Extra Cash: Pay Down Debt or Invest It? Here’s How the Math Works
In our latest video, Daniel Andersen, CFP®, and Trevor Stone, CFP®, EA, advisors with Parkshore Wealth Management, tackle one of the most common money questions: Should you pay off debt or invest your extra dollars? Watch the video below, or keep reading for the highlights.
If you have extra cash each month and are not sure whether it should go toward debt or into your portfolio, the answer may come down to a single number: the interest rate. Here is how Daniel and Trevor break down the decision.
Start with Your Emergency Fund
Before chasing interest rates, Daniel and Trevor point out that cash reserves come first. Once you have a buffer set aside for unexpected expenses, the next question is where your extra dollars should go.
The Short Answer: Chase the Highest Rate
Once your emergency fund is in place, the general rule of thumb is to send extra dollars wherever they can do the most good: toward the debt with the highest interest rate or into your portfolio if the return you might earn there is higher than the interest rate on your remaining debt. In practice, that means comparing the interest rate you would avoid paying against the return you might earn by investing instead.
A $100 Example: Credit Card, Student Loan & Investing
Consider three places an extra $100 could go: a credit card charging 24% interest, a student loan charging 5% interest, or a portfolio with a long-term average return of about 10%. Paying down the credit card saves you $24, investing might earn you $10, and paying down the student loan saves you $5. The credit card wins by a wide margin: It's unlikely any investment will consistently outearn a 24% rate, so that's the one to tackle first.
The closer call is the student loan against the market: a 5% guaranteed savings versus a shot at a 10% average return that isn't promised in any given year. Paying off the loan first is the safer bet; investing instead is the higher-upside bet.
These figures are hypothetical and for illustration only. Investment returns are not guaranteed and will vary, and past performance is not indicative of future results.
The Liquidity Trade-Off
Paying off a low-rate debt early is not without its own trade-off. Trevor shares that he paid off his own student loans ahead of schedule and, in hindsight, wished he had kept some of that cash on hand for other purposes, such as a home project. Extra payments toward debt reduce the cash available to you later, which is a real cost to weigh alongside any interest saved.
The Sleep-at-Night Factor
The math may favor investing over paying off a lower-rate loan, but there is also real value in the comfort of being debt-free. Deciding between the two is a personal decision, and there is no single right answer for everyone.
Where to Start
Deciding how to prioritize debt payoff against investing depends on your full financial picture, including your cash flow, your other goals, and how much liquidity you want to keep on hand. We help clients think through decisions like this as part of a broader financial plan.
If you are thinking through a debt payoff strategy for your situation, we would welcome the opportunity to discuss it. Schedule a consultation to get started.
This material was written in collaboration with artificial intelligence (Claude) derived from sources believed to be accurate. This information should not be construed as investment, tax, or legal advice.
Parkshore Wealth Management is an independent, fee-only Registered Investment Advisor with offices in Granite Bay and Folsom, CA, and Lehi and Logan, UT. We partner with financially responsible individuals and families who are eager to take positive steps that will allow them to use their money to build the life they desire. The firm is led by Daniel Andersen, CFP®, a member of NAPFA, the country's leading professional association of fee-only financial advisors.