Comparing the cash flows from a 401K match v credit card interest payments

What cash flows is our healthcare professional comparing?

Many entrepreneurial opportunities are mutually exclusive: you can execute one and sacrifice the other. This mutual exclusivity allows us to find the indifference point: the place at which the benefits of selecting one option is equal to those of selecting the other. In this case, our healthcare professional can't fund his/her 401K and pay the credit card bill: only one can be done.

It's fairly obvious what the cash inflows are for the 401K: a 6% matching amount from his/her employer over the course of one year. For the credit card option, however, the cash inflows aren't as straightforward because cash is generally going *out*. The cash inflows to our healthcare professional come from the savings s/he realizes by avoiding interest payments. 

Thus, we will be finding the indifference point between two opportunities:

the amount of cash the employer contributes to the 401K versus the amount of interest our HCP saves by paying off the credit card balance.

Another key consideration: simple versus compounding interest

The 401K matching is 6% of the HCP's annual salary. This 6% contribution is simple interest: so if our HCP earns $100K annually, the maximum cash inflow s/he will receive from his/her employer is $6000 (= $100K x 6%). Since we don't know what the HCP's salary is, we'll call it x and state that the annual cash inflow from the employer match = (6%)($x).

The credit card interest is compounded, and that makes it a bit more difficult (but not impossible) to compare to the employer matching. If our HCP contributes to his/her 401K, s/he cannot pay the credit card balance of $10K. The total amount of interest s/he would owe in one year (and thus, the cash inflow s/he would receive if the interest was saved) is ($10,000)(1+y%)^12 - $10,000, where y% is the monthly credit card interest rate. 

Finding the indifference point(s)

Let's compare the cash inflow from interest saved and that from the 401K match, over the course of one (1) year:

($10,000)(1+y%)^12 - $10,000 = 6%($x)

Given one equation but two (2) unknowns ($x = annual salary and y% = monthly credit card interest), we can perform a sensitivity analysis.

If the true monthly credit card interest rate is:

• less than the indifference value shown in the table, the HCP will have greater cash inflows by contributing to the 401K first.

• greater than the indifference value shown in the table, the HCP will have greater cash inflows by paying off the credit card balance first.

Average monthly credit card interest rate

The US Federal Reserve tracks credit card interest rates: the average as of 11/2023 is 21.47%. This value represents the non-compounding interest rate (learn more about non-compounding interest rates here or here): a equivalent to 21.47%/12 = 1.79% monthly interest.

Using the sensitivity tables above, our HCP can determine which option would result in greater cash inflows over a one year period.

Once again, the answer to a financial question depends on more than one factor. One size does not fit all, and analyzing your situation through a sensitivity table generates a more informed perspective. Let us know what option you'd choose and why.