and in a lot of cases really is the right choice. Especially when the debt is subject to higher interest rates.

    It’s just that the PF blogosphere all sings the same old song constantly and I feel like nobody sticks up for leverage, which can be a very beautiful thing.

    I enjoyed the post and what I’ve seen of the site so far. Keep up the good work.

    1. Haha first of all love the comment about how you were mostly drinking beer and the poop in the listicle punch bowl!

      I really enjoyed reading your points and I think it is important that everyone thinks independently. I dislike how so much of the finance community just tends to agree with each other on every point we all make. We should be challenging each other to think differently and be learning from others opinions.

      To put some context around this listicle punch bowl I was just focusing on my perspective and what has worked for me. Ditching the debt has been a great way to feel confident at 27 that I can maneuver freely in whatever life may throw at me and that is a personal choice.

      Whomever used leverage in the last 7 years will look like a wizard and a hero but we all know that there is the possibility of more challenging times ahead. That is why I feel it is important to teach others that they don’t necessarily need debt to get ahead. Many people first need to grasp the basics of finance before they can confidently borrow money to invest.

      Your strategy makes sense though and I can certainly appreciate the perspective. I carry a mortgage and that is all the debt I choose to have, this has given me the stomach to invest in equities 100% and has rewarded me as well as everyone else over this bull run. I also feel confident that when a possible down turn does come I will be well positioned to take advantage and have the guts to stay fully invested at 100%. I think many investors of my age group have only seen the good and I like to make sure I am keeping a level head and avoid the irrational exuberance.

      Really appreciate your detailed comment and no worries on taking a dump, I certainly hope you will stop by to relieve yourself in the future.

  8. I generally agree, mostly because of the cash flow reason. Having the extra cash flow is great.

    But it doesn’t make as much sense when you’re talking low interest loans like mortgages or maybe student loans. At that point the historic math says that investing will probably be a better bet.

    As far as ‘risk free’ goes – it isn’t risk free, it’s just guaranteed. There’s definitely risk – particularly if you think of a scenario of someone incrementally whittling down their mortgage balance each month but putting off some investing. Doing so exposes them to risk – for example if they lose their job, they still have a balance that needs to be paid toward the mortgage, but may find that they have insufficient cash flow or investments to liquidate to help cover that cost.

    That’s the real risk when it comes to paying down your mortgage IMO.

    Sure the historic math also says that investing tends to win, but just looking at numbers doesn’t do that predicament justice. There are psychological benefits. Physically sleeping better at night has value, it’s just next to impossible to put a number on it.

    Honestly though if you’re making a concerted effort to do one (or both) you’re better off than most other people which is awesome. I think as long as you understand the risks you’re taking (and avoiding) with whatever strategy you follow, that’s what’s important. Everyone’s risk tolerant and goals are different, so trying to use some blanket statement like “investing is always better than paying down debt” or vice versa is probably misguided without some additional context.

    1. Hey Dave,

      Good points I can see where you are coming from on all of them. There is risk in paying down your mortgage for those who are not adequately equipped to maneuver should a job loss or drop in income occur. I have found my balance and am investing heavily in the markets while paying down the mortgage.

      I would agree with you though that if you are at the point to debate both you are doing great. I max out all tax advantaged accounts ahead of paying down my mortgage just for clarity. I think I should of been a bit more specific in the article! Thanks for your input.

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