Debt Payoff: Why Math Trumps The Common Sense Approach of Rapidly Paying Off Debt

The High Cost of Advice To Focus 100% on Paying Off Debt

Debt payoff strategies abound on the internet, and many mainstream financial gurus have built an empire on the common-sense approach to focus your financial efforts first on paying off your debt. While credit card debt, auto loans, and even mortgages are all targets of these strategies, one of the newest and most common targets is the student loan debt which many millenials are graduating with.

The Math Doesn't Support This Advice

Unfortunately, math and common sense don't always align. Before you devote all of your extra income to paying off debt, make sure to do the math on how the debt payoff strategy might impact your ability to save for your future. No matter how appealing the idea of being free from debt might be, taking a more comprehensive approach will likely put you in a stronger financial position when considering not just your debt payoff goals but also your other goals, like retirement.

To illustrate this idea, the following is the mathematical reality of two strategies represented by the stories of two recent college graduates - Payoff Pat and Comprehensive Corey. Both are twenty-five years old, just graduated from college with $50,000 in student loan debt, and both have landed jobs paying $50,000 per year. 

Other Key Factors Used for the Calculations

  • 4.45% student loan interest (Current Federal rate)
  • 2% High-yield savings account (Current rate)
  • 3% company match on 401(k) contributions (lowest match a company is able to offer to avoid the costly and complicated non-discrimination testing the IRS requires)
  • 8% retirement portfolio returns (assumes an 80/20 equity to bond allocations)
  • 22% Federal tax bracket (current tax rate for 2018)
  • 8% other withholdings (includes state taxes, FICA, SDI, and others)
  • $2,008 in monthly expenses
  • Both have $909 to devote toward improving their finances.
  • Both are starting with $1,000 in savings
  • 0% Inflation - Inflation will cause the numbers to be different, but will impact both Pat and Corey in a similar way. As a result, inflation is not factored into the equation.

Payoff Pat

Pat bought a financial expert's book which advocated focusing all extra money on one goal at a time; paying off all debt first, then saving everything toward an emergency fund, and finally investing toward retirement.

The simplicity of the book's strategy and the allure of living debt free appealed to Pat. So Pat took all $909 of extra income and devoted it toward paying off student loan debt. Additionally, all of the money Pat saved on taxes for their student loan also went toward paying off their debt.

Comprehensive Corey

Corey was overwhelmed by the decision and talked with a comprehensive financial planner. Corey went on a 25-year repayment plan for their student loans, which set the payment at $249.51.  Corey also, however, contributed $125 each month to the company 401(k) - just enough to get the company 3% match. The remaining $534.41 per month Cory saved in a high-yield savings account to build an emergency fund.

5 Years Later

Pat's Net Worth: $1,000

Within 5 years Pat had completely paid off the student loan, and can now focus on contributing to their emergency fund and then 401(k). At the 5 year mark, Pat has $0 in student loan debt, but also has $0 in their retirement account and $1,000 in their savings account.

Corey's Net Worth: $9,216

Corey, on the other hand, still has $43,136 in student loan debt. Corey also has $18,369 in their retirement account and another $33,983 in the high-yield savings account.

Pat's Additional Risk

In addition to having significantly less net worth than Corey, Pat also was subject to significantly more risk during these 5 years. Because Pat only had $1,000 in savings, any job loss or unexpected expense would have likely resulted in additional debt and stress.

Corey, on the other hand, was saving more than $6,000 each year into an emergency fund, meaning there was significant savings available to handle any unexpected expense or a job loss. Within 6 months of contributing to the emergency fund, Corey can pay for over a year's worth of student loan payments if they lose their job. By year five, Corey can replace their income for over a year, definitely enough time to find a new job and get back on track.

While it seams like Pat's strategy of paying off the debt is the 'safer' alternative, this is only true once Pat completely pays off the debt. Pat actually took a significant unnecessary risk by devoting all of their extra income toward paying off the debt. Additionally, even though Pat can now devote all of their money to building an emergency fund, it will take Pat another 38 months to reach the value of Corey's emergency fund.

Savings at Retirement

The argument often made to these number is Pat will be able to save much more into their retirement account than Corey, which will allow Pat to catch up to Corey's head start. While this might make "common sense," the actual math doesn't work out. Both Pat and Corey are age 30 now, and have 35 years until retirement. 

Pat's Retirement Balance: $1,794,819

Beginning at year 5, Pat devotes the entire $909 toward their emergency fund. A short three years later, Pat has built an equivalent emergency fund to Corey. At that point, Pat devotes all $909 toward their retirement account, earning the 3% match and an average return of 8% over their 32-year period. The resulting account balance is nearly $1.8 million dollars.

Corey's Retirement Balance: $2,459,041

Corey's retirement balance is a little more difficult to calculate. Corey already has $18k in their retirement account. Corey is also finished with their emergency fund after year five, but still has twenty years of student loan payments to go. It is not until Corey pays off the student loan that they can devote the full $909 to retirement. As a result, three calculations are needed to figure out Corey's final balance.

The first calculation is how much Corey's year 5 retirement balance ($18,369) will grow to in 35 years. With the same 8% return, this money will be worth $299,281 at retirement.

The second calculation is how much Corey will be able to contribute until they pay off their student loans. Remember, Corey still has a $250 student loan payment. As a result, Cory can only contribute $659.41 monthly to their retirement account while paying the student loan. The fact Corey can begin these lower contributions immediately, while Pat had to wait 38 months to build their emergency fund, still leaves Corey with more money at retirement; $1,801,638 to be exact.

Finally, we have to calculate the contributions Corey can make during their last 15 years of retirement when the student loan is finally paid off. At $909 contributed monthly, this portion of their retirement balance will grow to $358,122. In total Corey accumulates $2,459,041 for retirement.

Why Corey has $650k More Money At Retirement

Corey has so much more money than Pat simply because Corey began investing for retirement earlier. Pat not only loses out on five years of the company's 401(k) match, but also loses out on nearly 8 years of compounding (5 years of loan payoff plus 3 years of emergency fund building).

Even WIthout A Match, Corey Wins

Having more years of a company match obviously helps Corey, but if we remove the match, Corey still comes out ahead investing on their own. Without a match, Corey ends up with $1,979,411 while Pat ends up with $1,577,820. Still, Corey has $400k more in their retirement account.

Do the Math & Don't Focus On Single Financial Goals

The moral of the story is twofold: first, math is important; and second there is an incredible cost to focusing on a single financial goal at a time. In the case of Pat and Corey, it cost Pat well over a half million dollars.

When considering your financial plan, focus on a comprehensive view of your overall goals. And make sure to do the math on the alternatives so you know the true costs and benefits of different strategies.

If you would like help, seek the help of a fiduciary and fee-only financial planner. These advisers are legally required to do what's in your best interest and don't take commissions or other kickbacks from the investments they advise you to buy. My financial planning firm, Purposeful Strategic Partners, works with people regardless of income or wealth; and there are many other similar financial planning firms.


Joshua Escalante Troesh is a tenured professor of Business at El Camino College and the founder of Purposeful Finance. He is also the owner of Purposeful Strategic Partners, a Registered Investment Advisory firm. He can be reached for comment at