Invest or Pay Off Debt? The $50,000 Mistake Most People Make

Should you invest your money or should you pay off debt? This is a common question and it is one of the most misunderstood concepts in personal finance, often because people treat all debt like it's all the same. I'm talking about credit cards, student loans, a mortgage, car payments. They just call it debt. But you've got to go deeper because that's the wrong question. Today I'm going to show you a framework so you know what to do with your money. And by the end of this video, you will know exactly when and in what order to pay off debt. And when to invest. By the way, I'll show you the $50,000 mistake that people make when they're trying to be responsible with their money in this video. So let's get into it. The $50,000 mistake. Here's what happens. Somebody decides they're finally going to get serious about money and they look at their debt and they go, ah, I just want this gone. So they take every extra dollar they've got and they throw it at the debt. They stop investing. They don't really save. Everything becomes about getting that debt to zero. And they actually feel responsible, right? Hey, I'm doing the right thing. I'm going to be debt-free. And sometimes it is. But sometimes this is a very expensive mistake. Let's look at some actual math. Take a look at 2 people. Both have an $8,000 student loan at 4% interest, and both people also have an extra $600 every month that they need to decide what to do with. Now, please, if you're about to leave a comment saying $600 must be nice, I don't even have $6 for fries. I'm trying to teach you how to adapt the principle for your own situation. If you don't have $600, maybe you have $200. If you don't have $200, maybe you have $50. It's math. It's not about the number itself. It's about the principle. Keep watching. Now, Person A decides to pay the minimum on their student loan, about $107 a month, and they invest the extra $600 each month In a low-cost index fund earning about 7% real return. That means we already factored inflation in, in the stock market. Person B hates debt. They hate having that student loan balance hanging over their head. So they decide they're going to take that extra $600 a month and aggressively pay off the loan in 1 year. Once that's clear, they'll start investing. Now, by paying off the loan early, they do save almost $2,300 that would have gone into interest. That's actually pretty amazing. But by waiting just 1 year to invest, Person B loses out on $50,000 of future returns over a 30-year timeline. Let me say that again because the math is so shocking. This person saved $2,300 in the short term, but lost $50,000 in the long term. If I said to you right now, I'm going to give you $2,300, but you have to give me $50,000 30 years from now. Would you do it? Most people would be like, what the fuck kind of crooked deal is this? And yet you do the very same thing with student loan debt and you think you are making the right decision. And guess what? This is actually an intentionally simple example because most people don't pay off their debt in one year. They actually do it aggressively but over multiple years. This is why I don't want you making huge financial decisions based on your Feelings alone. My feelings tell me that I want to eat a fat burger right now, ten times a day. Do you think that's the right decision? It might be. All right, anyway, listen. If your debt is charging you four percent, but your investments are earning significantly more over the long term, then you need to understand this trade-off. Also, if you don't understand any of the words I just said in the last sentence, then you need to read my book. I will teach you to be rich because this is important. Okay, now before you run into the comments and say, hey, Ramit, are you telling me that I should just pay the minimum on my debt and invest the rest? Which almost nobody ever says, but you should be asking that. The answer is not so fast, because if you have a credit card charging 24%, then your answer is going to be quite different. So that's why the answer for what to do with your debt really depends on the bucket that your debt falls into. And to figure that out, we We need to look at the one number that matters. When somebody wonders whether they should invest or pay off debt, the first thing I ask them is, what's your interest rate? Notice I didn't ask how much do you owe? I asked, what's the interest rate? Because a lot of people are not focusing on the right number. So they'll say, I owe $20,000 or $80,000 or $300,000. Okay, I like pens. That's not really relevant to the discussion. I want to know your interest rate because If I have a $450,000 mortgage at 2.3%, mathematically speaking, I'm paying the minimum on that for the rest of my life. Let's go! Why would I pay it off early? It's such a low interest rate. But let me show you some math to really hammer home the example. Imagine 2 people again. Person A owes $10,000. Person B also owes $10,000. Same balance. But Person A is paying 4% interest. Person B is paying 24%. These are completely different situations. One is a minor inconvenience. The other is a financial emergency. Just paying the minimum, Person A ends up paying a little over $3,000 in interest on their debt. Sucks, but okay, it's manageable. Person B, they end up paying more than $19,000. This is why before you do anything else, I want you to make a simple list. Write down each debt you have, the balance, the interest rate, and the minimum payment. And once you've done that, I want you to stop staring at the balance because the interest rate is actually going to determine your strategy. In fact, once you know the interest rate, every debt falls into one of 3 buckets, and that one number can help you decide whether to pay down debt, invest, or do both, and