Get Out of Debt or Invest? Don’t Take On Bad Risk

get out of debtA common question is whether to use leftover money to get out of debt or invest. The idea is that if the return you get in the stock market is greater than the debt’s interest payment, you should do it. I am here to tell you, DON’T DO IT. I will go over reasons why paying off debt is better than investing. I’m a big fan of using debt to your advantage if it makes sense. However, this isn’t one of those times where it makes sense. If you’re in a significant amount of debt, it means that you’re in a hole. Doing something that gets you out of the hole is the necessary action you need to take. Investing can put you in a bigger hole.

Yes, if you really know what you’re doing, you can get out of that hole faster than scheduled. However, be brutally honest. Do you really know what you’re doing or is it that you are confident that you know what you’re doing? When you invest in a stock simulation (I recommend Investopedia’s) do you end up making money or losing it over a period of time?

You might say “I didn’t take the simulation seriously because it’s not real money.” Or “it will be different when I actually have real money to invest.” I understand the difference. You will care more if your hard earned money was on the line. However, The difference is not significant because caring more will not make you more money in the stock market.

“I Know I Can Make More Money Investing”

A friend of mine recently asked me to help him open a Robinhood account. Let’s call him Mario. I was happy to help him out because he’s a good college buddy of mine. He used to teach me how to use technical analysis for the stock market. After learning it, I’m not convinced. I don’t recommend anyone use technical analysis to invest because those traders are fantastic at losing money. But I digress. 

From our conversations during college, Mario told me that he financed a part of his degree with debt. An almost 5 figure debt. He has a high paying job currently so it’s not a problem (he makes $7,500 a year more than me). However, he’s at his last $5000 of student loan debt and he wants to use funds to invest rather than get out of debt.

He’s getting tired of using money to do something he’s not happy with (paying off debt) instead of doing something he’s passionate about (investing in the stock market). I understand that it’s good to invest time and energy to something that gives joy. But losing money should never be joyful.

Why do I say that he will lose money? It’s not that I think he’s not smart. He’s very smart with great ethics. It’s that during college, he’s dreamed about investing in his parent’s basement right after college and making money that way. We used to talk about how great of a life it would to day trade.

However, from the years that he’s been investing, he’d lose money. I don’t know the specifics but he shut his investing operations down. He used to stay up all night watching the Forex markets in hopes to make money. I can’t imagine he would shut it down if he was making money.

Investing Requires Certain Characteristics

He’s not patient and he’s looking for instant returns. I remember talking to him one day and he was saying how he’s looking to get 100% returns in a week. Yes, it is very possible because he was invested in forex, where the volatility is ludicrous. It’s also very possible to lose 100% in a matter of minutes.  

He started investing in stocks then he didn’t do so well so instead of mastering one thing very well, he started branching out to options. He didn’t do so well either so he branched out to foreign exchange. You know where the story is going. He stopped investing because for 1) he was in debt and for 2) he was using his partner’s money to invest with.

The stock market has given out overnight millionaires before (the tech bubble where 10x returns in a month were the norm). It has also given out overnight bankruptcies before (think of the tech bubble bursting and the financial crisis of ’07).

These are black swan events where if you had prepared for them by taking advantage of index funds that give benefits of diversification and value, you wold have come out in a stronger position than before the crash. I’m a little worried at the lofty valuations set in place and want a bear market to come soon. It’s where investors make most of their money in.

Why Get Out of Debt? Instant Returns

I would much rather get out of debt surely than look for the easy way out. Furthermore, if you use money to pay down your debt, you get Instant and Guaranteed Returns. Mario’s rebuttal was that he isn’t getting a return because he’s PAYING debt, but that’s the wrong way to think. The return you get is the interest that you pay to get out of debt. In this case, he pays a 4% interest on his $5,000 student loan.

If he and I each had $5000 and I used it to get out of debt, I would end up with $0 by the end of the year. He would end up with $-200. $200 is a 4% return on $5000. I get a 4% return just by paying down debt. And this return? Risk free, baby! I would take a risk free 4% return ALL. DAY. LONG. The 1-year T-bill rate is at .57% right now. Almost 8x times better than the normal risk free rate, can’t complain about that!

The Average Investor Loses Money

The average investor loses money in the stock market. According to that article, 70% of investors lost money in 2015. The odds are against Mario to make money. Especially with his investing style of wanting to get returns, fast. When you’re working hard to get out of debt and dig yourself out of the hole, it’s not good to take on bad risk.

Bad risk is when you understand the odds are against you but you take it anyway. If you ALWAYS make decisions that will give you positive results more often than not, there’s no way you will lose over the long-term. In the short term, you might lose but if you simulate that decision over the long term, you will come out ahead.

