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WalletPrep worksheet · Debt

Should you pay off debt or invest?

Name ____________________ Date __________

Key ideas

  1. Paying off debt earns its interest rate. Every dollar that pays off a 24% card saves 24% a year, with no market risk.
  2. Never skip the employer match. A match is an instant return on what you put in, usually bigger than any debt rate. Get it first.
  3. Low-rate debt can wait its turn. For debt under about 4% to 5%, paying the minimum and investing the rest is a common choice.

Vocabulary

Employer match
Money your employer adds to your retirement plan when you contribute, up to a set percentage of your pay.
Minimum payment
The smallest amount you must pay on a credit card or loan by the due date to keep the account in good standing.
401(k)
A retirement savings plan offered through an employer. Money comes straight from your paycheck, often with an employer match.
Emergency fund
Cash set aside only for surprises like a job loss, a car repair or a medical bill. A common goal is 3 to 6 months of essential costs.
Stock
A small piece of ownership in a company. Its price rises and falls with how investors value the business.
Index fund
A mutual fund or ETF that tries to match a market index by holding the investments in it, rather than picking winners.

Work it out

Chris has $650 a month to split between a $4,000 card at 24% APR and an index fund. He already gets his 401(k) match. Assume the fund earns 7% a year, which is not certain.

  1. Card interest, $650/mo to card
  2. Card interest, $150/mo to card
  3. Debt first: invested at month 39
  4. Invest first: invested at month 39
  5. Debt first comes out ahead

Check yourself

  1. Which should usually come first?

    • A. Paying extra on a 3% mortgage
    • B. Investing in a taxable brokerage account
    • C. Contributing enough to get your full 401(k) match

  2. You have $3,000 on a card at 22% APR. Paying it off saves about how much interest in the first year, if the balance would otherwise stay the same?

    • A. $660
    • B. $220
    • C. $300
    • D. $1,320

  3. Your only debt is a 4% car loan, and you have a full emergency fund and the match. What is a common choice?

    • A. Stop all investing until the loan is gone
    • B. Pay the car loan on schedule and invest the extra
    • C. Take a cash advance to pay off the car

Your turn

Write down every debt with its APR. Check that you are getting your full 401(k) match. Then pick the highest-rate debt above about 8% and set an extra automatic payment toward it for your next payday.

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Answer key

Should you pay off debt or invest?

Work it out

  1. Card interest, $650/mo to card$312
  2. Card interest, $150/mo to card$1,773
  3. Debt first: invested at month 39$23,081
  4. Invest first: invested at month 39− $21,902
  5. Debt first comes out ahead= $1,179
  1. Debt first: all $650 goes to the card, which is gone in 7 months with $312 of interest. Then $650 a month goes into the fund.
  2. Invest first: $150 to the card for 39 months ($1,773 of interest) and $500 a month into the fund.
  3. After 39 months the card is paid either way. Debt first has $23,081 invested, invest first has $21,902. $23,081 − $21,902 = $1,179.

Check yourself

  1. C. Contributing enough to get your full 401(k) match The employer match is an instant return on what you put in. It usually beats paying any debt early.
  2. A. $660 $3,000 × 22% = $660 a year, roughly. A sure $660 saved is hard for any investment to beat.
  3. B. Pay the car loan on schedule and invest the extra For low-rate debt, paying the minimum and investing the extra usually comes out ahead over long periods, though returns are never certain.