When in your twenties, is it better to invest your extra money or use it to aggressively pay down student loans?
I am in a position to begin aggressively paying down my student loans but wonder if my money would have greater long-term value being invested.
Answers ( 2 )
Jeff's advice is great. I would summarize succinctly:
As disturbing as debt always is, you need to make a "cold-blooded"comparison: if you can get a bigger return on your investment than the interest on your debt, as long as there is negligible risk of the investment "going bad", it makes sense to play one off against the other.
Of course, peace of mind is sometimes worth more than net profit.
Hi Jack, In my opinion there are multiple pieces that would go into this.
1) What is your mindset on finances?
2) What are the interest rates for your student loans?
3) What would you be investing in and what are your expected returns?
1) What is your financial mindset? E.g. Do you feel comfortable having debt
Some people are looking to be debt free and don't like having a balance so that is why it is important to know about how you view finances first. Dave Ramsey talks about paying off your loans and has made a lot of people financially stable. On the other hand, there are a lot of millionaires that are making money by borrowing money to invest and then profiting on the returns. If you are comfortable having money outstanding, then it becomes more a math question.
2) What are the interest rates for your student loans?
If your interest rates for your student loans are less than 3%, I would personally focus on investing since with inflation and other factors, you should be able to make more than 3% on your money.
If it is more than 3% you should to see if you can get a lower rate through consolidation or refinancing. This will depend on what type of loan you have as well as who it is with.
IF after all of this it is between 3-5%, it will depend on your expected returns for the investment. If it is above 5% I would look to aggressively pay it off.
3) What would you be investing in and what are your expected returns?
To start off, past results are not guaranteed future performance. I am sure you have heard this or something like this before. But I say that as whatever you decide to do, you are making an educated decision and will not know which will be best for you until after it has been done.
HOWEVER, if you look at investing as a whole, it becomes more a math problem to see what your compounded return would be if you invested the money vs. if you paid off the loan during the same time period. For example If you are able to get 8% return on an investment yearly and your interest on your student loan is 3%, you would have a 5% return by investing the money vs. paying off your loan. Remember the amount you are debating is the money you are looking to invest and not the entire balance of the loan.
Also, if you aren't already doing it look at 401k and your company match. That skews it even further in favor of investing vs. paying off debt.
Ultimately, there is a risk in the investment but if the interest rate is low enough, the compounding factor of investing will benefit you in the long run financially.
A good example and some more feedback is broken out here. https://www.debt.org/students/pay-off-student-loans-or-invest/
Hope this helps!
Jeff