Should I Pay Off Student Loans or Invest?

Should you pay off your student loans or invest? It’s a classic question for recent graduates and young adults. If you’ve exited college and are either actively employed in the work force or still seeking a job, it is likely that you may have at least some amount of student loan debt to pay off. The good news is that you’re not alone, as it is estimated that roughly 40 million people are in the same boat, with an average student loan amount of $35,000.

But being a part of this group doesn’t make it any easier to determine what exactly you should do going forward in terms of paying off your debt obligation or investing your money for the future.

Fortunately, asking yourself “should I pay off my student loans or invest?” is the right question to be asking because where you put your money determines how you maximize your wealth, and is thereby a step towards becoming debt-free and financially independent.

Pay Off Student Loans or Invest

Considerations For Your Future Finances

Today, people are living longer than ever before, which in turn means that you could essentially spend 30 or more years in retirement. While that time may seem a long time away, the earlier you start investing could be the difference between retiring a millionaire and running out of funds.

On the other hand, student loan debt is still an important financial obligation – one that is required to be repaid, so at the very least, you should make the minimum monthly student loan payment. However, by paying off your student loan(s) more quickly, it could mean that you will have more disposable income to invest with once the student debt is fully paid off.

Pay Off Debt or Invest?

In determining the best course of action for you, there are a number of key factors that you should consider. Here’s how to decide whether you should pay off your student loans or start investing young and early.

Liquidity Requirements

As you enter into the world, you will need to have a good idea of how much money you need to not only meet your everyday living expenses, but also in case of an emergency. With that in mind, many financial experts advise building up an “emergency fund” in the amount of between three and six months of your expenses. That way, just in case of a job loss or other emergency, you will be able to still pay your bills for a certain period of time.

Also, you will need to be sure that you are comfortable paying your monthly expenses after you’ve paid your student loans or made contributions to your investment account. Therefore, calculate just how much you have coming in (after taxes and other deductions), versus what you need to live on each month. If you have an overage on the income side, even with making your student loan payment, then putting those funds into savings or investments can make sense.

Ultimately, the best situation is to have enough money to both pay off your loans and invest at the same time. The amount you contribute to each financial need really depends on your rate of return.

Employer-Sponsored Savings Plans

Whether your employer offers a retirement savings plan can also make a difference. In this case, many of these plans, like the 401(k), allow you to defer a portion of your income before taxes. This can mean that the amount of your annual income is reduced when tax time comes, resulting in a lower amount of income tax due or a bigger refund.

You should also check into whether or not your employer offers a matching program on your retirement plan contributions. If so, it may require you to contribute at least a certain amount of money into the plan. If you qualify for the employer match, it is like receiving “free money” in your account, so be sure to always maximize your 401K match.

Interest Rates vs Expected Investment Returns

Another important factor to consider is the amount of interest that you are paying on your student loan versus your anticipated investment returns. Criteria here will be dependent on what you plan to invest in.

For instance, some of the “safer” options such as money markets, CDs, and bonds are currently paying very low rates of interest. For example, if your investments will only be paying you 2%, but the interest rate on your student loan is more, then it makes sense to forge ahead and pay off your loans first.

The same goes for other types of debt. If you have credit card debt that is costing you 20% to 30% interest per month, don’t even bother investing till you’ve paid off your credit card bill.

Also, many of the risk-free savings and investment options will not keep pace with inflation, so it is essential for you to factor that into your equation. For example, an annual inflation rate of 3% and an investment return of 2% actually mean you are losing money.

This means that the investments you choose should ideally beat the rate of inflation, as well as the interest rate on your student loan. Long-term, your best bets are equities in the stock market.

Student Loans vs Investments

While you may want nothing more than to invest for your future, sometimes paying off debt can be your best investment. Consider the factors above as they relate to your specific financial circumstances and decide what makes senses for your money. If the sides are evenly balanced, figure that becoming debt-free can often provide a huge intangible benefit – peace of mind.

Contact us if you want ideas on how to lower your payments via consolidation or refinancing and free up some extra cash to invest.