Should You Still Invest if You Have Student Loans?
If you’re in your twenties (or thirties) and have a college education, odds are you had to take out loans to pay for that education. Student loans can be a huge burden for young people, particularly recent graduates that don’t yet have jobs and are suddenly hit with a loan payment for hundreds of dollars per month.
BUT, it’s also a really good idea to start investing for retirement in your twenties because then your money has forty years to compound before you hit retirement age.
So… should you pay off your student loans first or invest?
You really have two options here:
Focus on paying off your student loans entirely before investing
Pay off student loans and invest at the same time
Focus on paying off your student loans entirely before investing
Debt sucks. It’s like this dark cloud hanging over you all the time, taking away your money as soon as you earn it.
Student loans are a particularly terrible beast because many people take them out at 18 years old, when they don’t have a full understanding of how that debt will affect the rest of their life.
Then, when you graduate at 22, you’re slapped with a $500/month payment. Ouch.
One possibility here is that you put all your focus on paying off your student loans as quickly as possible. Put any additional money you can towards the principal to pay down the debt faster and once you’re finally able to pay off the entire balance, you’ll no longer have a $500 bill every month and can focus on other savings goals.
If you have private student loans in the 6-7%+ range, this is probably the best choice for you. This is considered “high-interest” debt, so focusing on paying the balance as quickly as possible will help you save tons of money on interest.
The one exception to this is if you’re working a job that has an employer 401k match. If your employer offers to match your contributions to your 401k account, do it. This is free money that you will only get by contributing to your retirement account. Make the minimum amount of contributions in order to get your full employer match (this is usually around 3-4% of your salary). Then focus the rest of your money on paying off your debt.
Pay off student loans and invest at the same time
If you have federal loans or any loan that is around 5% or lower, you’ll want to work on paying off your student loans and investing at the same time.
The reason is, if you invest in the stock market, your average rate of return on your money is around 7%. Even if you’re paying 4% interest on your student loans, you’re still making an overall return of 3%.
Basically, the 7% you make minus the 4% you pay = 3%.
So, if you have the cash available, it can be a good idea to start investing, even while you’re still paying off your student loans. Any amount of money you can put into a retirement account in your twenties is great, even at a 3% return, because it has decades to compound before you need it.
At some point in the future, you’ll have paid off the student loans and then you can focus more money on your retirement and the money will grow even faster.
Other considerations
Now, whether or not you are investing while paying off your student loans, you should still have an emergency fund that covers at least 3 months of living expenses.
If you have an emergency, lose your job, or run into hard times, you don’t want to worry about whether you can cover your student loan payments or regular household expenses. Get at least 3 months of living expenses in an emergency fund before starting to invest (if you can do 6 months, that’s even better).
Also, consider whether any loan forgiveness programs could help you pay off your debt faster. These programs only exist for federal loans, but if you qualify for one it can be a great way to blast away your debt.
If this is the case, then you should definitely be investing, because the government may forgive your debt, but they’ll never give you extra money for your IRA.
Action Steps
Find out what the interest rate is on your debt. If you can’t find it on your statement, call your lender and ask. If it’s 6%+, you’ll probably want to focus on paying down the balance before investing. If it’s under 6%, you should pay off the loans and invest simultaneously.
Build your emergency fund. Regardless of the interest rate on your loans, you should always work to have at least 3 months of living expenses in an emergency fund. If you have an emergency and are short on cash, missing loan payments will only cause you to pay more in late fees and extra interest.
If you have federal loans, see if you qualify for any student loan forgiveness programs. If you have private loans, shop around for refinancing options and see if you could get a lower interest rate elsewhere.
Your life may not be perfect, but it is imperfectly yours. The only way to live it is your way.
