InvestingStudent Loans

Should I Invest or Pay Off Student Loans First?

This is a guest article by Kevin Watts.  If you are interested in contributing to Debt RoundUp, please follow our guidelines.

invest or student loansThe rising cost of education compels an increasing number of people to end up with debt in the form of student loans. Often, debt is not restricted to student loans but can include additional debts in the form of credit card dues, personal loans, mortgages, etc.  The problems are compounded due to the increasing costs of daily living. Once a person starts earning, the question that arises is whether spare funds should be used to pay off these loans or used for investments. It is very obvious, that the loans other than the student loan must be repaid as they come at a very high cost. The high interest rates and the penal clauses makes living with these loans very expensive and therefore settling the loans earliest might be the best way forward.

The student loans may need to be dealt with on a slightly different footing. What is it that makes the student loans different from other debt? The answer to that lies in rate of interest. The rate of interest on student loans have been deliberately kept low in order to encourage students to equip themselves with more and better skills. The rate of interest is also generally a fixed rate rather than a floating rate and hence will not vary with changing market conditions.

Are investment gurus right?

Many investment gurus advise that repayment of student loans should be postponed for the longest period possible. The logic of their advice is something like this. Think of the spare funds with which you seek to repay the student loan, as your invest-able funds. The options available before you are two. The first is to repay the student loan and save paying interest on it. The second is to invest this amount elsewhere in safe investment avenues, where you can earn a good rate of return.

The gain for you in this exercise is the difference between the amount you earned on your investments and the interest that you need to pay on the student loan. This strategy will work only when there are suitable and safe investment avenues, where the rate of interest is higher than the rate of interest to be paid on the student loan.

Taking advantage of the strategy as aforesaid will give the person the advantage of investing early. Investing early gives your investments an opportunity to grow at a faster rate due to compounding. A few years delay in commencing investments can result in a much lower accumulation in your retirement funds.

Employees may also invest the amount saved in 401(k) pension plans depending on the scheme implemented by the employer. In a case where the employer matches the employee’s contribution, this can see an immediate gain of 100% in the amount invested.

While all this may seem like a good option, making this strategy work in a real situation is a Herculean task. The first and foremost drawback is that it presupposes a level of understanding of investments and finance. Most people do not have the capacity to take investment decisions on their own. Taking the advice of a financial consultant can wipe off the benefits of the entire exercise due to the fees and related costs involved.

Investing

Investments can be risky. The risk is not only of non payment of interest but, more importantly, there is a risk of loss of the principal amount invested. The more the risk, the greater is the return. For example, investment in stocks can sometimes generate returns in excess of 1000% in a short time but in a case of a crash in the stock market, the stocks may be reduced to worthless paper. Investors have time and again lost their capital chasing a high return investment.

Monitoring investments take a lot of time and careful study. This time can be put to better use like developing skills, self development, freelance working, etc. These activities may result in a source of income or may ensure that you are capable of handling additional responsibilities thus increasing your market value.

Peace of Mind

Perhaps the most important issue is gaining peace of mind. For the vast majority, having debt is a daily worry. They lose sleep with the worry of having to repay large amounts of debt notwithstanding the fact that it carries a low rate of interest. Repaying the loan in such cases would be the only prudent solution.

All said and done, being a disciplined investor is not everybody’s cup of tea. For the multitude it may be a better option to ensure regular repayment of the loan, which will ensure a healthy credit rating and permit you to avail credit facilities in the future when you need it the most.

Author Bio:  Kevin Watts is the owner of  Graduating from Debt, a site dedicated to helping people get out from under the burden of student loan debt.  Follow him on Twitter or like him on Facebook.

I combined images from FreeDigitalPhotos.net

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46 Comments

  1. March 28, 2013 at 7:22 am — Reply

    There is certainly a psychological reason to pay off student loans even if you have low rates on them. I personally have chosen to not pay them off any faster than I need to, but that could change. The monthly cash flow that you gain once you have them paid off is huge…at least it will be for us! Whether or not to pay down the loans faster is something I think about at least on a monthly basis.

    • March 28, 2013 at 10:27 am — Reply

      As always, this decision is personal. I would be more happy to take a dual-pronged approach and invest and reduce debt at the same time. That is what I did with my credit cards.

    • March 28, 2013 at 8:13 pm — Reply

      For me even though logically it made more sense to start investing a portion of my income I paid off my debt as quickly as possible. I have seen family members consumed by debt and I didn’t want the same fate.

  2. March 28, 2013 at 7:25 am — Reply

    I am of the thought that you should invest enough to meet your company match. From there, pay off your debt ASAP. That way, you are able to take advantage of the “free money” available to you AND pay off your debt quickly.

    • March 28, 2013 at 10:27 am — Reply

      Great point Greg. It depends on your investment vehicle though. Who doesn’t love “free” money?