potentially leave you with tens of thousands of dollars more over time. Now, this framework only works if you actually know what's happening with your money. And there is one thing that can create all kinds of financial headaches. Which is finding your personal information floating around online. Go ahead, Google yourself right now and add your city next to your name. You're going to notice your name, email, maybe your phone number, home address, maybe even your family members showing up on random sites in the search results. It's kind of shocking how much of your life is out there for anyone to find. These are data brokers and people search sites that collect and sell your personal information. And when your information is out there, you're exposed to more spam calls, phishing attempts, scams, harassment, identity theft, which can wreck your finances and take years to untangle. It's also just personally annoying. That is why I use a service called DeleteMe, this video's sponsor. DeleteMe is a hands-free subscription service that continuously goes out and removes your personal information from hundreds of data broker sites. I love this service. It's basically a system that protects your privacy so you don't have to spend hours every single month tracking this stuff down yourself. And I know that this works because I'm a public person. I've got books, a Netflix show, a podcast. I want my information protected. I actually even bought DeleteMe for my parents because I know that parents are more vulnerable to scams and phishing attempts. DeleteMe has been the leading expert in personally identifiable information removal for over 15 years, and they were recently named by Wirecutter as the number one data removal service. When I log into my DeleteMe dashboard, I can literally see which sites had my info, what they found, including phone, address, relatives, and confirmation that it's been removed. It's like watching dozens of little fires get put out without you having to lift a finger. If you want your information removed from the web, go to joindeleteme.com/ramit and use code RAMIT at checkout for 20% off a plan for you or your entire family. The link is also in the description below. Now let's look at the different debt buckets so you can determine what to do next. Bucket number 1, high-interest debt, which is above 7%. If you have a credit card balance right now, this section is for you. That's because the average credit card interest rate today is around 24%. 24%? Like a lot of people are just like, okay, 24%. Yeah, whatever. It's a number. I'm like, oh shit. You're about to get buried. You just don't know math, so you don't understand it. Allow me. Let's use that earlier example. Suppose you have $10,000 on a credit card charging you 24%. If you are just making the minimum payments, do you know how long that debt's going to take you? It's going to take you 29.5 years. And over those decades, as you age, because you also don't use sunscreen, remember that you're going to pay more than $19,000 in interest. On top of the original $10,000 you owed. So whatever $10,000 purchase you all made, some used car or some freaking couch, I don't know, is a couch $10,000? That couch cost you a shitload of money. That used car, way more than you thought. Now listen, people, this is not the time to get clever. I don't want a bunch of you writing these, my investments made 15%. It's actually quite easy to beat the S&P 500. That's nice. Your credit card is charging 24%. Your ass is getting chewed up. You're losing. It's like somebody bragging to me, oh, I won in the casino. I went to the Wynn and I actually won over the first 3 minutes. Yeah. Okay. Let me check back with you in 57 minutes and see how things are going. This is really the equivalent to financial quicksand because the stock market is not going to beat the high interest rate that your credit card is charging you. If you have debt in this bucket, your mission is really simple. Pay it down aggressively. Every extra dollar attacks that debt. And if you have multiple debts in this category, prioritize the one with the highest interest rate first. This is called the avalanche method, and mathematically it saves you the most money. A lot of people don't love this because it feels slow and they want quicker wins. They want to feel like they are making progress, which I can understand. You can also choose the snowball method, which attacks the smallest balance first. Personally, I don't really care which method you choose. I want you to just choose one, attack the debt aggressively, and move on with your life. Next, let's look at the category of debt that confuses people because the answer for this one is not that obvious. Bucket number 2, the middle zone, 6 to 7%. If you are thinking about buying a house, if you already own a house, if you have a car payment, Pay special attention to this section. As you know, mortgage rates today are around 6.5%. A lot of auto loans fall into that number right now as well. And this is where I see people start looking for a simple yes or no answer, but it's actually not simple because if you can make 7% in the market and your interest rate on your loan is 6.5% or 7%, what are you supposed to do? Here's my general approach here. Split the difference. Pay down debt and invest at the same time. Why? Because I don't want you to stop building your rich life entirely. Let me show you some math. Let's say you have a 72-month auto loan. First of all, why the fuck did you take a 72-month loan? 60 months or bust. If you can't afford it at 60 months, you probably can't afford that car. 72 months? What the hell's going on? What's crazy is this is not that far off from the US average, but that's for a different video. which you can check out here. Okay, let's say that you have $1,400 each month to work with. What would you