Invest Or Pay Debt

Should you invest your money or use it to pay off existing debt? It’s a tough question, and one we receive often at Betterment.

As a fiduciary, it’s our responsibility to advise our clients on what to do based on what’s in their best financial interests, regardless of how we as a business are impacted.

With this in mind, it may be prudent for some of our readers not to invest with us—at least not just yet.

So, where to start? You can follow our five-step action plan to develop a solid debt payoff and investment strategy:


Our 5-Step Action Plan:

  1. Always Make Your Minimum Debt Payments on Time
  2. Take Advantage of Your Employer-Sponsored Retirement Plan
  3. Pay Off High-Cost Debt
  4. Build Your Safety Net
  5. Save for Retirement

1. Always Make Your Minimum Debt Payments on Time

First things first: You should prioritize paying at least the minimum amounts due on your required debt payments on time. Not doing so can lead to penalties, extra interest, and higher finance charges, in addition to ruining your credit score. Negative information, such as excessively late payments or collections, generally stay on your credit report for up to seven years.

If you are having trouble staying current on all of your debts, consider consolidating or restructuring to make your payments more manageable. Also consider calling individual creditors to negotiate your rates and payments; you may be pleasantly surprised that your actions can result in more formidable terms.

2. Take Advantage of Your Employer-Sponsored Retirement Plan

Check to see if your company offers to match any percentage of your contributions to an employer-sponsored retirement plan, such as a 401(k). If it does, and you’re eligible to sign-up for the plan, then you should participate and take advantage of that free money.

Match programs generally work like this: Let’s say you’re participating in your employer-sponsored 401(k) plan by contributing 6% of your pre-tax income, based on an annual salary of $80,000.

After a year, you’ll have contributed $4,800 to your 401(k) account. If your employer offers a dollar-for-dollar match for up to 6% of your contributions (i.e., 100% match on the first 6%), then you’ll pocket an additional $4,800 just for participating, for a total of $9,600 in contributions for the year.

Any match is free money, and that return beats out many investment alternatives.

Keep in mind that matched contributions come in various shapes and sizes. Match formulas can even be tiered based on income and employee tenure, so check your company’s benefit guidelines regarding the relevant thresholds.

3. Pay Off High-Cost Debt

After continuing to make timely bill payments and evaluating your eligibility for matched retirement plan contributions, your third goal should be to pay off high-interest debt.

For most people, the most expensive debt is associated with credit card or unsubsidized student loan debt.

The average American has $4,400 in credit card debt and the average interest rate on those cards is around 15%. The graduating class of 2015 averaged $35,000 in student loan debt, more than any class in history.

This high-interest debt is an emotional burden and drag on your finances, which is why eliminating it from your balance sheet is a top priority.

At Betterment, we consider any debt above 5%1 to be high-cost debt and it should be paid off before general investing. Others may use a higher number (e.g., 8%), but we take a more conservative view here.

So if you have debt over 5%, pay it off as fast as you can. Start with the highest-interest debt first.

4. Build Your Safety Net

After your high-cost debt is gone, you should begin building a safety net fund for financial emergencies.

We recommend saving three to six months of living expenses, including your monthly housing payments, bill payments, utilities, and other recurring monthly bills. A safety net can provide a financial buffer and prevent you from turning to your credit cards or tapping into your home equity for a line of credit when unexpected expenses occur. A safety net also provides some wiggle room in case your income is interrupted as a result of job loss or medical emergencies.

If you don’t have high credit limits or access to additional liquidity in the form of a line of credit from your home equity, you could consider building a starter safety net fund while paying off high-cost debt. After paying your regular bills, see if you have any cash left over to allocate toward a savings account. Any amount saved can go towards building a solid safety net fund.

5. Save For Retirement

With your high-cost debt eliminated and safety net in place, you are now ready to invest for the long-term.

By the time you reach 59½ years of age, or when you’re allowed to withdraw from your 401(k) penalty-free, that 401(k) match alone may be insufficient to support your post-retirement lifestyle. That’s why you’ll want to start saving for retirement early. Here are some points to consider:

  • How Much to Save: To get this number, you need to consider factors such as when you want to retire, your future Social Security benefits, inflation, taxes, and estimated investment returns.
  • Where You Should Save: To optimize to which accounts you want to direct your money, you should factor in your future tax bracket and investment account fees.

If deriving these numbers sounds like a complicated task, it’s because it is. That’s why we built RetireGuide, our retirement planning tool, which can help tell our clients how much you need to save for a comfortable retirement. RetireGuide also takes into account when and where you plan on retiring, as well as your current and anticipated income (for example, Social Security benefits).

Knowing how much you need and actually investing to reach that goal requires follow-through. Make investing for your retirement a priority and be careful not to sacrifice funding it through wasteful spending that can restart the debt cycle.

Putting It All Together

Balancing how to attack paying off debt versus investing requires prioritizing what’s important and putting your money to work as efficiently as possible.

Hopefully, Betterment’s steps have helped take the guesswork out of your action plan, so that you can start eliminating debt, benefitting from your retirement plans, building a safety net, and investing for retirement.

Of course, there’s no specific timeline to achieving these steps; that depends on your unique financial circumstances and priorities. However, we suggest you stay the course and be diligent with our five-step framework.

Get Started with Betterment

With a Betterment account, you can sync all of your accounts to make our five-step plan even easier to follow. You can easily sync your accounts (including savings accounts, retirement plans, and debts) to view all of your finances in one place.

If you’re a property owner, you can also add your real estate owned to get an even better sense of your overall wealth.This way, you can see as your net worth increase as you get closer to reaching your goals.

You’ll also want to turn on RetireGuide, our retirement planning tool, to understand how much you need to save for a more comfortable retirement. We make it easy to automate deposits, create new Individual Retirement Accounts (IRAs), or roll over existing retirement accounts.

We handle investments so you don’t have to, and we offer a globally diversified portfolio of index-tracking exchange-traded funds (ETFs), with personalized advice in a goal-based investing framework. With powerful tax efficient features such as tax loss harvesting, everything we do is designed to help you save money on taxes while you’re investing for your long-term investing goals.

Our customer support team is also available seven days a week to answer any questions. Get started today.

More from Betterment:

1From 1928-2015, the U.S. stock market has returned an average of 9.5% per year. However, that return is not guaranteed and fluctuates from year to year. When you pay off your high-interest debt, that interest savings is guaranteed. It is the guaranteed savings that makes paying off debt so attractive, even if the rate is slightly lower than what you might expect from investing.

This article is intended for educational purposes only. The information provided is educational in nature, and is not intended to serve as the primary or sole basis for your investment or tax-planning decisions, or be relied upon as financial advice. Investing in securities involves risks, and there is always the potential of losing money when you invest in securities. Before investing, consider your investment objectives and Betterment’s charges and expenses. Past performance does not guarantee future results, and the likelihood of investment outcomes are hypothetical in nature.