  3. March 28, 2013 at 7:33 am — Reply

    I’m lucky in that I have never had to use a student loan for my education. Much of it was out of pocket and employer assisted. There’s a physiological aspect to this that needs to be considered as well. If I had what amounted to a Prince’s ransom in student loans hanging over my head, It would nag at me endlessly. Even if it is at a low interest rate I would feel compelled to pay it off before investing. The only exception to that would be if it were competing with a 401k. I firmly believe that you should contribute as much as possible, at an early age to a 401k. I could probably be retired by now if I had done that when I was in my twenties.

    • March 28, 2013 at 10:28 am — Reply

      I am working on pushing my 401k investments up because I reduced them to pay down my credit card debt. Those rates are much higher than student loans though.

  4. March 28, 2013 at 7:37 am — Reply

    I think it depends on how you will manage and budget your money. You can also take advantage to get a company match while you are still working like what Greg said. At the same time if you have extra cash you can use that to add it in your monthly payment for your loan. By doing this you can pay off your student loan at earlier time.

    Commit to live frugally for the time being in order to have more cash to pay off your loan.

    • March 28, 2013 at 10:29 am — Reply

      Spot on Walt.

  5. March 28, 2013 at 8:02 am — Reply

    Hey thanks for mentioning my post! For me, the peace of mind definitely outweighs the possible investment returns. When I had almost 40k in debt, I wasn’t able to sleep at night it stressed me out so much! Once my debt is paid off, I’ll be 25, and ready to start investing aggressively.

    • March 28, 2013 at 10:29 am — Reply

      That is a personal decision and I like it. Some people like investing more than they like paying down debt. I would always recommend doing both if possible.

  6. March 28, 2013 at 8:03 am — Reply

    What is it that makes the student loans different from other debt? The fact that they have no consumer protections!

    • March 28, 2013 at 10:30 am — Reply

      Well, that depends on when you got your loans. The rates now are higher, but before you could get some good rates and I know people that would invest and pay down their loans at the same time. They were ahead when they finally paid them off. I think it is crazy that they have no consumer protections.

  7. March 28, 2013 at 8:13 am — Reply

    Interesting topic. I was actually watching CNN the other night and they had Suze Orman on and I just had to watch as I usually disagree with her on many things. Someone asked this very question and she told them to throw everything at paying off the student loans and put off investing until you do so – including the 401k. I understand the desire to get the loans paid off, but that can lead to missing out on gains for years. If you’re able to, I think you should do both…at the very least to get your match and even put away a little in a Roth if you can. Thanks for the mention Grayson!

    • March 28, 2013 at 10:31 am — Reply

      I am with you John. If I didn’t save money when I was paying down my credit cards, I would have had nothing when I was done. Since I went with the hybrid approach, I came out with a better financial picture. It worked for me.

  8. March 28, 2013 at 8:20 am — Reply

    I am trying to invest rather than paying debt, but you make a great point about the debt still weighting on your shoulder and I hate that feeling. It is not just about the money and optimizing your finances but about what is right for every person.

    • March 28, 2013 at 10:32 am — Reply

      This always goes down to a personal choice.

  9. March 28, 2013 at 8:40 am — Reply

    I’ve been trying to help a friend make this decision recently. He wants to invest his money and earn super high returns, but if he pays off his student loans, it’s like locking in 8% returns. It seems like an easy answer to me because the long term average of investing is around 7%. Maybe a hybrid approach would be best.

    • March 28, 2013 at 10:33 am — Reply

      I would advise him to do both. Maybe he can put away some of what he would pay extra on his loans and invest it. When he is done paying down his loans, then he will have some returns on his investments. You can’t get back years of compounding interest.

  10. March 28, 2013 at 8:42 am — Reply

    In addition to the numbers you can actually quantify that equate out every time, you have to add a number that changes for every person, and that represents the importance of paying off loans. If increasing cash flow is important to you, if you have worries about the debt you hold, then you’ll probably assign it a higher number and will therefore see that it makes sense to pay off the debt for you, where it may not for other people, even if their ‘hard’ numbers are the same.

    • March 28, 2013 at 10:33 am — Reply

      Well put Money Beagle. This is a great idea.

  11. Girl Meets Debt
    March 28, 2013 at 9:52 am — Reply

    This post brings up many great points but from the point of view of someone who does have huge student loan debt – $45K, I feel the need to pay it off as soon as I can before I start to seriously invest in my future. That doesn’t mean that I’m not saving for retirement at all, it just means I’m only putting pocket change away for now until the debt is gone :)

    • March 28, 2013 at 10:34 am — Reply

      This is the approach that works for you. I think there is nothing wrong with that. If you need to pay them off, then get on it. Some, like me wanted a hybrid approach. It all depends on what your goals are.

  12. March 28, 2013 at 10:03 am — Reply

    I think if my rates were lower, then I wouldn’t be in such a rush to pay them off. However, most are at 6.8% at that’s just too high for my liking!

    • March 28, 2013 at 10:35 am — Reply

      It really depends on your rates and that all depends on when you got loans.

  13. March 28, 2013 at 11:06 am — Reply

    My wife and I recently paid off her only school loan of $7500. I still have one outstanding but it’s at a much lower rate. We will make minimum payments on it and contribute to a 401k and Roth this year.

