Should you pay off debt or invest?

Get any employer 401(k) match first, then pay off high-interest debt like credit cards before investing more. For low-rate debt, like a 4% car loan or mortgage, investing alongside the minimum payments usually makes sense, because the expected return can beat the rate, though it is never certain.

A paid-off debt is a sure return

The SEC's investor education office says no investment strategy pays off as well as, or with less risk than, eliminating high-interest debt. Investment returns vary and can be negative. A paid-off balance can't lose value.

The match comes first

If your employer matches 401(k) contributions, put in at least enough to get the full match before paying extra on debt. Skipping it leaves part of your pay on the table.

Rates decide the middle ground

Debt above about 8% usually beats any return you can count on, so pay it first. Below about 4% to 5%, investing alongside the minimum usually wins over long periods. In between, splitting your extra money is reasonable.

Your feelings count too

Some people sleep better with no debt, even at a low rate. Paying a 5% loan early instead of investing costs some expected growth, but it is never a bad use of money.

The order that works for most people

First, save a small emergency fund of about $1,000 so a surprise doesn't land on a card. Second, put enough in your 401(k) to get the full employer match. Third, pay off high-interest debt, like credit cards and personal loans at double-digit rates.

Fourth, grow the emergency fund to 3 to 6 months of essentials. Fifth, invest for retirement, often aiming for 15% of income including any match. Pay low-rate debt like a mortgage or a low-rate car loan on schedule along the way.

How to compare a debt with an investment

A debt's interest rate is a known cost. An investment's return is a guess about the future. A broad stock index fund has gone up over long periods in the past, but it can fall 20% or more in a single year, and past returns don't promise future ones.

That is why the comparison isn't simply 7% versus 6%. A sure 6% from paying off a loan is worth about as much as a higher, uncertain return. The bigger the gap between the debt rate and what you expect to earn, the clearer the choice.

Credit cards and other high-rate debt

Credit card rates are often 20% or more. No realistic investment return beats that reliably. Once you have the match and a starter emergency fund, every extra dollar should go to the highest-rate balance first.

Use the avalanche method (highest rate first) to save the most interest, or the snowball method (smallest balance first) if quick wins keep you going. Either one is better than spreading extra money across everything.

Student loans, car loans and mortgages

These usually have lower rates, often under 8%. For a loan around 3% to 5%, paying the minimum and investing the extra usually comes out ahead over long periods, though not every year.

Federal student loans have extra things to weigh. Income-driven repayment and forgiveness programs can change the math, so paying extra on a loan that may be forgiven could be wasted. Check your options with your loan servicer and on the Federal Student Aid site before you prepay.

When a split makes sense

If your debt is in the middle, around 5% to 8%, you don't have to choose one. Put half of your extra money toward the debt and half into investing. You make progress on both and avoid the regret of guessing wrong.

Revisit the choice when something changes: a raise, a new loan, a rate change on a variable loan or a big drop in the market. The plan should follow your rates and your goals.