Student loans: Pay them down or invest?

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  • 1. “A unique voice on money, i w r d an do i l l ail d i wn fo ds, one singularly attuned to…his generation.” t e y t nt loa a c ac er I WIll h y tic act Vis u t o l tip e sp —San FranciSco chronicle o a iv it b e r s, b re i c on ads h . us h co m ee ts TEAch You by RAmIT SEThI founder and writer of iwillteachyoutoberich.com ToBE No Guilt. No Excuses. No B.S. Just a 6-Week Program That Works
  • 2. I Will Teach You to Be Rich Student Loans— pay them Down or Invest? S tudent loans are a big kick in the face that the real world has arrived. CNN reports that the average college graduate has around $20,000 of student loans—plus, as the U.S. Public Interest Research Group recently indicated, more than $2,500 of credit card debt. It can seem hard to get ahead when you have the baggage of student loans weighing you down. The good news is that student loans were probably an excellent financial decision (unless you ended up being an artist or actor . . . In those cases, get a real job). College graduates far outearn those with only a high school degree. Still, if you have $20,000 of debt hanging over your shoulders, you’re going to want to know how to handle it. Although we already talked about getting out of student debt in Chapter 1, there’s one additional question I constantly get asked: “Should I invest or pay off my student loans?” 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 in student loans each month. But when it comes to putting money toward investing or your student loans, you really have three choices: n Pay the minimum monthly payment on your student loans and invest the rest. n Pay as much as possible toward your student loans and then, once they are paid off, start investing. n 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 had 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 220
  • 3. A RICH LIFE having any debt at all 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. 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 would stand to make by investing would be 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, 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 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. Most people will simply choose a 50/50 split to keep things simple, but if you’re more aggressive, you’ll probably want to invest more. 221
  • 4. Get the full book at Amazon.com About the book At last, for a generation that's materially ambitious yet financially clueless comes I Will Teach You To Be Rich, Ramit Sethi's 6-week personal finance program for 20-to-35-year-olds. A completely practical approach based around the four pillars of personal finance—banking, saving, budgeting, and investing—and the wealth-building ideas of personal entrepreneurship.