Pay down debt vs. invest | How to choose | Fidelity (2024)

Table of Contents
Key takeaways The rule of 6% How to adjust When to consider our guideline More on our methodology2 Looking for help with investing? Looking for more ideas and insights? Thanks for subscribing! We're on our way, but not quite there yet Oh, hello again! Thanks for subscribing to Looking for more ideas and insights? You might like these too: Fidelity Viewpoints® Decode Crypto Fidelity Smart Money℠ Active Investor Insights from Fidelity Wealth Management ℠ Women Talk Money Educational Webinars and Events FAQs

A simple guideline to help you decide which to prioritize.

Fidelity Viewpoints

Pay down debt vs. invest | How to choose | Fidelity (1)

Key takeaways

  • If the interest rate on your debt is 6% or greater, you should generally pay down debt before investing additional dollars toward retirement.
  • This guideline assumes that you've already put away some emergency savings, you've fully captured any employer match, and you've paid off any credit card debt.
  • It also assumes that you're investing in a tax-advantaged account and that the interest on your debt is not tax-deductible.
  • While 6% is typically the critical number if you have a balanced asset allocation, the right number for you may be higher or lower.

Choosing between paying down debt and investing can be like trying to solve a riddle.

If you've ever tried to work out the answer, you've probably run into some version of this advice: Compare the interest rate on your debt with the return you expect to earn on your investments, and put the money toward the option with the higher percentage figure.

While that advice might make sense in theory, it isn't exactly easy to put into practice. Plus, even seasoned experts find it difficult to forecast precise return rates, so it hardly seems sound to base your decision on a single number plucked out of thin air.

The rule of 6%

So we crunched the numbers to come up with a clearer formula (more on our methodology below). Our conclusion? For many people, it generally makes sense to first pay down any debt with an interest rate of 6% or greater. This assumes you have at least 10 years before retirement, that you're investing in a balanced portfolio with about a 50% allocation to stocks, and that you're investing in a tax-advantaged account, such as a 401(k) or IRA.

Pay down debt vs. invest | How to choose | Fidelity (2)

If the interest rate on your debt is less than 6% (and again, based on our set of assumptions), it likely makes more sense to invest those extra dollars instead. That's because at lower interest rates, there's a greater chance your long-term investing returns will beat the bang for your buck you'd get by paying your debt off faster.

How to adjust

Although 6% is the number to remember if you have a balanced asset allocation, you can consider a higher (or lower) threshold if you invest more (or less) aggressively. Here's what the critical number looks like at different levels of aggressiveness, in each case considering a 35-year-old investing for retirement in a tax-advantaged account.1

Why does the relevant figure change with your asset allocation? A less aggressive investment mix, meaning one with a lower allocation to stocks, may be expected to result in slightly lower returns (on average) over the long run. And with slightly lower expected returns on investing, paying down debt comes out ahead even at slightly lower interest rates.

The reverse goes for a more aggressive asset allocation. A greater allocation to stocks may result in higher expected returns on your investments, which means investing may come out ahead over the long term even if your debt has a slightly higher interest rate.

When to consider our guideline

While the rule of 6% is easy to remember, there's some fine print to understand before you try putting it into action. Namely, you should make sure you're checking off a few other boxes on your financial to-do list first, before you even get to the question of paying off debt or investing.

Pay down debt vs. invest | How to choose | Fidelity (4)

Why do these other tasks take priority? Paying your minimums, socking away a cash buffer for emergencies, and digging out of any credit card debt are crucial to establishing basic financial security (plus protecting your credit score), so that your finances could survive any unexpected curveballs life might throw your way. And an employer match is essentially "free money," which you should generally try to capture in full.

In sum, consider the rule when deciding between investing unmatched dollars toward retirement or paying down debt.(And if you have more than one debt at or above the relevant interest rate, work first at eliminating your highest-rate debt, then move on to your next-highest, and so on.)

More on our methodology2

This guideline is based on estimates of future investment returns3—which, of course, aren't guaranteed. By contrast, the "return" you earn on every dollar of debt you pay down is indeed guaranteed (through the extra interest you avoid).

Most people prefer a sure thing to a risky bet, so we incorporated an additional margin of safety into our methodology. In essence, our guideline assumes that you would only choose investing (the riskier bet) if it has at least a 70% chance of beating the more certain return you would earn by paying down debt (based on our estimates of what likely future investing returns will look like).

Put another way, if our methodology2 suggests that you should invest, that doesn't mean we're 100% sure that investing will come out ahead. But we believe it should beat the return you'd get from paying down debt about 70% of the time.


Need some help sorting through your financial priorities? Consider connecting with a financial professional, or learn more about how to balance paying off debt with saving.

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Pay down debt vs. invest | How to choose | Fidelity (2024)

FAQs

Pay down debt vs. invest | How to choose | Fidelity? ›

A general rule of thumb to consider is that if your expected rate of return on investments is lower than the interest rate on your debt, you should pay down debt first. Historically, the stock market has returned an average of between 9% and 10% annually.

Read The Full Story ›
Is it better to invest than pay off debt? ›

A general rule of thumb to consider is that if your expected rate of return on investments is lower than the interest rate on your debt, you should pay down debt first. Historically, the stock market has returned an average of between 9% and 10% annually.

