When you graduate from college with a costly, new diploma, instinct tells you to latch on to the first decent job offer an employer throws your way, and then whittle down your student loan debt as best you can.
But what about investing those first earned dollars in the stock market? The more money you put in – and the earlier you put it in — the more money you can potentially get out of it for retirement, buying a home or whatever other significant financial goals you have.
If you brood on this long enough, you can’t help but ask yourself: Could I put my extra cash to better use?
In other words, is it better to pay down student loan debt or invest in retirement?
“Pursuing either to the detriment of the other isn’t advisable,” said Riley Adams, a licensed CPA and founder of the personal finance blog Young and the Invested. According to Adams, “the individual should contribute to the allocation which makes them feel best.”
It’s not an easy decision, but if you plug some numbers into a hypothetical situation, the answer might be a little easier to find.
Paying off Student Loans Early
This can work, but you need a high enough and steady enough income from your first job. You will have a lot of trouble paying off your student loans early if you’re already struggling with rent and utilities. Get a roommate or live at home for a year or two if you want an easy way to cut expenses and use the money to pay off the student loans.
Also, you should have an emergency fund stashed away in the amount of 3-6 months of your income before tackling your student loans. It’s tough to get to work if your car breaks down and you haven’t put any money away to fix it.
With that all settled, it’s time to whip out the budget. The more you can bolster your required payment the better. The key here is to allocate as much as you can, without depriving your life of all joy and meaning. It’s OK to eat out now and then, but picking up restaurant tabs five or six times a week is a step backward financially. And that two-month-long African safari? Put that one on hold. If you’re having trouble establishing a balanced budget, consider calling up a nonprofit credit counseling agency for some free advice on how to make ends meet.
Another possibility is to get in touch with a lender and see if you’re eligible to refinance that student loan. Car loans, mortgages and credit cards can all be refinanced. Student loans are no different.
A note of caution: refinancing is a way to unburden yourself from student loan debt, but it cuts you off from the lifelines provided by federal loans. This means that if you refinance with a private lender, you give up qualifying for any sort of deferment or forbearance, should tragedy come knocking.
Student loan refinance lenders want to know how steady your income is, and what your credit score looks like. A steady earner with a good credit score (680 or above) is the best candidate from the eyes of the lender. You could get rates anywhere from 2.4%-8% in the summer of 2019.
This is only a good idea if your lender is reducing your interest rate. If you’re having trouble finding a decent offer, consider working on your credit score for a few months, and then reaching back out to lenders.
The average student graduates with around $37,000 in student loan debt with an average interest rate of 4.5%. That means payments of $384 a month for the next 10 years. If you’re wise, you’ll make more than the standard payment to avoid racking up interest.
Let’s say you find a lender offering you a rate of 3.5%. After crunching some numbers, you figure you can throw an extra $200 a month toward your payment.
For this example, we will add the $200 a month to the original monthly minimum of $384, which is what you would have paid, had you not refinanced. After all, if you could make it work then, you can make it work now. This means you will pay $584 a month on your new loan.
This method will pay off the debt in just under six years (as opposed to the standard 10-year plan) and cost you $3,968 in interest. That is a total of $40,968 for an undergraduate diploma.
Unfortunately, college is still pretty expensive. On the bright side, you save $5,048 by reducing your interest rate by a single percentage point and paying $200 more each month.
Investing in Retirement
So, you can save a lot of money by aggressively paying down your student debt, but what about the stock market? Compound interest, that property your economics professor would preach about daily, can earn you a lot of money, if you make the right choices.
Stocks or Student Loans?
Let’s say, instead of worrying about your student debts, you open a mutual fund and contribute $200 a month or $2,400 a year. That would be an investment of $24,000 over 10 years. A 6% return is a safe and conservative expectation for your investment. This means you could expect to amass a total of $35,480. That’s a profit of $11,480.
The question is, how have your student loans held up after only making the required payments?
If we stick to the $37,000 average, after 10 years you will have paid $9,016 in interest. This means by going the investment route, you came out on top by $2,463. You could have earned even more money if you had chosen to refinance your student loan.
401K or Student Loans?
What happens when we add a 401k into the mix? For one, you can earn even more money. The 401k programs are popular because your employer is essentially, handing you free money.
The median employer match for a 401k is 3% of your salary. This means if you invest 3% of your salary into your 401k, your employer will invest another 3%. The money is tax-free, at least until you pull it out in retirement.
Let’s say you decide to take full advantage of your 401k. You and your employer both contribute 3% of your salary. If you’re making $50,000 a year (average entry-level salary for a college graduate), this comes out to $3,000 invested in your 401k at year’s end. That is $1,500 from you and $1,500 from your employer.
This is an even better option than investing on your own. Instead of putting up $200 a month of your own money, you only risk $125, and end up with even more cash stashed away for retirement.
Saving for a House
Buying a home means saddling up for a mortgage. Ideally, we would like to be rid of those student loans beforehand.
Consumers who refinance their student loans and invest early, especially if their employer offers a 401k plan, will be in the best position to purchase a home when the time comes.
If your debt is at or below the national average of $37,000, you can repay it in 10 years by sticking to the standard plan, but you will have overpaid in interest by thousands of dollars.
All that money lost to interest could have gone toward your down payment and lowered the cost of your monthly mortgage.
If you’re struggling to meet your required monthly payments, let alone invest in retirement, consider signing up for one of the federal student loan repayment programs. Some programs are income based and will adjust your monthly payment based on your salary, sometimes to as low as zero dollars a month. This does not mean your loans have been forgiven. In fact, interest will continue to accrue as before, but it could give you some time to get back on your feet.
Bents Dulcio writes with a humble, field-level view on personal finance. He learned how to cut financial corners while acquiring a B.S. degree in Political Science at Florida State University. Bents has experience with student loans, affordable housing, budgeting to include an auto loan and other personal finance matters that greet all Millennials when they graduate. He has a prodigious appetite for reading, which he helps feed with writing from Scottish philosopher Adam Smith, the “Father of Capitalism.” Bents writing also has been published by JPMorgan Chase, TheSimpleDollar and Interest.com.
- NA. ND. What is Income-Driven Repayment? Retrieved from: https://studentloans.gov/myDirectLoan/ibrInstructions.action
- Shamrell, M. (2019, May 9) FIDELITY® Q1 2019 RETIREMENT ANALYSIS: ACCOUNT BALANCES REBOUND FROM DIP IN Q4, WHILE SAVINGS RATES HIT RECORD LEVELS. Retrieved from: https://www.fidelity.com/bin-public/060_www_fidelity_com/documents/press-release/quarterly-retirement-trends-050919.pdf
- Hess, A. (2019, February 17) College grads expect to earn $60,000 in their first job—here’s how much they actually make. Retrieved from: https://www.cnbc.com/2019/02/15/college-grads-expect-to-earn-60000-in-their-first-job----few-do.html
- Adams, R. Young and the Invested: https://youngandtheinvested.com