Should I Pay Off Debt or Invest First?

The debt versus investing question is one of the most practical financial dilemmas, and the answer is more nuanced than most financial advice suggests. The key insight is that not all debt is created equal, and the math provides a clear framework for decision-making.

Warren Buffett draws a sharp distinction between productive debt and consumer debt. He has consistently used leverage at Berkshire Hathaway through insurance float and low-cost borrowing, demonstrating that debt used to acquire productive assets at attractive prices can be tremendously wealth-building. However, he has been equally emphatic that consumer debt -- credit cards, personal loans, car loans for depreciating assets -- is financially destructive and should be eliminated as quickly as possible.

Charlie Munger puts it simply: "If you owe money on a credit card at 18-24% interest, there is no investment strategy that reliably earns more than that. Pay off the credit card first -- it is the best investment you can make." This is pure mathematics. If your credit card charges 20% interest, paying off $10,000 of credit card debt is equivalent to earning a guaranteed, tax-free 20% return on a $10,000 investment. No stock market strategy can guarantee that.

The framework is straightforward. Compare the interest rate on your debt to the expected return on your investments. If the debt interest rate is higher than your expected investment return (typically 7-10% for stocks), pay off the debt first. If the debt interest rate is lower than expected investment returns, invest first. The breakpoint is typically around 5-6%.

High-interest debt (above 7%): Credit cards, personal loans, payday loans -- pay these off aggressively before investing a single dollar beyond employer match contributions. The guaranteed return from eliminating high-interest debt exceeds any reasonable investment return.

Low-interest debt (below 5%): Mortgages, some student loans, subsidized loans -- these can coexist with investing. A 3.5% mortgage while investing in stocks earning 9-10% is mathematically profitable and appropriate for most investors.

Medium-interest debt (5-7%): This is the gray zone where personal preference and risk tolerance matter most. Both paying off the debt and investing are reasonable choices.

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The emotional value of being debt-free should not be dismissed. Even when the math favors investing over paying off low-interest debt, the psychological freedom of owing nothing has real value for many people.