What's Better? Should You Pay Off Debt or Invest?

Let’s just get this out of the way first…this question is so personal that there is no absolute answer. Not in this post, on this blog, or anywhere else out there. But, the question of “invest vs. pay off debt” comes up so frequently that I really want to help provide a guide for thinking through your individual scenario to figure out what is best for you.

pay off debt vs. invest — Which path will you take?

Let’s start with paying off debt

What are the pros?

Minimize liabilities and maximize your “margin”
- Remember, your margin is what you earn minus what you spend
Increase your cash flow
- Once you no longer have to pay monthly debt payments, all that money just goes in your pocket
Increase your net worth 1:1
- Each dollar paid to lower your debt increases your net worth by $1. Few to no other investments do that
Improve your mental health
- There is something about debt that makes it always seem like it’s hanging over your head. Even if you know that you are investing that money in something with a greater theoretical yield. I’ve never met anyone that was unhappy they had no debt. That means something
Behavioral advantage
- By this, I mean that paying off debt is a very good way to build financial discipline. I’ve also never met anyone whop paid off their debt and then went into a personal financial crisis. Paying off your debt builds good financial behavior overall
It’s guaranteed
- Paying off your debt gives you a guaranteed return equal to the interest rate on your debt. Have 8% debt? Paying it off gives you an automatic and non-negotiable 8% return!

Now onto the cons off paying off debt

Theoretical loss of return
- If your debt is at an interest rate of 4% and you can invest in broadly diversified index funds with an expected return of 7%, you lose a theoretical 3% of return by paying off debt. But remember, your debt return is guaranteed. Investing return is never guaranteed
Lack of “investment momentum”
- After you make a payment to your debt, your money stops working for you. So the momentum of your money is minimal
- However, a different kind of momentum comes into play when paying off your loans. And that is the fact that your monthly payments increase as you keep paying off more and more loans. So as you go, you will pay off loans faster and faster
Theoretical loss of future loan forgiveness
- There is talk in the current political climate of forgiving some portion of student loans. I’m not sure if this will happen. But currently it is no where close to happening. And high-income earners like physicians will probably be phased out of any advantages. But it could happen…

I honestly cannot think of another potential disadvantage of paying off debt. If you can think of one, leave it in the comments below or email me. Seriously!

What about the pros and cons of investing?

Here are the pros…

Make your money work for you
Your money keeps working for you even after the first investment payment
Grow your margin
Achieve theoretically (and often realistically) higher returns
Take advantage of interest arbitrage
- I.e. You have loans with a 3% interest rate and instead of paying off, invest for a theoretical return of 7%. Your interest arbitrage is 4%. Invest in things like real estate and this can be potentially higher

And the cons…

Investment returns are not guaranteed
Past performance is not a predictor of future performance
- Investment advisors are required by law to provide this disclosure to their clients
Risk of over-leverage
- Paying off debt has minimal investment momentum as we discussed. Meanwhile, investments have potentially endless forward momentum when leverage is added in. The problem is that with more leverage comes more risk if the investment doesn’t pan out. If you lose $100,000 in an investment that was supposed to net you 15% returns, I bet you’ll wish you had just used it to pay off loans
Behavioral disadvantage
- See example above. If your “investing” becomes gambling, that’s a very bad thing. Build a solid foundation with solid principles first

How can you figure out what you should do – pay off debt or invest?

Well, you have to weigh your individual or family circumstances.

Answering the following questions will help:

Do you have high interest debt (>8%)?
- This includes things like credit card debt or hard money loans
- If the answer is yes, you need to pay this debt off first before you invest

Do you have an emergency fund?
- If the answer is no, “invest” in this first before investing elsewhere or paying off more debt

Do you have medium interest loans (~3-7%)?
- This is where it gets sticky
- I lean towards paying this off for all of the advantages I listed above
- With that being said, I do invest some of my money in real estate instead of paying all of it to these loans
- So I think a wise option is at least splitting it up. Pay more than the minimum on loans. Also invest some. Win-win.
- For me and Selenid, we are happy to invest money as long as we stay on track to pay off all ~~our~~ my student loans in 5 years or less

Do you have an unbelievable investment opportunity presented to you with amazingly high returns?
- If the answer is yes, please pay off your debt instead
- Investing the right way is a marathon. Investing in index funds is a marathon. Even investing wisely in real estate is a marathon
- If anyone tells you they have a short cut, run. Take the guaranteed returns of paying off debt

An exception that proves the rule

As you can see, I am definitely more in favor of paying off debt in my situation. Once I pay it off, I will have even more to invest. And then that money will make me even more money.

However, there is one good exception to this rule. This morning I gave a talk to the general surgery residents at Harvard, and one of them asked about this exact scenario.

The PSLF paradox

If you are going to qualify for PSLF, pay the minimum income based repayment amounts for your loans. And invest the rest of your money. There is no sense paying more to the loans when they will be forgiven in the future.

But otherwise, I say that debt wins the loans vs. invest argument.

However, it’s win-win

Pay off debt. Or invest*. (*Invest wisely)

They are both good things that will build financial success, increase your financial well-being, and lead to financial freedom when done right.

Is one sometimes better than the other? Yes. But they are always a pretty close together step #1 and step #2, no matter which currently holds the top spot in your situation.

Take the steps to figure put your strategy!

Essentially, this is exactly what a written financial plan does!

And then…don’t tell anyone about it…just kidding…but only kinda. But what I mean to say is that people will have a ton of opinions about your financial plan in general.

But nothing gets people fired up like the debates between investing or paying off debt.

So, if you don’t feel like getting in to it or just don’t want to continually second guess, just keep your plan to yourself. Trust your plan. Why? Because only you are in your position and know what is the best plan for you!

Anyway…

Here are a bunch of posts to help you create your own financial plan:

the prudent plastic surgeon graduating to success

Or, you can sign up for my course, Graduating to Success, which will teach you all of the personal finance strategies you need to achieve financial well-being, including writing your very own financial plan!

What do you think? Should you invest or pay loans first? What are you currently doing? Has your strategy changed at all? Let us know in the comments below!

Like the blog?! Don’t forget to join our Facebook group and sign up for our weekly newsletter using the form below!

2 thoughts on “What’s Better? Should You Pay Off Debt or Invest?”

MarkSanDiego
July 8, 2021 at 2:59 am
There is actually an answer to this question, assuming you have emergency funds in savings. The answer is to compare the after tax interest rate of the debt to the after tax rate of the investment. Put your money towards which ever is higher. Estimate your investment gains on the conservative side, since they there is risk your estimate may be incorrect.
If the after tax gain estimate for the investment is very close to the after tax interest rate, then paying off debt is safer since the debt interest rate should not vary, but the investment after tax gain may.
You must also consider the ability to reborrow if you pay off debt and at what rate your new debt will be. Also, the time to reborrow may impact your decision, as refinancing can take time.
- The Prudent Plastic Surgeon
  July 8, 2021 at 6:20 am
  Thanks for your comments Mark! What your describing is basically integrate arbitrage. And I definitely don’t disagree with the cold hard rational of that argument. But I think there is a big behavioral component to this decision that can’t be ignored. And that will vary person to person…muddying the waters a bit