Money Monday Reader Question: “Should I Invest while Paying Off Student Loan Debt?”
Happy Monday, everyone! I have to say, I was thrilled by your response to my first Money Mondays post. In fact, we already have a mailbag question!
In our very first Money Monday Reader Question, Silvia F. asks:
“Do you recommend making small investments while still paying off student loans?”
(Want to have your own personal finance question answered? Send it to me via the form at the bottom of this page!)
Great question, Silvia. Common pathways to a writing career can be expensive – e.g., moving to a major city like NY or LA, taking out loans and/or cutting down on work hours to enroll in an MFA program – so many emerging writers can likely relate.
Though this article will focus on investing versus paying down student loan debt, its guidelines can be considered for high-interest loans like credit card debt, too.
To answer your question, Silvia, I want to explore the various courses of action available to you: (1) focusing on investing; (2) paying down debt exclusively; and, as your question suggests, (3) doing both at the same time.
In Favor of a Strong Investment Focus.
There are a couple of arguments for investing even as you’re paying down debt. For one thing, time is part of the calculation of an investment’s future value (source).
In other words, it’s safe to say that an investment made earlier will accrue more wealth over time than the same investment made, say, twenty-one years later (the average amount of time it takes a bachelor’s degree holder to pay down their debt!).
For another, many financial experts use the phrase “good debt” to refer to student loan debt (source). "Good debt" means that there is some potential for future value coming out of the debt transaction, which sets student loan debt apart from “bad debt” like credit card debt.
One thing you've likely noticed about good versus bad debt is the difference in interest rates. If you haven't, think about how your first credit card likely had an APR of 20% or higher, while federal student loans for the 2017-18 academic year have an interest rate of 4.5%.
This means that, so long as your budget allows you work effectively towards paying down your student loan debt while investing, there’s no reason not to explore the benefits of investing.
In future posts, I'll talk at greater length about how and why to invest, but for now, I’ll say this: always make sure there’s a purpose behind your investment. Whether it’s saving for a mortgage down payment, supplementing your retirement savings, or something else, don’t invest just because all the finance majors you knew in undergrad are doing it. Invest purposefully, and it will suddenly be clear to you what sort of rates of return you need, etc.
In Favor of Paying Down Debt First.
Your first priority, according to many financial advisors, should be paying down debt (source).
This is an undeniably stronger argument than the argument for focusing on investing. Whereas investing while paying down student debt should be seen as an option if it is available to you financially, paying down student debt is obviously a requirement.
If you have multiple student loans, consider consolidating your debt, which is also known as refinancing. You'll be paying all of your debt to one lender, which means you won’t have to worry about whether you’ve forgotten to pay the monthly minimum on one or the other. Bonus points: if you opt for a consolidation or loan refinancing with a private lender, you may even be able to negotiate a lower interest rate (source).
For more information on how to consolidate student loan debt successfully, check out this helpful post from LendEDU.
How to Pay Down Debt and Invest Simultaneously in a Way that Works for You.
We will discuss budgeting at greater length in future articles, too, but for now, know that a good rule of thumb is the 50/20/30 rule. This rule states that 50% of your income should go to necessary expenses like housing, groceries, transportation, at least 20% should go toward savings and debt, and 30% or less can go to incidentals like nights on the town.
As your circumstances change, you may be able to leverage a greater fraction towards savings and debt. However, put simply, when it comes to simultaneous debt reduction and investments, it all comes down to how much money 20% means for you, and how much of that 20% you can assign to each category.
At first, we can think about it like a simple subtraction problem.
Your student debt accrues interest that you’ll have to pay in addition to the loan principal at a percentage rate of x.
Conversely, your potential investment accrues interest in your favor at a percentage rate of y.
To see how much you truly stand to gain from investing, subtract the remaining value of x from the accruing value of y.
For example, 7% is often cited as the average long-term rate of return on stocks (source). If your investment earns you an average annual return of 7% while your student debt accrues interest at an average annual rate of 5%, then 7% investment minus 5% student debt means you’d ultimately make a 2% profit.
If this math seems oversimplified, it’s because it is, a bit.(Sorry.)
This 2% profit figure only makes sense if the amount you’ve invested and the amount of debt you have to pay down are exactly the same. It’s unlikely that, when you’re beginning to invest, this will be true.
Instead, it’s time to crunch a few numbers. To decide how to invest while also paying down your debt, determine what 20% of your monthly budget looks like, and what fraction of investing versus debt payment makes sense for you.
If you have $500 to put towards these two goals each month, it will make financial sense to invest vs. pay debt in a certain fraction. For instance, if you only pay $250 towards your student loan debts instead of $400, does that 5% interest rate mean you’re taking one step forward, two steps back?
Again, crunch those numbers and determine what ratio works best for you. This may mean only investing a small amount at first, but as that student loan debt decreases and that interest rate looks less and less scary, you may be able to adjust the ratio as you go.
The Bottom Line.
If you stand to earn more money than you stand to lose, by all means, consider investing while paying down student loan debt.
This subtraction problem, though, should encourage you to do your research so that you make smart investment choices, instead of just grabbing the latest and trendiest investment everyone's been talking about. (Bitcoin, anyone?) You can research stocks, bonds, futures, CDs, and other trading options on such free online resources as Google Finance, Yahoo Finance, NerdWallet, and BankRate.com.
Investing as a Writer Might be Different.
As an emerging writer or a newly minted college graduate, you may not have the capital to buy even one share of Google.
Don't let the price tag on popular investments get you down. (Margaret Atwood, I'd love to see the Latin translation for that.) There are tons of money market accounts and exchange-traded funds (ETFs) with low or no minimum investment amount.
One low-risk investment vehicle to consider is Acorns*.
Acorns is an investing platform that connects your bank account and/or credit card to an ETF with a portfolio strategy ranging from conservative to aggressive that you can change to meet your needs.
While you can make one-time or recurring deposits of larger amounts, the beauty of Acorns is that they round up to the nearest dollar for every transaction you make. If you buy a $4.50 latte, the remaining $0.50 are invested into your portfolio.
Because of this, Acorns can be a great solution for those just beginning to explore investing. Even if the math doesn’t allow you to actively invest in the early days of student loan repayment, you won’t miss these round-up pennies, and you’ll have a nice nest egg to invest more aggressively when your debts are paid down.
(* = Full disclosure: I invest with Acorns, but I have not been paid to mention them here.)
All right, that's it for this article. I hope my answer helped!
I’d like to close with three ifs:
If this article helped you and you think it’ll help your friends, please share via email and social media.
If you are a reader with any advice to share with Silvia, please do so in the comments below.
If you are interested in having your question answered on an upcoming Money Monday, fill out the form below.
I look forward to chatting with you soon!
Jessica Hatch is not a Registered Investment Advisor, Broker/Dealer, Financial Analyst, Financial Bank, Securities Broker or Financial Planner. The information in this blog post is provided for informational purposes only. It is not intended to be and does not constitute financial advice, is general in nature and not specific to you. Ms. Hatch is not responsible for any investment decisions made by you. You are responsible for your own investment research and investment decisions.