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Student loans: Pay them down or invest?Document Transcript
“A unique voice on money,
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founder and writer of
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I Will Teach You to Be Rich
pay them Down or Invest?
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
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.
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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