Should I pay off my Student Loans or Invest my hard earned money? This is a very common question and one that I and many other have asked themselves when trying to do the right thing with their personal finances following graduation. Here we will discuss a few things to consider in making the correct decision for YOU and your future!
Student Loan Debt Crisis
Currently There is a massive student loan debt issue in the US and this problem is only growing by the day as more students enter into student loans creating debt for their future.
As of early 2020 the student loan total debt in the US has climbed to 1.3 Trillion dollars according to Forbes. This is a massive number and will only grow as more students apply for colleges and expensive private school and graduate programs raise their prices annually.
I am unfortunately part of that statistic with over 6 figures of student loan debt myself.
Invest or Pay off Student Loan Debt
This decision relies heavily on what you want to do personally and there is no Right or Wrong thing to do in this situation. Both paying off student loan debt and investing are constructive and positive actions to take with your money.
That being said, these two actions come with different pros and cons which we will cover in this article. First I just want to ensure that either way you are making progress, don’t forget that and make the decision that is right for you based on your life and personal situation.
So What Should I do?
Let’s go over the pros and cons to Investing your money vs. paying off student loans.
The first thing you want to consider is your personal view on debt. If you are a very risk adverse person and the thought of your student debt is very stressful to you. It may be in your best interest to pay off your student loans and get them out of the picture prior to worrying about investing for your future.
However, if you don’t care about the thought of being buried in student loans along the compounding interest that is building those loans over time as you pay down you may be more apt to invest more of your money in this situation.
Pay off Student Loans
The first obvious pro for paying off loans as talked about prior is the amazing psychological benefit of being debt free. This is a massive point in Dave Ramsey’s large movement to pay off debt of any kind. This can reduce stress levels, improve mental health, and actually effect physiological health lowering blood pressure and reducing anxiety.
Another amazing benefit of paying off student loans is quite obvious as well, freeing up future income. This is obvious but lets dive in a little deeper to see how positive this can be. Imagine a day where that certain day of the month is where you pay your student loans, and then imagine not owing a single penny on that date… a dream world right? Well paying off loans can make that a reality.
Freeing up income can then lead directly to that income being available to put towards investments, retirement, house savings, mortgage, wedding, kids college savings, and many other personal finance endeavors.
The part of this we rarely think about is how being done say even a year earlier with paying off student loans can create a whole year worth of those payments that could be saved and invested. This money would add up quickly. So instead of just comparing interest numbers, also look at that monthly payment and calculate how much you could save by paying off your loans even 6 months or 1 year quicker.
Say you pay 1,000$ a month on your student loan. If you payed off your loan just 1 year earlier than your payment plan dictates by funneling extra payments in over time. This frees up not only stress, but also creates 12,000$ more income that is in your pocket to allocate wherever you want throughout the year! That is powerful.
The primary draw back of paying off student loans rather than investing can lead to you missing out on crucial years to build your retirement nest egg with the power compound interest over time.
Student loans have differing interest rates based on what type of loans and what company you go through. Average student loan interest rates in the US are 4.8% for undergrad, 6.4% for Graduate, and 7.4% for Parent PLUS loans as reported by Credible. These are very high depending on your loans as you can see. Regardless of where you fall personally, you may want to strongly consider refinancing your student loans to get a lower rate. I have reviewed some student loan refinancing companies that I have personally used here.
The interest rate is something that you strongly want to consider when looking at this argument. If you believe that investing you can earn higher interest than what you are paying on your student loan, then based on the math you would make more money on interest over time investing.
However, investing money into your student loan debt is a guaranteed return of whatever your interest rate is on that money. In the stock market nothing is guaranteed, so that has to be taken into consideration as well.
So the main CON here to paying into student loans rather than directing that money into investments, is the loss of the compounding interest that would be achieved on that money in the stock market over time. However keep in mind that there is no predicting when the stock market may go down, especially in the short term.
Investing rather than paying off your loans is definitely the sexier and flashier move to make here. Who doesn’t want to watch their money grow in exciting popular companies like Amazon and Microsoft instead of pay that money into a large sum of student loan balance or even interest and watch it seemingly disappear.
Investing is a way to grow your money and get a “hopefully” higher return on your money than if you were putting that money toward student loans. Remember we do not know what the stock market will do, and this is even more pronounced in the short term.
But long term what you expect from the market is that it will move positively as it has done in the past, looking around 30 to 40 years out if you are younger just out of college you can surely assume that you will be seeing a positive gain in that time frame.
The main argument with investing over paying off your loans is one of assumption and mathematics. It can be assumed based on historical data that the stock market should net you around a 7% return over time conservatively based on the type of investments you hold. This assumed percentage can vary wildly and is impossible to actually predict.
So you take that example assumed percentage of 7% and then subtract your interest rate which if it is lower (especially if you refinanced your student loans) of around 4-5% you are gaining at least 2% more on your hard earned money over time.
Remember this is a conservative number over time of 7% for the stock market, if you are in riskier investments you surely could expect a higher return. But don’t forget that with that risk you could also lose money chasing the higher returns.
So if you want to go purely by mathematical return based on an expected return over time, then maybe investing is the right route to come out in the end with the highest possible wealth created.
Risk. The main con of investing in the stock market is that the market as a whole is risky and volatile. The longer your time table and with proper diversification of equities and other holdings in a portfolio however, the risk decreases somewhat.
But the main point here is that you could allocate all of your extra money each month into the stock market for a whole year, and then the market plunges down 30% in a couple of days like it recently did here in March 2020 due to the Coronavirus.
In this example instead of locking in a guaranteed return on money in the amount of whatever percent interest is on your student loans, you have experienced a 30% loss instead on those funds.
This is where the risk is really shown in a bright light of what can happen in the stock market. However if you have a realization of this risk and are quite tolerant of a drop like that, and you do not have the urge to pull the money out during a market drop then those losses are not realized losses and you can expect the investment to go back up and increase in value from there over time.
So once again it comes down to tolerance, goals, and how you personally view debt as a whole.
Invest or Pay Off Student Loans
So after reading all of this what should you do? This all depends on your personal situation, investing timeline, student loan interest rate, and risk tolerance.
I personally recommend to Invest and pay off loans in a hybrid approach. I pay a large elevated amount much higher than my minimum payment right off the bat. I recommend putting this higher amount payment on auto pay so that it just happens each month without you having to make the decision, much less painful that way.
Then I recommend investing in either a Roth IRA or Roth 401k. I personally use Vanguard and am very satisfied with my experience with them in all aspects.
Investing in a retirement account is a great way to put the money aside and let it grow for the long term, like mentioned above making the assumption for a positive growth much less risky over time.
If you are with a company that has a match I am a Huge proponent of investing what ever your company offers up to the match percentage. That is a dollar for dollar return and you get a guaranteed 100% return on investment, that is a must.
So in the end as mentioned from the start paying off student loans and investing are both admirable moves for your money and are great ways to advance your financial position and net worth. This article tells you the reasons why you may or may not want to do both and lets you decide yourself what is best for you.
If you want to earn more money with some more risk over time, then you may want to throw more into the stock market rather than pay off debt quickly.
If you want to pay off student loans fast and just get it over with for the stress relief then go that route.
Either way Save, Save, and save money and keep putting it into your student loan debt and retirement savings over time and you won’t be disappointed in the long run. Take a view through a long term window and both are very good option.
Thank you for reading,
Comment below on where you are at in your student loan payoff journey and what you’re doing… I’d be happy to talk with you more!