do? I would throw $700 at the car loan every month and then invest the remaining $700 in a low-cost index fund. That's because one of the biggest mistakes I see people doing with money is turning it into an all-or-nothing approach. Everything goes to debt or everything goes to investing. Life doesn't really work that way, and good financial decisions often have to become more nuanced Personally, it is very important to me that you keep investing specifically because if you start investing now, you're going to see those numbers accumulate. And once that debt is paid off, it's going to be easier for you to take the existing investment amount and just turn that number up from $700 to $900 a month to $1,200 a month and on and on and on. So in this middle bucket, Pay extra if you can and start investing. That way you make progress on both fronts. Now, this next bucket surprises a lot of people, especially if you have student loans and you've been throwing every dollar at them. Bucket number 3, low interest debt under 5%. Okay, let's say you have student loans at 4%, or maybe you have a mortgage at 3.5%. A lot of people tell me, I hate debt, I just want it gone. And I get that. Many of us were raised being told over and over debt is bad. The implication being you're bad if you have debt. First off, just because you have debt does not mean you're a bad person. Next, you can live a rich life even if you have debt. But from a financial perspective, if you're in this situation with low-interest debt, I would generally rather see you investing while making minimum payments on low-interest debt. Now, this is quite counterintuitive because most people have been taught that debt is bad and you should get rid of it as quickly as possible. Sure, you could pay off more, but if you have low-interest debt, maybe it doesn't make sense. Maybe you pay the minimum, even though it will take you a while, and you take the extra money you might have and you invest it because over time that will turn into way more. What I'm begging you to do here is to look ahead and not simply make decisions based on your short-term feelings. Think about it. What would you rather end up doing? 20 years from now, you're debt-free and you have nothing invested, or 20 years from now, you're debt-free and you have $180,000 in your portfolio? One way or another, you're going to be debt-free. You choose. But if it were up to me, I'd rather run the numbers. Let's say you have a $39,500 student loan at 4%. to be paid over 20 years. So your monthly payment on that loan is $239. Let's also assume that you have an extra $200 a month that you could use to either pay more towards the loan or invest. Now, if you put that extra money towards your loan to pay it off early and then start investing, after 40 years, you'll end up with about $555,000 in your investments. But let's say instead you invest that extra $200 while you are paying the minimum on your loan. And then after your loan is paid off in 20 years, you take that minimum payment, $239, and add that to your investments each month. After 40 years, that second strategy will have made you almost $616,000. And even accounting for the extra interest you paid on your loan over that 20 years, you still come out ahead by more than $50,000. It's not just about maximizing every penny. This is about you understanding the math So you can make the right decision for yourself. Now, if you're listening to this and you realize, hey, this is actually a little bit more complicated than I thought, gosh, I sure would like to end up with tens of thousands of dollars more. Well, then you're wondering, how do I figure this out myself? Maybe you're trying to pay off debt and invest at the same time. Maybe you're wondering if you're actually investing enough. That is why we created the Road to $100K, because for most people, reaching your First $100,000 is when things really start to change. It's when you see 6 figures. It's when those numbers start to accumulate faster than you thought possible. It's where you stop wondering if you are making progress and you can see it month to month. Inside Road to $100K, you'll get a personalized plan based on your actual numbers, not generic advice. You'll see exactly where you stand. You're going to see what's holding you back, and I'm going to show you the specific moves you can take to help you reach $100,000 faster. In this program, you will also get access to live coaching, including from me, and a community of people working towards the same goal. Most people are actually a lot closer to $100,000 than they think. If you're ready to stop guessing, if you're ready to start making real progress, scan the QR code on screen or click the link below to learn about the Road to $100K. But Ramit, I hate debt. Well, I hate corned beef hash, but people still eat it. So let's talk about this. Money is not just math. It is deeply embedded in psychology. And I can understand why you'd want to pay off your low-interest debt early. Most of us are not sitting here calculating interest rates. We just see a number. It seems to be growing, and that feels bad. But years from now, you are going to wish that you spent 10 minutes calculating these numbers because it could be the difference between 6 figures in your portfolio or nothing. But this takes you deciding, I'm going to take this seriously. I'm going to respect money. Maybe paying off your student loans would help you sleep better. Maybe seeing a zero balance would make you feel relieved. Those are real benefits. I respect that. We don't always have to do what the math tells us. In fact, I talked to a couple on my podcast who did exactly this. We put it all at the house, paid off any debts we had. We paid off both our cars. Paid off your house? How fast? Well, we bought it in 2019, June of 2019, and we paid it off 2 months ago.

