Zach emails about his student loan money:
Now for the most part all of that money will be used to do things like pay rent, and buy groceries, but when I’ve calculated it out, there’s around $1000 left per semester minimum, and more if I can be frugal about how I spend it.
My questions was, do you think it would be smart to turn around and pay off part of my loans with the extra cash, or could you recommend me a direction to maybe take this extra money that I have, and invest it to make a return? I know right now that I could either drop it in my ING savings account which is at 4.5% or put it into a money market account at my bank which is about 4.5% also. Other than that I wouldn’t know where to begin.
The problem with investing money in the short term is that it’s dumb. Sure, you could make a few percentage points — or you could lose most of it. Short-term volatility is very high, while time (and good investing choices with low fees) smooth out short-term volatility. As I’ve written before, time pressure=bad decisions. For example, I remember when I was a sophomore, we hosted this prospective freshman in our room for Admit Weekend. This guy left our room with a single decree: “Guys,” he said, “I’m not coming back until I hook up with a hot girl tonight.” My roommate and I looked at each other and laughed and laughed. Then we told him to just pack his stuff and take it with him — he wouldn’t be coming back, and it was nice to meet him. When he sheepishly came back around 3am, alone, I believe that moment of happiness will rival even the birth of my children. Setting a rapid timetable for getting ass, it turns out, is difficult.
Back to student loans. Do you want to invest your student-loan money for the possibility of making just $7.50/month (9% returns) but possibly losing some/most/all of it in the short-term? “But Ramit,” you might say, “I’ll just invest it in something safe so I can’t lose it.” Lower risk = lower rewards, so if you invest it in a safe government bond, you’ll earn about 5% — basically your savings rate. You need time and more capital to grow your money, not $1,000 and a few months. That’s the domain of get-rich-quick quacks, something I hate. Remember, the first thing I ask when someone wants to know about investing is, “When do you need this money?”
Ultimately, it comes down to risk and reward. This is why I find those 0% credit-card games so moronic. These are the ones where people get 0% interest money from their credit cards and transfer it around to earn interest on relatively large sums of money. Sure, you can make a hundred bucks a year, or maybe even a few hundred, but the risks of time, mismanaging the process, and screwing up your credit score just aren’t worth it to me. Plus, I’d rather do something useful and sustainable instead of spending a year getting $200 band-aid.
If it were a college student and I had some money left over from my student-loan account, I’d put it in a high-yield savings account like ING or HSBC and let it get about 4.5%. (Note that this would earn you about $4/month in interest, just about enough to buy Sisqo’s greatest hits on iTunes.) Separately, the most profitable thing I could do would be to learn about investing, asset allocation, and building an infrastructure to manage my personal finances.
The basic messages here are:
Risk and reward. Before you get overly excited about something, ask yourself if it’s worth it. You might make $200 in a year, with the possibility of messing up your credit for doing those stupid balance-transfer games? Not worth it.
Sexy vs. rich: Making it sustaintable. Are you building a long-term infrastructure or are you doing something short-term and dumb to distract yourself from the hard work of learning about real banking, budgeting, saving, and investing? Do you have a savings account? A Roth IRA? An investment account with proper asset allocation? Have you bought even one personal-finance book? (Here are 50 books I recommend.)
Learning and building a system may not seem as sexy as INVESTING IN DERIVATIVES AND SHORT-TERM SECURITIES!!!!11*#! but it’ll damn sure make you richer over the long term.