Pay Off Your Student Loans Or Start Investing?
What’s the better choice?
Students graduating this spring – and I am one of them – certainly have a lot to consider, but the decision to invest or pay down your debt shouldn’t be put off.
According to The New York Times, the average student graduates with $26,500 in student loan debt, but it’s really the type of debt you have that largely determines whether to pay these loans off as quickly as possible or pay just the minimum and invest the rest.
Types of Student Loans
|Type of Loan||Interest Rate||Who’s Eligible|
|Direct Stafford Loans||3.4% (subsidized)6.8% (unsubsidized)||Undergraduate and graduate students; limit depends on your year in school and whether you are an independent or dependent student|
|Direct PLUS Loans||7.9%||Parents and graduate students|
|Perkins Loans||5%||Undergraduate and graduate students with exceptional financial need; not all schools participate|
|Private Loans||Varies||Varies; interest rate generally set based on credit score and can be fixed or variable|
No longer your older brother’s payback scenario
Prior to 2006, Stafford Loans had a variable interest rate based on the 91-day T-bill rate + 1.7% during school and + 2.3% after school. In plain English, student loans had interest rates that were below the market’s long-term rate of return. With rates like these, the standard advice would be to pay your loans off slowly, invest the rest of your savings, and reap the rewards of returns being greater than interest rates.
If you’re lucky enough to have secured a loan at a rate of ~4%, you might be better off investing as much as possible and paying down as little as possible of that debt. Investments might yield 7-8% – so you can think of yourself earning a 3-4% spread on the money that’s been loaned to you and you’re investing (over the long term, and assuming average historic rates or return prevail). There’s no bright line here – the only thing that’s certain is that the earlier you start saving, the better.
However, while there are still some loans (e.g. Perkins loans) that have interest rates below long-term market returns, many other loans these days have interest rates that are equivalent or higher than market returns. In this case, financial aid experts recommend paying off your loans as quickly as you reasonably can, while still leaving money to pay your bills and enjoy your 20s.
Retirement… the one big exception
The one big exception to this advice is investing for retirement. The effects of compounding can be huge, so before we even think about student loan payments, we should put some money away for our golden years. And if you work at a company with 401(k) matching, you’ve got an even better reason to take advantage of the match and stash some money away.
It’s a personal decision
In the end, deciding how quickly to pay off your student loans is a personal decision. If you have other, higher interest debt; focus on paying that down first. And if you can’t stand having any debt and it’s keeping you up at night, pay off your debt as fast as you can and get some sleep.
Jon Stein on “How I Built This:” Reflecting on Our Story
Jon Stein joins NPR’s Guy Raz for an episode of “How I Built This” to look back at how Betterment started, what mistakes were made, and how they turned into learnings for the robo-advisor we are today.
Reducing Your Biggest Retirement Expense: Where You Live
You’ll probably want to retire somewhere different than where you live right now. Let’s make that part of your retirement plan.
Investing in Your 20s: 4 Major Financial Questions Answered
When you're in your 20s, you may be starting to invest or you might have some existing assets you need to take better care of. Pay attention to these major issues.
Explore your first goal
Our high-yield account built to help you earn more on every dollar you save.
This is a great place to start—an emergency fund for life's unplanned hiccups. A safety net is a conservative portfolio.
Whether it's a long way off or just around the corner, we'll help you save for the retirement you deserve.
If you want to invest and build wealth over time, then this is the goal for you. This is an excellent goal type for unknown future needs or money you plan to pass to future generations.