Should You Pay off Your Student Loans or Start Investing?

Meme stocks, trending cryptocurrencies (Dogecoin, anyone?), And GameStop’s newfound fame – investing is no longer the boring hobby it used to be. With so much hype, it’s only natural that more people want to be part of the fun.

But if you’re one of the 40+ million adults in college debt, market immersion is a classic chicken-or-egg scenario: Do ​​you want to build wealth by paying off your loans faster or investing for your own money? Future?

Sure, the earlier you start investing, the more you can get compound interest over time, but investing can also be risky as the market can be a volatile place and you don’t want to make it even harder for yourself to pay off yours Debt when things go south.

However, you can balance the two goals if you are strategic. Here are some tips to help you decide where to put your excess cash.

What are your finances like?

Student loans (or making money in the stock market) can grab your attention, but it shouldn’t necessarily be the first financial goal you focus on. You need to first do an honest inventory of your finances, says Gregory Giardino, financial advisor at JM Franklin & Company, a New York-based retirement planning company.

Ask yourself: Do you have a stable income or does it fluctuate every month? Do you have an emergency fund? Are you contributing to an individual or employer-funded retirement plan?

As a general rule, financial planners say you should have three to six months’ worth of emergency fund for non-discretionary expenses (aka enough to pay for all of your essential expenses plus monthly financial obligations).

However, if you are a freelancer or your income fluctuates every month, Victoria LeBlanc, Certified Financial Planner at Raymond and James, recommends creating a nest egg of at least 8 months of non-discretionary spending prior to investing.

If you want to maximize your savings, make sure you keep your money in a high yield savings account or a certificate of deposit as these two offer higher returns than traditional checking or savings accounts.

As you top up your emergency fund, you’ll also want to build your retirement savings, says Peter Lazaroff, chief investment officer at Plancorp, a St. Louis-based investment firm.

Employer-sponsored retirement plans are often the cheapest place to get access to a diversified investment for retirement, he says. Also, in many cases, you get some sort of matching for every dollar invested.

“Well, take advantage of it,” says Lazaroff.

Start by contributing enough to your 401 (k) to keep your business going, if you have one. Your long-term goal is to save 15% of your salary each year for retirement. If you don’t have a 401 (k), try maximizing a Traditional or Roth IRA by contributing $ 6,000 a year. (IRAs are also a useful tool if you are concerned that you might need your savings for other purposes; for example, you can withdraw up to $ 10,000 to buy your first home without incurring a tax penalty.)

Then the next step is to find out how much money you have left after you’ve met all of your basic financial obligations, including paying your minimum monthly student loan payments, of course. If you find your money is tight, your best bet is to use the extra cash that comes in (think of side gig money, tax refunds, or bonuses) to pay off your debts.

LeBlanc says that while you remember that while you can get a higher return on investments than you are currently paying on the interest on your student loans, there is always the risk that you will lose money on your investments and still owe debt.

In other words, investing is not a guaranteed money maker. So you want to have a solid financial footing so you can better handle the inevitable ups and downs of the stock market.

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Getting started

What are the interest rates on your student loan?

When you have followed all of the above and find that you have extra cash every month, the real analysis of the investment or debt repayment begins. A rule of thumb to help you decide whether to pay off your student loans faster or focus on interest.

Both Giardino and LeBlanc say you should compare your student lender’s interest rate to potential investment returns.

Predicting investment returns can be tricky, but history can help you: Over the past 140 years, US stocks have posted average 10-year returns of about 9%, according to Goldman Sachs.

Analysts there predict that the S&P 500 will generate average annual returns of 6% for the current decade. (Bonus tip: The S&P 500 is an index of the 500 largest companies on the stock market. If you invest in a single company or a handful, your individual returns may differ from the index as a whole.)

Because of this, Giardino says if the interest rate on your student loans exceeds 6%, “it may make sense to make the difference in paying off your student debt”.

Also, think about the role taxes play. When it comes to student loan interest, tax laws can work in your favor, as you may be able to get a deduction of up to $ 2,500 on interest paid. This essentially gives you a lower post-tax interest rate.

It is the other way around for stocks. If you sell them you will have to pay capital gains taxes on your earnings, which will lower your net income. Most investors pay a 15% or 20% tax rate on long-term capital gains. If you sell stocks (or other assets such as bonds or cryptocurrencies) within a year of buying them, they are considered short-term gains and are taxed at the same rate as your income. Note that you may also owe government taxes on investment gains.

What kind of student loans do you have?

Private student loans typically have higher interest rates and fewer repayment options than federal student loans. For this reason, Lazaroff recommends investing additional money in getting rid of personal student loans before investing.

But if you have federal student loans, and especially if those loans have an interest rate below 6%, then, according to Lazaroff, it can’t hurt to make minimal payments until the debt is paid off and allocate excess money to other financial goals like investing.

This is especially true if you are on the Public Service Loan Relief Program because you want to minimize the amount you pay so that at the end of the program you can maximize the amount of federal debt waived.

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The bottom line

There is no one-size-fits-all answer when it comes to deciding between paying off debt or investing – even experts disagree on which should come first. Some argue that debt is like “handcuffs” and the sooner you can get rid of it, the better. Others feel that you need to start investing as early as possible so as not to miss out on potential returns.

In the end, Lazaroff says that “the choice between paying off your student debt or investing in the future doesn’t have to be a mutually exclusive decision. A mixture of both can be the mathematically and emotionally optimal solution. “

When you start investing, LeBlanc says you should avoid stock picking and day trading at all costs, especially if you are on a budget. Instead, you should start with ETFs and low-cost mutual funds, as these allow you to have moderate exposure to the market and diversify your portfolio across different asset classes.

Finally, you should invest with one goal in mind, like saving money on a down payment or retirement, says Patricia Hausknost, a California-based wealth planner.

“But don’t just do it to play in the market, if you’re lucky enough to find another GameStop,” she adds.

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