This is an age-old question with one of those annoying answers: It depends. Let’s delve into it!

You’ve probably heard that simplistic solution: Always invest if you can earn a higher interest rate from investing than you are paying on your loans.

Not necessarily! In fact, this can be dangerous. Remember the stock market frenzy? Unfortunately, a lot of homeowners created more debt for themselves by cash-out refinancing or through home equity loans. When the bear market hit, the reason that this solution is not so simple after all became far too clear.

Evaluating your debt
So how do you decide how to most effectively use the money you earn? The best answer lies in separating good debt from bad debt. It's almost always a good idea to get rid of credit card and other high-interest loans before you start setting aside cash. However, you probably don't want to accelerate mortgage or student loans at the expense of saving for retirement.

Feeling overwhelmed? Here’s some steps you might consider following:

1. Make a list
List all of your debt and the interest rates you are paying on each debt. This will help you prioritize which ones you should pay first. Don’t skip this step and just assume that you automatically know where the highest rates are – you might be surprised! Then look at your alternatives for saving and investing and, if necessary, reset your priorities.

2. Pay off the high-interest debt
First, tackle any high-interest credit card debt that you may have. Based on the interest rates of most credit cards, you’d have to make a whopping 20% after-tax return on stocks, bonds or mutual funds to make them a better investment than paying off a credit card with an interest rate above 15% - so you’re better off paying off the cards instead of investing. Exception: If your employer offers a 401(k) plan and will match your contributions up to a certain level, fund it up to that level -- even if you have credit card debt -- because you're getting a 100% return on your investment.

Drowning in debt? Consider liquidating assets such as stocks and use your savings (but not a 401(k) or IRA) to pay off your credit cards. If the situation is critical, you can borrow up to 50% (no more than $50,000) from a 401(k). Although you pay yourself back with interest, you give up tax-free compounding, and you will have to pay back the loan immediately if you leave your employer.

3. Know which debt is good debt
Unless you have piles of extra cash sitting around, it’s usually not worthwhile to pay off your mortgage. This is because you can deduct part of your interest payment on your tax return. Instead, use that money to invest in liquid assets. Exception: Close to retirement? Try to pay off our mortgage and any other debt before you retire so that you can get by on less money.

Student loans: There’s no rush here, either, since qualifying interest on student loans can be written off no matter how long it takes to pay them off. However, you can ease the burden of repaying student loans: if you have more than one student loan from the federal government, you might be able to receive an interest rate reduction if you consolidate your loans. You can also lower your monthly payments this way, leaving you with more money to pay off consumer debt. Also, if you elect to have your loan payments automatically deducted from your bank account, you can get a 0.25% interest rate reduction on your student loans. The Education Department's Direct Loan Program has more about repayment incentives.

4. Save and invest
Finally eliminated high-interest debt? Now it’s time to start saving as much as you can. The best place to begin is a 401(k), and the second best place is an IRA.