Investing vs. Paying Off Student Loans
The Federal Reserve reports that the average college graduate has around $35,000 of student loans—and those of you carrying such debt may find it an impediment to achieving your Rich Life. But the surprisingly good news is that student loans were probably an excellent financial decision. We’ll look into the reasons why in this article.
Statistics clearly show that college graduates far outearn those with only a high school diploma. (That said, you should take responsibility for researching college majors and their average salaries.)
Please don’t listen to the pundits who have jumped on the bandwagon of saying student loans are “evil” and you should skip college. God, if I hear this nonsense one more time, I’m going to jump up and beat someone with an onion. (That way it’s unclear why they’re crying.)
I used to have anxiety wondering how I would ever be able to pay off my student loans, have savings, and have a retirement plan. Now my student loans are almost entirely paid off, I have savings account (plural), have two retirement accounts, and have no stress around those things. I have all of it automated, and I know how much money comes in, where it goes, and how much goes out.
—DEANNA BEATON, 30
Investing vs. Paying Off Student Loans
It can be difficult to hear the drumbeat of “Invest early!” when you’re scrambling to pay $500 or $1,000 toward your student loans each month. But when it comes to paying down your loans or investing, you really have three choices:
■ Pay the minimum monthly payment on your student loans and invest the rest.
■ Pay as much as possible toward your student loans and then, once they are paid off, start investing.
■ Do a hybrid 50/50 approach, where you pay half toward your student loans (always paying at least the minimum) and send the other half into your investment accounts.
Technically, your decision comes down to interest rates. If your student loan has a super-low interest rate of, say, 2 percent, you’d want to pursue option one: Pay your student loans off as slowly as possible, because you can make an average of 8 percent by investing in low-cost funds.
However, notice I said “technically.” That’s because money management isn’t always rational. Some people aren’t comfortable with debt and want to get rid of it as quickly as possible.
If having debt keeps you awake at night, follow option two and pay it off as soon as possible—but understand that you could be losing lots of growth potential just so you can be more comfortable.
My Ultimate Advice
I recommend you take a close look at option three, and here’s why: The interest rate on most student loans these days is similar to what you’d get in the stock market, so frankly your decision will be a toss-up.
All things being equal, the money you stand to make by investing is about the same amount that you’ll pay out in interest on your student loan, so basically it’s a wash. It won’t really matter whether you pay off your student loans or invest, because you’ll get roughly the same return. Except for two things: compound interest and tax-advantaged retirement accounts.
When you invest in your twenties and early thirties, you get huge benefits from compound interest. If you wait until you’re older to invest, you’ll never be able to catch up on those earnings. Plus, if you’re investing in tax-advantaged accounts like 401(k)s and Roth IRAs, you’re getting gains from tax benefits.
That’s why I would consider a hybrid split, paying off your debt with part of your money and investing with the rest. The exact split depends on your risk tolerance. You could choose a fifty-fifty split to keep things simple, but if you’re more aggressive, you’ll probably want to invest more.
Creating a bright financial future starts now
As you start on the path toward becoming a fiscally responsible person, you’ll have a lot of learning to do. There are many resources to help, from our “I Will Teach You to Be Rich” book to spending tips, retirement guides, and more.
Continue to read up as your knowledge expands. The financial freedom and peace of mind that smart financial planning brings are great motivators. Your future self will love you for it.