Here's how to face the debt dilemma.
Many recent college graduates face this conundrum: Do I pay off my student loans fast, or do I start investing? With student loan debt on the rise, many feel as though they're drowning in debt and want nothing more than to be rid of it quickly. On the other hand, the earlier you start investing, the longer you have to build a comfortable nest egg for the future. Deciding how to proceed can be tricky, but there are a few things you can keep in mind as you proceed.
What's your interest rate?
Start with your interest rate. When you pay off debt, it's like having a rate of return equal to your interest rate. If your student debt averages 4.45 percent, that can be your expected return. However, the S&P 500 has returned close to 10 percent on an annualized basis over time. That gives you a pretty good chance of getting more by investing instead of paying down debt -- especially when you consider that a portion of the interest you pay on student loans is tax-deductible. If you have private loans or other circumstances that put your average student loan rate closer to 8 percent, it might be worth it to more aggressively tackle that debt.
Do you have student loan forgiveness plans?
Another consideration is whether you plan to have some of your debt forgiven. If you know you'll qualify for the Public Service Loan Forgiveness program, have some of your debt taken care of by AmeriCorps, or if you can get partial forgiveness based on a profession you choose, investing can make a lot of sense. You know that a portion of your debt will be forgiven, so paying it down might not be as urgent. Instead of putting extra money toward the debt, you can invest it and get an early start on earning compounding returns that will reward you in the future.
Will you sleep at night?
Of course, it's not just about the math, it's also an emotional situation. For some, the idea of having a large amount of student loan debt for a long period of time makes them queasy. While it's true that safeguards for federal student loans -- deferment, forbearance, and income-driven repayment -- can help in the case of financial trouble, the reality is some people just prefer to not have obligations hanging over their heads. However, if you're more worried about building up enough wealth for retirement, it can make more sense to focus on investing. After all, you can't replace time in the market. Opportunity cost is a real issue the longer you wait to start investing.
Can you pay off student loans and invest at the same time?
The good news is that you can work toward more than one financial goal at the same time. Where you place your emphasis might depend on a number of different factors, but it's possible to put extra toward paying off student loans while still investing. One of the easiest ways to make sure you're doing both is to use your employer's retirement plan to automatically save for the future. If your company offers a match, maxing out that match can provide you with a solid start toward investing in your future. Once you've done that, you can put extra money toward paying down your student loan debt faster.
Live with the loans.
If you decide that investing should be your priority, you might decide that you don't care how long you make student loan payments, as long as you're building a solid nest egg. For some investors, especially when it comes to low-cost loans with a tax advantage, paying them off quickly isn't much of a priority. Others choose to refinance student loans to lower interest rates and lower monthly payments in order to free up more money for investing. However, when you follow this path, you lose access to federal student loan protections and programs, and you have to be relatively certain that you can handle the ups and downs of the market.
Consider the choices carefully.
As with all things money, how you decide to handle paying off student loans versus investing depends on your situation and how you weigh different risk factors in your life. Carefully consider how you feel about debt and investing, and allocate your resources in a way that offers you the best chance to meet your financial goals.
Tings to consider about student loan debt and investing
-- What's your interest rate?
-- Do you have student loan forgiveness plans?
-- Will you sleep at night?
-- Can you pay off student loans and invest at the same time?
-- Live with the loans.
-- Consider the choices carefully.
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