After graduating college or professional school, there are many things on a person’s mind. When can I start working? How much will my starting pay be? My student loan debt is how much??? Investing is usually the furthest thing from a graduates mind. Yet this could be a mistake as recent graduates have the most powerful investing tool on their side: time.
Time spent investing is one of the biggest contributors to investing successfully. Compounding interest is your friend here, and the more time you give it to work, the more it will do for you. This article at get Rich Slowly gives a nice visual aid in this point. The bottom line is that waiting even 5 years before starting to invest can greatly effect your nest egg. Even small contributions like $25 a month can be very helpful and provide you with a good point to start adding to as your financial situation improves.
Now that we know how important it is to invest early on, the questions becomes how to prioritize your investments versus your student loans. The simple answer is to just look at the interest rates and compare them to possible rates of return.
I’m an advocate of making extra payments to any student loans above 6% before increasing your initial investment amount. The reason I pick 6% is that paying off student loans early is a guaranteed return on investment. Paying off a loan early means you won’t have to pay that interest rate on that extra money you paid, effectively giving you a future 6% return on investment. Numbers vary depending on who you ask, but the historic return in any 25 year period of the stock market is around 7%, not counting taxes. I’d rather take a guaranteed 6% return from paying off a student loan rather than a possible 7% return from investing in the stock market.
Using this 6% rule of thumb, or whatever rule works best for you, can make it a lot easier to determine when to pay off student loans early and when to invest. The other advantage of paying off student loans early, especially if you’re close to eliminating one, is that it frees up more income for you. Now depending on your financial situation, and the 6% rule of thumb, you can decide if you want to use that extra money to pay off another student loan or to increase your investing account.
Deciding when to pay off student loans and when to invest can be a pretty personal decision with many factors involved. Leave a comment below and talk about your investing strategy while having student loan debt.
What are your thoughts on people that have IBR or ICR repayment plans on their student loans? Is it better to just pay the minimum monthly payments and possibly have the remaining balance forgiven after 25 years? Or is it still better to pay the loan off faster?
Hey doc. Everybody’s situation is different, but I think it’s always better to get rid of debt earlier, especially high interest debt (anything above 5% in my book). The reason is that getting rid of debt is a GUARANTEED rate of return, while stocks or a business can go up or down. Also, getting rid of debt can free up cash you can use to attack your loans harder, or invest it elsewhere possibly. That being said, it might be worth it in some cases to pay the minimum on your low interest debts because you do get a tax break on the interest.
I will actually be writing a post about this very topic soon so stay tuned!