The One Simple Reason to Kill Debt Before Investing

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. Josh Holt from The Biglaw Investor 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 the first 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!

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. 🙂

Reprinted with the permission of

12 replies on “The One Simple Reason to Kill Debt Before Investing”

Also in 2018 the new tax law also favors paying down debt if you are no longer going to itemize. If you had a 4% mortgage but could deduct the interest it could very well be considered 3%. But if you are going to take the standard deduction in 2018 (like many more people will including me), than your fixed mortgage rate effectively just rose by your marginal tax rate. Since January 2018, I am leaning more towards paying down what most would consider good debt.

I’ve always been on the side of investing over paying off low interest debt, but I never asked myself the question “Would I borrow money at 3% interest to invest and potentially make 8-10%?”

It’s certainly another way to frame the decision and I may have to reconsider my stance on the debate. I think my main counter argument would be liquidity. Having funds accessible must count for something.

“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%?'”

In many cases, I think you are correct. But as with so much in the personal-finance arena, individual circumstances may support a different result. For example, suppose I am 50 years old and the only debt I have is a student loan, which has a $24,000 balance and a 2.5% interest rate. If I max out my 401(k) contribution at $24,000 instead of paying off the student loan, I will get an immediate tax savings from not having to pay tax on the $24,000 I put into those tax-advantaged retirement accounts. At my tax bracket, I immediately realize a 22% gain on that money, which looks like a better deal than using it to pay off the loan to save 2.5% in interest and then turning around to write a check to Uncle Sam for $5,280. And that doesn’t even account for any employer match I might receive by contributing to the 401(k). In this scenario, the offer is more like “I will loan you this money at 2.5% to invest with a guaranteed return of 22%, plus the possibility of more (through the employer match and growth in the investments).” When put that way, it seems to make sense.

I mean, borrowing money at a low rate of interest and putting it to use in some enterprise to make a higher return is essentially what banks do every day, isn’t it? And other businesses? In principle, borrowing money to invest with the expectation of being able to service the debt and have some left over (profit) is a fundamental commercial activity. Whether it makes sense in a given scenario or not is really a function of the risk/return analysis. In other words, the answer to the question “is borrowing 3% for the chance to make 8-10% sensible?” depends on a number of factors, including the borrower’s own risk tolerance and the nature and length of the investment.

“would I borrow money at 3% interest to invest and potentially make 8-10%?”

The problem here is “potentially.” It would make more sense if it were a guaranteed return (such as a savings account). But it’s not, and never will be, simply because that’s how banks make money – they take your savings account money (and checking, CDs, etc) and loan it out. If savings account rates were ever higher than loan rates, banks (and bank-like institutions such as credit unions) couldn’t exist.

I wouldn’t borrow much to invest because…. yes essentially it is margin.. but when a 3% mortgage effectively becomes 2% after tax optimization it is a small impact for being a little risk averse.

I had the same thought about a year ago and did an entire spreadsheet of calculation. Weather or not to increase my mortgage payments or invest the difference in an investment. The problem is that the margins are too small, tax takes a chunk, and compound interest on the mortgage also plays a factor. After all the calculations, investing the difference did put me in front of increasing the mortgage payment. But it does come along with risk if your investment doesn’t earn what you expected it too

Outstanding post and exactly mirrors my philosophy. I decided to destroy the last of my remaining debt (my home mortgage) and basically funneled all excess cash into that until the balance read 0.

Could I have put the money into the stock market and made more? Given the amazing bull run we had since that time, yes I could have come out quite ahead.

Do I have regrets? No. Hindsight is always 20/20 but at that position in time the stock market could have just as easily gone down.

A great way to look at it is this. Say you have a fully paid off home. Would you take a loan/mortgage out to buy stocks? If you ask anyone who is debt free I guarantee you the majority would say no.

Once you have experienced being completely debt free it is hard to go back.

Well written, I however,completely disagree with the points that were attempted. We must ask ourselves what is our end goal. Is it FIRE? Is it to live debt free while continuing to punch the clock ? If the the answer is the later then by all means pay off every penny of debt and never borrow again. If your goal is FIRE in some form, then wealth accumulation should be a part of your current plan.

No one should want to borrow at 3% to possibly make 8-10%. However, that is not what is happening here. One is borrowing at 3% to have a house to live in or a student loan that allowed that person to make more than their high school diploma would demand. You can’t live in a stock or index fund, etc that you borrowed at 3%. You can’t utilize a stock or index fund, etc at 3% to expand your career to make a higher income. I see more apples to oranges than many of you do

My company matches 30% of my 401k contribution. I am maxing 401k plan as a priority to accelerated debt pay down.

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