Discover More Details ›
Should I pay more down payment or invest? ›

It's typically smarter to pay down your mortgage as much as possible at the very beginning of the loan to avoid ultimately paying more in interest. If you're in or near the later years of your mortgage, it may be more valuable to put your money into retirement accounts or other investments.

See Details ›
Is it better to have an emergency fund or pay off debt? ›

On one hand, paying off debt could save you thousands in interest. On the other hand, failing to build your savings could force you into further debt if you encounter unexpected expenses. Generally, building an emergency fund should be your priority.

Learn More Now ›
Is it more important to save or pay debt? ›

It's tempting to focus on saving money or paying off debt but it's better to try to handle both. This way you get the benefit of saving money from tackling debt while also having an emergency fund for the unexpected.

Read More ›
Do millionaires pay off debt or invest? ›

Millionaires usually avoid the following: High-interest debt: Millionaires typically steer clear of high-interest consumer debt, like credit card debt, that offers no return or tax benefits. Neglect diversification: They don't put all their eggs in one basket but diversify investments to mitigate risks.

Get More Info ›
Is it better to have big down payment or pay off debt? ›

If you have a substantial amount of high-interest debt, consider paying it down before saving for a house. Any interest – but especially high-interest debt – can significantly extend your debt repayment timeline and eat away at the money you could be saving for a home.

See More ›
Should I put $20 down on a house or invest? ›

You would have a $40,000 higher net worth and have paid $60,000 less in finance costs over 10 years by putting 20% down. This considers your home equity and investment balance. Most people stay in a home for 13.2 years on average, says the National Association of Realtors. They keep mortgages for even less time.

View More ›
How to pay off a 250k mortgage in 5 years? ›

There are some easy steps to follow to make your mortgage disappear in five years or so.
  1. Setting a Target Date. ...
  2. Making a Higher Down Payment. ...
  3. Choosing a Shorter Home Loan Term. ...
  4. Making Larger or More Frequent Payments. ...
  5. Spending Less on Other Things. ...
  6. Increasing Income.

Find Out More ›
How to pay off a 30 year mortgage in 10 years? ›

Here are some ways you can pay off your mortgage faster:
  1. Refinance your mortgage. ...
  2. Make extra mortgage payments. ...
  3. Make one extra mortgage payment each year. ...
  4. Round up your mortgage payments. ...
  5. Try the dollar-a-month plan. ...
  6. Use unexpected income. ...
  7. Benefits of paying mortgage off early.

Continue Reading ›

What is the 50 30 20 rule? ›

The 50-30-20 rule recommends putting 50% of your money toward needs, 30% toward wants, and 20% toward savings. The savings category also includes money you will need to realize your future goals. Let's take a closer look at each category.

Tell Me More ›
How much savings should I have at 40? ›

By the time you reach your 40s, you'll want to have around three times your annual salary saved for retirement. By age 50, you'll want to have around six times your salary saved. If you're behind on saving in your 40s and 50s, aim to pay down your debt to free up funds each month.

Explore More ›
How can I pay off my debt when broke? ›

How to get out of debt when you have no money
  1. Step 1: Stop taking on new debt. ...
  2. Step 2: Determine how much you owe. ...
  3. Step 3: Create a budget. ...
  4. Step 4: Pay off the smallest debts first. ...
  5. Step 5: Start tackling larger debts. ...
  6. Step 6: Look for ways to earn extra money. ...
  7. Step 7: Boost your credit scores.
Dec 5, 2023

Tell Me More ›
Is it better to invest or pay off debt? ›

Investing and paying down debt are both good uses for any spare cash you might have. Investing makes sense if you can earn more on your investments than your debts are costing you in terms of interest. Paying off high-interest debt is likely to provide a better return on your money than almost any investment.

Tell Me More ›
What are the three biggest strategies for paying down debt? ›

Some of the most popular strategies include the following:
  • Prioritizing debt by interest rate. This repayment strategy, sometimes called the avalanche method, prioritizes your debts from the highest interest rate to the lowest. ...
  • Prioritizing debt by balance size. ...
  • Consolidating debt into one payment.

View More ›
What debt should you avoid? ›

Generally speaking, try to minimize or avoid debt that is high cost and isn't tax-deductible, such as credit cards and some auto loans. High interest rates will cost you over time.

Read More ›
Which is better to invest equity or debt? ›

Which is better debt fund or equity fund? The choice between debt and equity funds depends on individual investment goals, risk tolerance, and time horizon. Equity funds offer higher potential returns but come with higher risk, while debt funds are safer but offer lower returns.

See Details ›
Should I pay off my car or invest in stock? ›

Comparing the interest rate on your auto loan to what you expect to earn on your investment is the most common way to approach the question of whether to pay off your debt early or invest the extra money. That's usually where I start, too. The lower your interest rate, the more sense it makes to invest the money.

Find Out More ›
Is it better to use debt or equity? ›

Since Debt is almost always cheaper than Equity, Debt is almost always the answer. Debt is cheaper than Equity because interest paid on Debt is tax-deductible, and lenders' expected returns are lower than those of equity investors (shareholders). The risk and potential returns of Debt are both lower.

Discover More Details ›
Is it worth paying off all debt? ›

Paying off all your debt, however, doesn't always make sense. It depends on the type of debt you have, interest rates offered, investment returns, your age and, ultimately, what your bigger financial goals are.

Read The Full Story ›
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