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As I was browsing my money forums early in the morning drinking my coffee, I saw this question posed and found it intriguing that I spent close to an hour thinking and responding to it. I thought it had enough importance that I actually decided to share it here with all of you. It comes from one of my new, favorite money-centered places, the Rockstar Finance Forums. After reading, please comment below and let me know how else we can approach this question or go to the forums and chime in yourself, they’re free to join!
Today, we have a question that I thought would be great to tackle: Should I invest first or pay off student loans?
I’m about to pay off my last consumer debt, my car. This leads me to the age old question:
Should I get really aggressive and pay off my student loans (~$35,000 at an average of 5.3%) or should I start investing?
I make just under $60,000/year pretax, I participate in my company 401(k) up to the match of 6%, and I have approximately $1,000 to put toward debt or investing. I have expenses of $1,000/month and have a three month emergency fund.
Part of me wants to be debt free, and the other part wants to start building wealth.
Here’s how I answered the question:
Great question to be pondering! I can see you going either way, but personally, I’d probably go the pay off the debt first and then start investing. It’s good to see that you have some savings set aside as well. $1,000 a month can make you some great progress either way.
In 2011, we had over $27,000 in student loans. We ended up paying them off over a two year period by throwing everything we had at them. Our mindset was that they had to go. We were so focused on getting out of debt that building wealth wasn’t on our to-do list yet. The combined drive that we had and education we received from taking Dave Ramsey’s FPU really accelerated the payoff.
Also, the one thing that has helped my family succeed more financially than anything else was the fact that we focused on one thing at a time.
We used to put some into retirement, some into savings, some into college funds for our children (then unborn), some towards debt, etc. But we never got the traction to move forward until we decided to focus on doing one thing at a time with ALL of our effort. By putting all of our money towards one loan at a time, we knocked it out much faster than we expected because we got excited and wanted to see it gone. We worked harder on our budgets and tried to make more money to throw at it because we were motivated. When you are intensely focused on something, you WILL make it happen!
If you invest the money, it’s possible you’d reap some compound interest earlier, but would be leaving partial risk on the table as you work through the debt. If you lose your job or something happens, you might leave yourself in a bad position.
However, if your focus is to pay off student loans first, your investing slows for a little while. At the end of the debt, you free up even more cash each month to put towards the debt.
Plus, even when you’re paying off debt, you’re still building wealth. Getting rid of liabilities frees up cash flow and ultimately grows your net worth.
Ultimately, it’s obviously going to be up to you and you have to do what you feel is right. In the process, don’t forget that so many people overlook risk in return for reward. The more free you are from debt, the bigger your shovel becomes to build wealth!
I’d love to know which way you end up going in the process!
To wrap things up
There were many other replies over at the Rockstar Finance Forums telling them to do many other things. Like take a hybrid approach and to do what feels right. I’m don’t have the only right answer here. However, I want to stress that people don’t factor risk into their equation.
I honestly feel that paying off debt will give this person more options. More options than if they were to invest the money and slowly pay off the loans.
How would you advise this reader? Let me know in the comments below.
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I can say definitively (because this what we did) that I would invest up to my company match, then use the rest to pay off debt, particularly student loans where the interest is not -too- dissimilar from what you would get from investing.
Do you think they would get as much traction as just paying off the debt first and then using the extra cash flow to build the emergency fund, then throw into investing once the foundation is built? That’s what we did and it allowed us to knock out the debt that much quicker and I think we are in a better place for it now. I guess running the numbers either way would get you there.
I would throw anything extra at the debt – at $1k per month it would be gone in less than three years! And that’s assuming they kept everything else the same, not reducing the 401k or the emergency fund. I know there’s a lot of power in focusing strongly on one thing at a time, so if that would work better, they’d wipe out the debt even faster.
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The focusing on one thing at a time was a HUGE benefit for us and really helped us turn things around.
