Investing vs. Paying Down Debt in an Era of Rising Interest Rates

A challenge faced by many ordinary Americans in today’s era of ultra low interest rates is whether to pay down debt or to invest for the future.  This issue has become even more pressing as a result of a confluence of several factors, including stagnating middle class wages that have not risen since the 1970’s and college costs that have continued to skyrocket, leaving both graduates as well as their parents with increasing debt loads related to those educational loans.

Millennials Are Graduating With Ever Greater College Debt

This is a unique challenge for millennials, who are facing record levels of student debt just as they are preparing to graduate and enter the workforce.  This year’s graduating class is, like those graduating classes before it, is likely to have the highest average student debt load of any graduating class in the history of the United States according to many experts.  Thankfully, this year’s graduating class is also facing a better employment market than the classes that came before it during the Great Recession of 2008.  With such high debt loads, a question facing this generation is whether to focus on repaying their student loans as quickly as possible or whether to invest for their retirement.

Parents of College Students and Other Adults Are Facing This Same Dilemma

However, the question as to whether to pay down debt versus saving for retirement  or other goals is also a question that that is facing millenials’ parents and those closer to retirement. Due to skyrocketing college costs, students’ parents are increasingly being forced to take on substantial amounts of debt to help their children to graduate in the form of parental Plus loans or borrowing against equity they may have in their homes to fund their children’s educations.  Many parents are doing so at a time when they may be saddled with other debts like mortgages while also attempting to save as much as possible for their own retirements.  In addition, due to the death of the fixed pensions that many retirees today enjoyed, a fact that even the Social Security Administration has commissioned papers on, many persons in their 40’s and 50’s today are responsible for shouldering an ever greater share of their own retirement.  Accordingly, out of a fear they may find themselves unable to work any longer but not having saved enough money to retire, such persons may put off paying down their debts in favor of investing a greater amount in their 401(k) plans and other retirement investment vehicles.

Like Anything Related to Money, This is Not an Easy Question

Like anything, the answer to this question is that it depends.  One of the most important factors is the interest rate of the debt in question.  The experts generally agree that if the debt in question is charging you interest in excess of 5 or 6%, you generally are better off paying off the debt rather than investing the money.  However, even this “rule” has its caveats.  The answer to the question posed by this blog post also depends on your time horizon.  A 63 year old who is looking at having to retire due to health reasons in six months is much more likely to want to pay off his debt before entering retirement so that his or her possibly reduced income in retirement is not eaten up by the interest being generated by that debt rather than a 23 year old who has 30 years to pay off her student loans and who is not going to retire for more than 40 years.

This is An Emotional Topic

This, like any financial topic, is also a highly emotional question whose answer can depend in part on a philosophy towards money and, in particular, the attitude you have towards being indebted to someone or something else, most likely a financial institute.  Some people abhor debt on a fundamental level and, if you are one of those people, it may make emotional sense for you to focus on paying down debt rather than investing because doing so will help you sleep easier at night.

Tax Considerations Also Come Into Play

Other considerations also come into play in this calculus, such as if your loan interest payments are tax deductible and/or you can lower your income taxes by using tax-advantaged accounts such as a 401(k).  For instance, subject to certain income restrictions, student loan interest payments, mortgage interest payments, and other loan payments are tax-deductible.  In addition, if you have a government or public service job, you may be eligible for programs like the Public Service Loan Forgiveness Program, which provides for the forgiveness of the balance of all remaining student loans after a person has worked in a government or public service job for ten years.  (Further information on this program can be be found at the U.S. Department of Education’s website, website.)  In that instance, a government employee is better off making the minimum on student loans no matter what interest rate they are at instead of trying to pay down the debt immediately.

Conclusion: This is a Complicated Question with No Straightforward Answer

As with any question involving money, whether to invest versus paying down debt is a complicated question that is influenced by many factors, including your investment time horizon, the interest rate of the debt that you are paying off, as well as what type of debt you are paying off.  We have attempted to discuss only some of the relevant considerations which you should take into account when faced with this dilemma but, above all things, remember that this is a very personal decision.