Estimate Time4 min

Should you pay down debt or invest?

Key takeaways

  • If the interest rate on your debt is 6% or greater, you should generally pay down debt before investing additional dollars toward retirement.
  • This guideline assumes that you've already put away some emergency savings, you've fully captured any employer match, and you've paid off any credit card debt. 
  • It also assumes that you're investing in a tax-advantaged account and that the interest on your debt is not tax-deductible.
  • While 6% is typically the critical number if you have a balanced asset allocation, the right number for you may be higher or lower.

Choosing between paying down debt and investing can be like trying to solve a riddle.

If you've ever tried to work out the answer, you've probably run into some version of this advice: Compare the interest rate on your debt with the return you expect to earn on your investments, and put the money toward the option with the higher percentage figure.

While that advice might make sense in theory, it isn't exactly easy to put into practice. Plus, even seasoned experts find it difficult to forecast precise return rates, so it hardly seems sound to base your decision on a single number plucked out of thin air.

The rule of 6%

So we crunched the numbers to come up with a clearer formula (more on our methodology below). Our conclusion? For many people, it generally makes sense to first pay down any debt with an interest rate of 6% or greater. This assumes you have at least 10 years before retirement, that you're investing in a balanced portfolio with about a 50% allocation to stocks, and that you're investing in a tax-advantaged account, such as a 401(k) or IRA.

(Infographic) A scale shows the number 6% in the middle, with an image of a coin growing like a flower on the left side and a hand holding a coin on the right side.

If the interest rate on your debt is less than 6% (and again, based on our set of assumptions), it likely makes more sense to invest those extra dollars instead. That's because at lower interest rates, there's a greater chance your long-term investing returns will beat the bang for your buck you'd get by paying your debt off faster.

How to adjust

Although 6% is the number to remember if you have a balanced asset allocation, you can consider a higher (or lower) threshold if you invest more (or less) aggressively. Here's what the critical number looks like at different levels of aggressiveness, in each case considering a 35-year-old investing for retirement in a tax-advantaged account.1

(Infographic) A panel of 3 people. The person on the left is labeled

Why does the relevant figure change with your asset allocation? A less aggressive investment mix, meaning one with a lower allocation to stocks, may be expected to result in slightly lower returns (on average) over the long run. And with slightly lower expected returns on investing, paying down debt comes out ahead even at slightly lower interest rates. 

The reverse goes for a more aggressive asset allocation. A greater allocation to stocks may result in higher expected returns on your investments, which means investing may come out ahead over the long term even if your debt has a slightly higher interest rate.

When to consider our guideline

While the rule of 6% is easy to remember, there's some fine print to understand before you try putting it into action. Namely, you should make sure you're checking off a few other boxes on your financial to-do list first, before you even get to the question of paying off debt or investing.

(Infographic) A panel of four icons. From left to right, a building with columns, a flame, a percentage sign with an arrow running through the middle, and an open hand with a coin floating above it.

Why do these other tasks take priority? Paying your minimums, socking away a cash buffer for emergencies, and digging out of any credit card debt are crucial to establishing basic financial security (plus protecting your credit score), so that your finances could survive any unexpected curveballs life might throw your way. And an employer match is essentially "free money," which you should generally try to capture in full.

In sum, consider the rule when deciding between investing unmatched dollars toward retirement or paying down debt. (And if you have more than one debt at or above the relevant interest rate, work first at eliminating your highest-rate debt, then move on to your next-highest, and so on.)    

More on our methodology2

This guideline is based on estimates of future investment returns3—which, of course, aren't guaranteed. By contrast, the "return" you earn on every dollar of debt you pay down is indeed guaranteed (through the extra interest you avoid).

Most people prefer a sure thing to a risky bet, so we incorporated an additional margin of safety into our methodology. In essence, our guideline assumes that you would only choose investing (the riskier bet) if it has at least a 70% chance of beating the more certain return you would earn by paying down debt (based on our estimates of what likely future investing returns will look like).

Put another way, if our methodology2 suggests that you should invest, that doesn't mean we're 100% sure that investing will come out ahead. But we believe it should beat the return you'd get from paying down debt about 70% of the time.

Need some help sorting through your financial priorities? Consider connecting with a financial professional, or learn more about how to balance paying off debt with saving.

Looking for help with investing?

We've got you covered with our options for simple investing and financial advice.

1. The "less aggressive" asset allocation assumes a 20% allocation to stocks, the "balanced" asset allocation assumes a 50% allocation to stocks, and the "more aggressive" asset allocation assumes a 100% allocation to stocks. Critical interest rates are calculated using estimated asset class returns distributions. See footnotes 2 and 3 for further details. 2. This analysis used a horizon of 10-40 years comparing the rates of return that could be experienced with various levels of interest rates. First the return over the accumulation horizon is determined by running 250 Monte Carlo simulations of the balance growth of a portfolio. Next a 70% confidence level was used to identify the rate of return over which debt would be preferable to pay down. The 70% confidence level is used because it represents a typical level of loss aversion. After determining the effective rate of return over the horizon at the 70% confidence level, this return is used to compare to interest rates on the debt. If the debt interest rate is greater than the return over that horizon then paying down debt would be preferential. 3. The values in this article are based on a Monte Carlo simulation–based approach to estimate potential growth of account balances. The analysis is based on historical market data to estimate a range of potential outcomes for various hypothetical portfolios under different market conditions. Monte Carlo simulations are mathematical methods used to estimate the likelihood of a particular outcome based on market performance historical analysis. While over very long periods of time, markets have averages, it is often the case that the market performs both above and below these averages. The Monte Carlo simulations are designed to reflect this historical market volatility.

This information is general in nature and provided for educational purposes only.

Investing involves risk, including risk of loss.

Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917