Personal finance websites preach index funds because they work. The stock market, over the long term, provided positive returns. An average return of 7% or so. My 401k is 90% invested in the S&P 500 and 10% in a bond index fund. The 5 figure cash balance I racked up is in my trading account because I can afford to take risks when I’m young. My retirement account will ensure that I never will be in financial trouble because I save 55% of my money into it. 

Mitigate Risk, Look for Margin of Safety

I’m protected to the point where in 1-2 years, I won’t ever worry about money. Therefore, I can afford to take a lot of risk in my trading account and I fully intend on taking advantage of the risks that I’m allowed to take. If I lose 100% of my trading account, I still won’t need to worry about money. My risk is so mitigated to the point where I can sleep very soundly at night. I have no debt, my trading account funds is enough to last me for the next 2 years, and I have steady income coming in from my job.

I worked hard to get to this point, however. Afternoons were spent working and summers were spent working in internships. I sacrificed a couple years working hard so that I could enjoy decades of stress-free life. The investment was well worth it. Now, my risk is low enough that I’m able to make a few mistakes going forward without huge repercussions. Investing while being in debt is taking on extra risk, which isn’t smart. In the short-term it could work out in your favor but in the long term, it could come out bad. 

Readers, would you rather get out of debt or invest? Do you have successful stories of getting out of debt through investing? Let me know in the comments below!

Finance Solver

I grew my net worth to $40,000 as a college student through hard work, discipline, and a little bit of luck. I graduated college in 2016 and will be starting to plan for my retirement once I start working.I am planning on reaching financial independence by my early 30's and I will document my moments of inspiration all the way to desperation here.

My goal is to enable your success in personal finance so that you can realize the American dream. The first step is starting today!

Read more about me here.

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38 thoughts on “Get Out of Debt or Invest? Don’t Take On Bad Risk

  1. I made the personal decision myself to just pay off my student loan debt, even though it meant I couldn’t invest as much.

    It probably wasn’t the best move from a pure mathematical standpoint – at the time I paid off my student loans, I had a 2% variable interest rate. But I also wanted to just free up the cash flow and be able to start over fresh.

    There’s definitely a personal decision that you have to consider. We’re not robots after all. One thing is, if you choose to pay off debt, you’ll rarely be wrong in that decision.

    • Finance Solver says:

      Paying down debt is NEVER a bad option! Freeing the shackles so you can live life the way you want to, it sounds like a great decision to me!

      That’s so true. The other side of my viewpoint is that you could learn more, get more returns, and get out of debt faster if you were to invest that money instead of paying it down. For me personally, it feels like a lot of risk but it’s all up to the individual.

  2. Personally I am a big fan of paying off my non-mortgage debt before investing in anything else. This allowed me to stay laser focused and personally allowed me to sleep better at night.

    Not to put down Mario but he sounds less like an investor and more like a gambler. Investing takes time, research and most importantly patience. Some of the greatest investors of our time didn’t have 100% returns in a week.

    • Finance Solver says:

      Same here! Debt is so pesky and annoying.. I hate the feeling of being chained to another person’s will. I enjoy the freedom to allocate my capital the way that I want to!

      That’s how I view it too. I really see him as a close friend who I can talk about anything with but I don’t agree with his investing principles. Anytime he talks to me about something related to investing, I don’t reply receptively. Forex actually looked a lot like gambling when I saw him investing those dollars late into the morning!

  3. Exactly! Successful investing in stock market takes decipline and focus which many people seem to lack. Investing solely based on technicals sounds and looks impressive but it’s essentially gambling and in gambling the house always wins.

    • Finance Solver says:

      Yep! I used to be a firm believer but all they do is draw pretty lines and hope for the best. Since then, I’ve changed my ways and look for actual reasons that the stock is going up or down, instead of saying “the momentum is great.” There are some good technical analysts out there but I don’t know how much of that is based on luck and how much of that is based on actuality. I’ll never find out!

  4. It highly depends on the type of debt, the cost of the debt, and the investment choices you make. Say your student loan is 1% interest. Now say you can buy treasury debt at 2% interest. After all the tax deductions you’ve actually done better by investing and paying as you go with no real added risk. Another example where you may want to choose the investment is in the case of a 401K, where you might be giving up a match and tax deferred space. Debt Leverage can often lead to a higher return, but usually (not always given a rising rate environment) not without added risk. I wouldn’t take a loan to invest in the stock market or do what your friend Mario is doing. But that being said remember there are varying degrees of the risk you outline and you have to evaluate them as you proceed. Full disclosure: When I was your age I paid off my student loans first to the exclusions of all other investments other then an emergency fund. These days I regret not having contributed to the 401K in tandem.

