This is a guest article by Kevin Watts. If you are interested in contributing to Debt RoundUp, please follow our guidelines.
The 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.
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.
I combined images from FreeDigitalPhotos.net
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