So 3 years.

Why'd you do that?

Ironically, we use your psychology, which I know this wouldn't be your advice, but we used your psychology. Okay. What is your rich life? For us, With how uncertain everything was and how it just felt like the world was crumbling underneath us. And we didn't even live together for the first year of our marriage. Like, I wanted to just feel like that we had something concrete, that if the whole world crumbled beneath us, that we had someplace to go to that we could be safe at and financially safe at.

Mm-hmm.

So Dan very graciously agreed to work with me on that because he would've preferred to put it into investments and savings. But given our background and the fact, I think at this point I was in Texas, so we still weren't living together, and we just decided to put all of our extra funds into the house. It was very unconventional, but when we sat down and looked at what does our rich life right now look like, That was our rich life, is just to feel safe and to feel like we could transition out of our field if we both felt like it was better for our mental health.

And I get this. Security matters. Peace of mind matters. Those are real benefits. If paying off your low-interest debt gives you that peace of mind and you have run the numbers, go ahead. It's your money. It's your decision. But here is the tradeoff. How much do you invest per month right now? Is the answer zero?

Nothing.

Nothing. Okay.

The answer is zero.

This is the part that people miss, because when you are so focused on unilaterally eliminating debt that you are not thinking about what it's costing you, you don't realize the game being played. Your feelings matter. But when it comes to making one of the biggest financial decisions of your life, Feelings are not enough. You've got to have your feelings and you've got to have the numbers, and then you can decide which one is more important to you. Personally, I tend to go with the math, but some people go, hey, I understand that I'm giving up $50,000 and I really don't care because I want this debt off my back. Okay. You've got to make that decision consciously, though. What if, like many Americans, you have debts that fall into multiple buckets? Guess what? That's okay, because real life is a little messy. Let's say that you have an $8,000 balance on a credit card at 24%. That's high interest. A 72-month auto loan of $20,000 at 6%, which we could consider the middle zone, and a $30,000 student loan at 4%, which we would consider low interest. Each month you have $1,300 to invest or pay off debt. What do you do? Well, let's break it down. Pay the minimum on your student loan, $400. Pay the minimum on your auto loan, $331. And to your credit card, you put all the remaining money towards that $569. That is the fire that's burning in your financial house right now. At this point, it doesn't really make sense to invest when the stock market could never beat your credit card interest rate. At that rate, your credit card will be paid off in 17 months. You've now cleared bucket number 1's debt. Let me pause you here because a lot of people find this really overwhelming when Not because it's particularly complicated, but because they are impatient. As you are watching this, are you going, that seems like it'll take forever? Like we're talking about years now. Yeah, that's life. Part of being successful in life is accepting reality. So you may wish that it happened tomorrow, but that's not gonna happen. And sometimes we need somebody as direct as Ramit Sethi to just say, hey, this is what it's gonna take. So sit down, get comfortable. Put on a— drink a glass of water. I can't believe I'm burning airtime just drinking water, but it's my channel. And accept reality with what it's going to take. Sometimes in order to be debt-free, it's going to take you years. Yes. Let's fucking go. Okay. Now it's time to reassess. You're left with the auto loan, which falls into bucket 2, and your student loan, which falls into bucket 3. Personally, at that point, I would likely split the difference between paying off the debt and investing. So here's how I'd break down that $1,300 a month. I would keep paying the minimum on my student loan. That's $400. That leaves me with $900 to split. Here's what I would do. I would increase the car loan payment to $450. Then I would start investing $450 per month. Now, stylistically, you could go, hey, Ramit, I actually want to invest more and I want to keep the car loan where it is. Totally defensible. That's up to you. But in this example, your car loan would be paid off in another 40 months. Which is 15 months earlier than your original term. And in that time, your investments will have grown to about $20,000. You are starting to see how making these conscious decisions can be worth tens of thousands, even hundreds of thousands of dollars. Let's keep going. Now that your car is paid off and bucket 2 is cleared, it is time to get really aggressive with your investing. Remember, your student loan is in bucket 3. That's low interest debt at 4%, which means in my opinion, you should prioritize investing over paying that off if you want to make the most money. So keep paying off your student loan, $400, then increase the investing to $900 per month. In the next 2.5 years it will take you to pay off your student loan, your investments will have grown to over $53,000. You remember the people at the beginning of this video who I was yelling at, oh, boohoo, I can't find $200 a month and I fucked it. Do you see how by making a few key decisions correctly, you can end up with 5 figures, 6 figures, even 7 figures over time? This is important. So for all the jokes I make, I actually expect you to take this seriously because the last thing I want is for you to end up 40, 50, 60, 70 going, where did it all go? All those years working, what do I have to show for it? This is why these videos are not just entertainment. You should actually be following what I am talking about. Now, notice what we are doing. We're not treating every debt the same. We are letting the interest rate guide our decisions. And that framework is going to make you a lot of money in the long term. If you want to get better at making decisions like this with your money, hit subscribe, because the goal may not be to become debt-free as quickly as possible. The goal is actually to build a rich life. And paying off debt too early might actually be one of the most common mistakes that I hear. But the second and third most common mistakes are just as brutal. And to avoid those ones, watch this video next.