    I think the psychological burden of loans is what drives most people to pay them off early…

    • March 28, 2013 at 11:34 am — Reply

      It is always a personal decision, but if you can beat the rate when you should at least invest some while paying down the loans.

  14. Brian
    March 28, 2013 at 11:16 am — Reply

    You should look at the numbers. If you can’t beat the 6.8% that most federal loans are at then you should pay them off first. In my case my loans are at 2.25% or something stupidly low like that, so that is extremely easy to consistantly beat, even in a bad market.

    I just realized I pretty much echoed what Michelle was saying above.

    • March 28, 2013 at 11:35 am — Reply

      Always look at the numbers. You are correct and with your rate, I would be all over some investing because it is super easy to beat 2.25%.

  15. March 28, 2013 at 12:14 pm — Reply

    I think you can do both! In fact, I wrote an article that I will publish next week explaining my reasoning.

    • March 28, 2013 at 12:59 pm — Reply

      I think a dual-prong approach is the way to go. I will look forward to your article.

  16. March 28, 2013 at 1:17 pm — Reply

    I was in this exact position a few months back and still jhavenm’t made up my mind. Its such a massive decision. Thanks for the article though, its been useful and given me a few things to think about.

    • March 28, 2013 at 6:48 pm — Reply

      Good luck coming up with a solution John.

  17. March 28, 2013 at 4:03 pm — Reply

    Really interesting and relevant topic to what I’m dealing with now – I have some cc debt (but at 0% for the next few months and will pay it off before it expires) and some student loans, but really curious about learning how to invest. Right now, I’m taking a 70%/20%/10% approach with debt repayment/retirement and savings/investments. That way it at least helps me stick my toe in the investment pool, so to speak, so I can ramp it up when I’m debt free. Great post!

    • March 28, 2013 at 6:49 pm — Reply

      That is a great way to handle it Anna. Coming at it with a diverse solution will ensure that you are better off once you get done paying down your loans.

  18. March 28, 2013 at 5:04 pm — Reply

    On one hand, yes, the argument presupposes that you’re diligent enough to invest that money rather than aimlessly spend it on discretionary items. It also presupposes that you know enough about investing to make responsible choices.

    On the other hand, a person doesn’t need to “know” much about investing, in the sense that they’re not being asked to make individual stock picks. They can simply put their money in a low-cost broad-market index fund that’s tied to the performance of the overall Dow Jones or S&P 500. And they can make automatic deductions from their checking account so they don’t need to manually do this.

    At the end of the day, though, this decision comes down to personal preference. What will make you sleep easier at night?

  19. Justin
    March 28, 2013 at 6:38 pm — Reply

    I prefer having the piece of mind that debt free brings. Plus once the debt is paid off there isn’t any reason that you can’t invest the money that would otherwise have gone to paying down the debt.

  20. March 28, 2013 at 8:20 pm — Reply

    One thing I didn’t mention in the post that I am slated to pay off my student loans next month and let me tell you I feel fantastic! It’s like a huge weight as been lifted off my shoulders. Now I feel like I can sit down and really learn about investing and saving and everything there is to learn about personal finance.

  21. March 28, 2013 at 11:48 pm — Reply

    If the organization where I worked offered an investment scheme where they put in a certain % you’re darn right I’d be maxing that out. At the same time I’d be getting rid of as much student debt as possible. If my work didn’t I’d balance my investments with payind down the debt.That’s just me and like others have said it’s personal.

    • March 29, 2013 at 9:36 am — Reply

      I am with you there Mr. CBB! They good ol’ hybrid approach.

  22. March 29, 2013 at 1:51 am — Reply

    I struggle with balancing this as well. Right now, I put $500 (plus extra income) towards my student loans each month and I put about $1200 a month towards RRSPs and TFSAs each month.

    • March 29, 2013 at 9:37 am — Reply

      If this works for you, then awesome. I changed up my percentages as I got more out of debt.

  23. Alex
    April 18, 2013 at 2:50 pm — Reply

    This article was awesome!! Thank you. Being fairly new to the credit and student loan arena I am constantly trying to gather as much information as possible to try and keep myself headed in the right general direction. Spending some time on this post has actually given me a lot of great points to think about. In my recent research I have also been able to find some pretty useful information related to this topic when I Googled the credit locker university. This was helpful as well. Thanks again!

  24. August 26, 2013 at 12:41 am — Reply

    I think it is very important to develop an investing habit even when you have debt. Now if it is high interest “bad debt” then maybe you can hold off until that is paid off. I have a large amount of student loans, but I paid off some of the higher interest ones. I’m not in a rush to pay off the ones in the 2% to 4% range…I think investing will give me a better return in the long run.

  25. Joseph Hogue
    November 8, 2014 at 10:06 pm — Reply

    Great post. I think debt gets a bad name sometimes. It can be a great tool if used right, especially with rates so low. If you can borrow at 3% and get a 5% return on a responsible investment plan, then go for it.

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