Helping clients choose between investing and paying down their debt with their spare money is a common challenge advisers face, especially at times when interest rates are elevated.

Comparing the interest rate a client pays on their debt with the return they hope to achieve from their investments, and directing funds to whichever is the highest, can be a useful starting point.

However, in reality, there are a number of variables to consider when helping clients to weigh up the trade-offs and get the right balance for them. Every client is different and the answer will ultimately depend on their individual goals and circumstances, as well as their attitude to risk and their process of weighting their longer-term objectives relative to shorter-term financial security.

For many clients, the perfect balance between investing and paying down debt may mean doing a bit of both.

When discussing this issue with clients, there are a number of key assessments to be made. Our three-step framework can provide valuable context for that conversation.

1. Assess debt

The first thing to consider is the nature and cost of the debt. Each type of debt has its own characteristics and some kinds are more flexible than others. Generally speaking, repaying high-interest-rate debts such as credit-card debt should be prioritised where the interest rate is high and compounding works in favour of the lender as the effect of being charged interest on interest can soon cause the debt to spiral. Paying off these debts can also help clients to feel in control of their finances and contribute greatly to their sense of financial wellbeing.

Repaying other forms of debt, such as student loans and mortgage debt, may be less urgent. Specific rules tend to govern student-loan debt in terms of when repayments start and whether or not it might be written off before it is repaid.

Student debt doesn’t start to be repaid until the borrower earns above a certain threshold. Even then, the borrower pays a fixed percentage of the amount above this threshold, like a form of taxation. The debt in some situations can even be written off eventually.

Paying down a mortgage, meanwhile, may seem prudent, either by shortening the repayment term or making overpayments. Some mortgages, for example, allow overpayments, while others limit them, and clients should beware of early redemption charges on fixed-rate deals. Overpayments may seem a good idea for homeowners coming to the end of a fixed-rate deal who will have to renew at a higher rate, but such considerations should be balanced with other longer-term goals like saving for the future.

Whether or not it makes sense to prioritise debt repayments over investing, these debt differences need to be considered.

2. Understand investment options

Tax benefits add to the attraction of saving and investing. The power of tax-advantaged savings can make a large difference to wealth creation over the long run. But the potential tax benefits differ, depending on the type of investment account chosen and the degree of flexibility required.

One important consideration is accessibility. For example, pension contributions may be tied up for a long time. Any strategy must balance the potential to generate greater returns with an investor’s risk tolerance and liquidity needs over time.

Some investment opportunities may be too good to pass up, like the employer contributions a client may get on their workplace pension or the extra tax relief they may get on pension contributions. This is especially true for higher-rate taxpayers and those whose employers match additional pension contributions. Clients are also less likely to miss money that comes off their salary before they receive it.

What type of financial future does a client aspire to? Those starting out in the world of work may have a modest salary just now, but their earning potential may be likely to increase considerably, paving the way for greater financial security but also more ambitious goals.

Short-, medium- and long-term goals all need to be considered, starting with ensuring clients have an adequate cash buffer for emergency savings, but also ranging to objectives like saving for a wedding, investing for school fees or building pension assets for retirement.

Paying down debt needs to be balanced with these personal goals, the need for financial flexibility and the benefit of starting to invest early to maximise long-term net wealth. When deciding between making debt repayments and investing, the client’s risk tolerance is also a key factor to consider.

Key takeaways