    • It really does! But I haven’t been able to find a student loan with 1% interest and T-bills at 2% interest. If that were the case, the arbitrage opportunities that these students would play..

      Ah I see your viewpoint! Which year did you have the chance to contribute to a 401k, if you don’t mind me asking? I just see debt as something that could detriment your finances significantly by reasons beyond one’s control. Like if there was a financial crash tomorrow and I lose all my income, then if I had debt, I would not be able to pay it off, causing me to default. There might be a low chance of a financial crises happening tomorrow (maybe less than 1%) but that less than 1% chance can ruin me if it does happen and I have debt.

      • Way back in 2004 I forgo investing in retirement to pay my student loans. A lot has changed since then. FYI there are actually ways to invest at 3.5 percent risk less. Look at ee bonds, held to a 20 year term they guarantee a doubling. Early withdraw rates however are catastrophic at .1 percent a year. Not sure what student loans run at these days.

        • Thanks for coming back and replying, I love interacting with readers! I haven’t heard of EE bonds and just looked them up. Never would have thought, learning something new every day.

          I’m not sure of other student loans but my loans are set to be at 4.66% after my grace period. Right now, I’m paying 0% interest because I’m on my grace period (until November) but will pay it off in full in November.

  5. FS, I can’t say that I have personal experience being deep in debt, but what you suggest is exactly what I’d tell my friends who are in debt!

    Paying down debt is a guaranteed use of your money, vs. trying to invest in order to pay it down at a later date. It’s way too easy to dig yourself a bigger hole.

    I say get out of debt, start clean, and invest slowly (and even conservatively).

    • Yes it is! Especially because the stock market is so unpredictable. Even in irrational times, the stock market can stay irrational more than we can stay solvent.. They have the ultimate power.

      Life is a marathon and going for a sprint during the marathon can cause injuries that could hurt chances of ever finishing the race!

  6. Good advice.

    Sounds like your friend is more interested in trading rather than investing. Those are two different things and I would definitely agree, pay off the student debt before putting money into a trading strategy.

    I do think if your employer provides a 401(k) match, it might make sense to invest enough to take advantage of the match. I would only suggest this for someone with a steady income and assuming the interest rate on the debt is very low.

    But again, only for a long-term investment (i.e., index funds) and not for a trading strategy.

    • I think that’s the case also. I hope he’s not fallen under the millennial trap of wanting instant gratification and is invested over the long-term. I don’t know if I got through to him but he just got approved for his account so only time will tell.

      That’s true, I haven’t thought of that. It’s a risk free return (my company pays me 2% for the first 3 years of service) that I’m going to capitalize on once I’m given the match. I’m also going to be maxing it out next year so I’m excited about that (that sounded much cooler in my head).

  7. I think it depends on the type of debt/the rates. For example, there are so many credit cards out there with an intro 0% interest rate for 12-24 months. At this point it would be smarter to invest the money, and have some debt at 0% interest…as long as you aren’t running up an amount that’s too high to pay off before it starts to generate interest.

    • Finance Solver says:

      That’s a great point about 0% interest rate credit cards. I’ve read somewhere about using 0% credit cards to earn risk free rates of return, and I thought that was a genius way to make a little extra money. The downside though is having to only pay the minimum balance on credit card payments, which could certainly hurt someone’s credit score.

      Thanks for stopping by!

  8. Great advice. There are differences between trading and investing. Trading is risky because you usually do not have sufficient knowledge. It’s kind of like gambling. Investing, on the other hand, is less risky as you’re in it for the long run and hopefully have spend time learning about the investments you’re purchasing.

    • I think my friend still sees what he’s doing as investing / trading (I’m not sure if he knows those two are different things). Yep! It definitely is less risky. I like it when risk is completely eliminated though which is why I personally would pay off my debt first before investing. Unless the debt has a 0% interest rate like my subsidized student loan 😉

  9. The instant return of debt pay off is definitely attractive. I think self awareness is critical here. Investing in low-cost, diversified index funds for the long haul can definitely provide a better mathematical return, depending on the interest rate of your debt, but that strategy might not work if you know yourself to be impulsive and emotional in your financial life.

    • I think Warren Buffett said it perfectly when in an interview he was asked “how come someone smart can’t make a lot of money in the stock market?” his reply “you need to be the most emotional stable, not the smartest.”

      But even without trading, it’s my own personal opinion that debt should be paid off first. Investing can provide a better mathematical return over the long-term but in the short term, investing with funds one doesn’t have can be worse. Not sure if I’m right but wanted to get my perspective out there!

  10. Nice post FS. There are many different types of investing, and many different types of debt. I’d choose high interest debt, like a credit card over investing every day of the week. It gets a bit trickier when it comes to really low interest debt (like 2% or less) – if you want to be debt free, that’s worth it to pay the debt down, even if not the bast mathematical return.