If the guy already has an emergency fund, pay off the debt! My husband and I paid off 22k in student loans in just 12 months. We literally put EVERYTHING towards knocking it out. It took a lot of discipline but it taught us responsibility and more importantly, taught us NOT TO GO INTO DEBT! After we worked so damn hard and sacrificed even being together to pay it off, we learned the true value of the dollar. In a year from now, we will be 100% debt free (no mortgage, no credit, no car payment, etc.) We are so happy!!!
Wow, 22k in 12 months, nice work! It took us almost 2 years to do 27k, but we were more relaxed. I totally agree with you that the discipline of paying off that debt will change your view and make you not want to go back into debt for sure! Thanks for stopping by and reading/commenting Liz!
Great article. I can see both sides, but I would absolutely use the laser focus that you did to throw everything and more at the debt. I did this to pay off my $33k in student loans in just over 18 months. It’s amazing what you can do when you set your mind and be intentional with your money. Also–people seem to not be aware that, as Dave Ramsey says, when you are gazelle intense, and set a budget, you magically “find money” in places you didn’t think were there. I’d throw it at the debt, catch up on investing after when you are debt free!
Thanks for weighing in! I agree, paying off the debt to lighten the load and increase cash flow would be the way I’d go as well! Thanks for sharing!
I agree, many people don’t factor in risk to investing before paying off student loans. However there’s two sides to that risk, losing your investment vs having more tax liability.
It’s something people should think about more before they decide to pay off student loans or invest. (I sure wish I did!)
Akash, I feel that if you are that worried about having more tax liability, you can get to the same result while still being debt free. Just donate the money to charity as a write off! You would get the same deduction and would actually be helping someone versus paying someone to use their money.
The tax write off for a charity donation is something to consider, but it generally only really applies to people who itemize their taxes. (If you take just take the standard exemption, you won’t actually get any tax benefit from your charitable donation, unless you donate an amount larger than the standard exemption). Of course, if you own a home that situation is completely reversed.
Akash recently posted…99K Challenge: Analyzing My Investment Portfolio
This is very true! I often forget about that since I’ve been a homeowner the last 7 years. Wouldn’t the student loan writeoff work the same way then?
It’s logical to think so, but the IRS actually lets you apply the student loan deduction along with the standard deduction. Our tax laws are super complicated =x.
Akash recently posted…99K Challenge: Analyzing My Investment Portfolio
Thanks for clarifying! I guess that makes sense since we were still paying off student loans when we were in our apartment and entered that info into our taxes each year…
This is probably the biggest thing I get in “arguments” about. I’m on the “pay off debts first” side of things. We’re on track to pay off around $78k in just over two years with the majority of it being student loans. And I know that not investing for those two years isn’t going to hurt our future that much because we’ll be able to really start throwing some huge amounts towards investing after this debt is paid off. But it’s a personal preference right? I love having that satisfaction of having less bills to pay each month. Less to worry about!
Overall, either choice is good and will help long-term.
My guidelines are if the interest rate is less than 6%, pay the debt minimums and invest the rest in an aggressive stock / bond asset allocation because you’ll likely have a higher return on your money through investing. This assumes you have a steady income, emergency fund established, and a long investment horizon, if the interest rate is 6% or higher, pay off the debt. That’s based on past market performance and the math only. The psychological part of personal finance also affects this. Depending on your personality, you may invest, pay off your debt first or somewhere in between.
After investing heavily for the past few years and watching the portfolio grow, I have decided to pay off my remaining student loans and car next year because it will give me peace of mind despite my guideline above. Hoping to payoff the rest of the mortgage by the end of 2019 too to be completely debt free.
I can see the value of this strategy, if it works out. I like paying off the debt aggressively first though since it’s a sure bet to reduce expenses. That’s the route that we went and now we’re investing that money into investments and the accounts are growing really well.
I hope you make your goal of being debt free in 2019! That’s amazing that it includes the mortgage as well! We are still just under 15 years from the mortgage ourselves