The Federal Reserve reports that the average college grad has about $35,000 in student loans — and those of you with that kind of debt might find it a hindrance to living a rich life. But the surprisingly good news is that student loans were probably an excellent financial decision. We look into the reasons for this in this article.
Statistics clearly show that college graduates far outnumber those with just a high school diploma. (That means you should take responsibility for researching college majors and their average salaries.) Please don’t listen to the pundits who have jumped on the bandwagon saying student loans are “evil” and you should skip college . God, if I hear that nonsense again, I’m going to jump up and hit someone with an onion. (This way it is unclear why they are crying.)
I used to be afraid of wondering how I would ever pay off my college loans, have savings, and have a retirement plan. Now my student loans are almost completely paid off, I have a savings account (plural), I have two retirement accounts, and I don’t stress about those things. I’ve automated everything and I know how much money is coming in, where it’s going and how much is going out.
– DEANNA BEATON, 30
Investing vs. Paying Off Student Loans
It can be difficult to hear the drumbeat of “Invest early!” if you have to pay $500 or $1,000 on your student loans every month. But when it comes to paying off your loans or investing, you really have three options:
■ Pay the monthly minimum on your student loans and invest the rest.
■ Pay up as much as you can on your student loans and start investing as soon as they’re paid off.
■ Take a 50/50 hybrid approach, paying half your student loan (always paying at least the minimum) and putting the other half into your investment accounts.
Technically, your decision will depend on interest rates. If your student loan has a super-low interest rate, say 2 percent, you should pursue option one: Pay off your student loans as slowly as possible, since you can earn an average of 8 percent with low-cost investments.
However, note that I said “technical”. That’s because money management isn’t always rational. Some people are uncomfortable with debt and want to get rid of it as soon as possible. If debt is keeping you up at night, follow option two and pay it off as soon as possible — but understand that you could lose a lot of growth potential just to make you feel better.
My ultimate advice
I encourage you to take a close look at option three, for the following reason: the interest rate on most student loans these days is similar to what you would get on the stock market, so frankly your decision is going to be a bad one. All things being equal, the money you can make from investing is about the same amount you’ll be paying in interest on your student loan, so it’s basically a wash. It doesn’t matter if you pay off your student loan or invest because you get about the same return. Except for two things: compound interest and tax-privileged retirement accounts. If you invest in your 20’s and early 30’s you will benefit enormously from compound interest. If you wait until you’re older to invest, you’ll never be able to recoup those earnings. Plus, when you invest in tax-advantaged accounts like 401(k)s and Roth IRAs, you’ll receive tax-advantage gains. That’s why I would consider a hybrid split, where you use part of your money to pay down your debt and invest the rest. The exact breakdown depends on your risk tolerance. You could choose a fifty-fifty split to keep things simple, but if you’re more aggressive, you’ll probably want to invest more.
Creating a bright financial future starts now
As you embark on your journey to becoming a tax accountable person, you have a lot to learn. There are many helpful resources out there, from our book, I’ll Teach You How to Get Rich, to spending tips, retirement guides, and more.
Read on as your knowledge expands. The financial freedom and inner peace that intelligent financial planning brings are great motivators. Your future self will love you for it.
Download the first chapter of I’ll Teach You to Get Rich below and learn how to take full control of your finances.
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