    For very low interest debt, for us, we may be tempted to invest instead. But in these times, it’s good to make use of low interest rates to pay down debt (and the stock market is at all time highs).


    • Thanks Tristan! I really enjoy the freedom of not having debt. It makes me feel like I’m in control of my money rather than someone not being in control of my money, which is why I’m so anti-debt. I may be missing out on some returns though, but I think I’d be happy missing out riskier returns than normal.

      You know what you are doing when you’re investing for those dividend payouts 😉 as long as research is done, I don’t think either way is wrong, boils down to personal preference at that point!

  11. Trying to make quick money, been there done that…..and lost. This was in 2009 when the market collapse had not completely bottomed out yet. Used leveraged products and they go fast (both ways). I wised up over the years and now have a diversified portfolio including ETF’s, dividend stocks and real estate. Making some good returns on investment actually, which beats loosing money.

    Nice post, and wise decision to first get rid of (most of) your debt before starting to invest (a mortgage can be a different beast).

    • Finance Solver says:

      They sure do go fast.. 3x might not feel that much but 5 – 10% moves in a single day, those are moving in lightening speeds in stock market time. My retirement account is completely full of ETFs (90% s&p and 10% bond) and I”m so confident that that is going to be enough to make me be financially secure.

      Thanks for stopping by! I always try to kill debt before doing anything.

  12. From a numbers standpoint I strongly disagree with you and even built a financial model on my website to prove my point : ) When I first wrote about investing > debt payoff I had about 47 negative comments and 3 supportive ones. After laying it out from a financial modeling perspective virtually every single person agreed that from a numbers perspective it makes sense to invest and hold lower-interest debt.

    I don’t really want to re-ignite the debate in a comments section of a website but I the post is on my site that lays out my reasoning. I’d leave the link here but I now most bloggers hate when other bloggers do that haha.

    • Finance Solver says:

      Ah, I will email you to get the link to that post, I would love to read it 🙂 I like hearing from both sides of the story to broaden my perspective. There’s no “end all, be all” rule that works all of the time in this case.

      I’m risk averse when it comes to debt (not when it comes to stock investing, I understand that I can’t get returns unless I take on risk) because one wrong move outside of your control can ruin my financial life. I can certainly get more returns by investing but I can also get more losses!

  13. Paying off debt is a guaranteed return, for sure. Personally, we paid off all student loan and consumer debt, but do still have mortgage debt. And at 3.25%, the numbers don’t point to paying it off over investing, though peace of mind is worth a lot. My husband and I have decided rather than pay it off, we are going to buy more (rental property), so I guess we’ll see how that works out!

    • Finance Solver says:

      I love risk free returns! I’ve been thinking of changing my mindset for mortgage debt. Those things are at historically low interest rates and can produce a lot of extra passive income if done correctly.

      Nice! I’m sure you’ll do a ton of research before going through with it and hopefully it will pay off, good luck!!

  14. I agree with Tawcan that trading is not investing. But if we’re talking about investing, I’d agree with DC…well depending on the interest rates of the debt. Much of my student loans are in the 2% range. I’m not in a rush to pay them back. However, I’ve realized that personal finance has a lot to do with emotions and is not purely math. If it helps you sleep better at night to pay off debt, then that might be the best route to take.

    • Finance Solver says:

      Whoa a 2% debt? That’s the cheapest student debt I’ve heard of from all of my friends. Great job for bagging such a great debt 🙂

      There’s definitely two sides to this debate, I like the sleeping better at night aspect of paying off debt more than investing in the stock market. I see investing while being in debt as taking on extra risk to get the same returns as someone who doesn’t have debt. However, it’s all based on personal preference, as you’ve said!

  15. Excellent advice! Borrowing money to invest is called gambling. I read this story of a guy last year who gambled away his house to short some biotech stock. The stock ended up going up huge and he owed over 100k to the broker. What made it to news was his request on crowd funding to help him pay his debt or he would lose his house.

    • Finance Solver says:

      Thank you! Wow… I really don’t like taking on risk that could ruin me in a single day. That’s a great story and a great example of taking on excessive risk can bust. I hope that he raised enough money in his crowdfunding campaign.

  16. Paying down debt is definitely the easiest way for people to increase their savings and help out their future net worth.

    As for the debate about paying down low interest debt or invest it, I think either answer leads to a win. It is better to put that money towards your net worth than to spend it!

    • Finance Solver says:

      That is a topic that’s greatly debated, for sure. I personally don’t like the additional risk that comes with investing when being in debt. It’s taking on additional risk but getting the same returns as someone investing without debt.

      However, if someone is great at investing and can beat the low interest rate, I won’t stop them. Personal finance is never an end all be all!

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