It’s exciting to start working after college. You’ll get a genuine job and a genuine salary. What should you do? Pay off student loans or invest?
Don’t let a complex choice depress you. We see no reason to pick.
Student loans can be invested in.
To the point: you can repay student loans and invest. Planning is needed.
You’ll need a budget that maximizes savings and student loan payments. Once you’ve calculated it, stick to it. In a few years, you’ll have a solid financial base and be financially free.
Pay off student loans or invest?
You should invest while paying off college loans. Should you prioritize loans or investments? Let’s see what you prefer.
Rates to consider:
- First, evaluate student loan rates. Are they higher than investments? If so, pay them off.
- The 50-year average stock market return is 10%. Perkins Loan rates are 5%, and Direct Subsidized and Unsubsidized Loan rates are 2.75.
- Many grads should therefore invest more. If you have high-interest private student loans, pay them off quickly.
Tax advantages
Student loan payments can result in a $2,500 tax deduction. This will reduce your tax bill.
Will that outweigh your investing gains? Calculate how much the tax credit will cut your student loan interest rate. Multiply your student loan rate by 1 minus the marginal tax rate.
Let’s see with an example. The 2022 marginal tax rate for income over $41,775 and below $89,075 is 22%, the category most graduates fall into. So 0.22-1 = 0.78.
Multiply 0.78 by your student loan rate, say 5% for a Perkins Loan. Your new anticipated interest rate after the tax credit is 3.9%.
Is your investment return estimate higher? In most circumstances, yes—keep investing there. Also, you may earn investment tax savings, such as a retirement account tax credit.
Forgive student loans.
Federal student loans may offer income-driven repayment or forgiveness based on employment. Teachers and public servants can get a loan canceled. If your school closed or lost accreditation, you may qualify. Those that qualify can invest more.
You can’t forgive private loans, but you can refinance to lower your interest rate. Consider the benefits and downsides before acting.
Student loan investments
We’ll share recommendations to help you decide whether to pay down student loans or invest.
Pay the minimum.
Never skip a student loan payment, even if you invest heavily. Even skipping one payment might hurt your credit and lead to debt default.
Maintain a cash reserve.
Unexpected bills require an emergency reserve. Three to six months of living expenses are recommended.
Refinancing might reduce monthly costs.
Refinancing may lower your high student loan interest rate. This reduces monthly expenses so you can invest more.
Use your company’s plan.
Do you have a 401k? If so, contribute! Especially if they match 401ks. This means they’ll double your contribution—extra free money!
IRA
IRAs are a stress-free way to invest. You can contribute up to $6,000 annually.
Investment results
If you have big loan payments, you may not be able to invest much. Every little bit adds up over time!
Say you make $50,000 a year after taxes, or $3,400 a month.
Let’s call the average monthly student loan payment $250. Suppose you have $2,500 in living expenses, $200 for an emergency fund, and $200 for pleasure. That leaves $250 for investing.
It adds up. In the next 10 years, the average large-cap index is expected to return 6% annually. Let’s use that amount conservatively.
After 10 years, you’ll have $39,359, with $1,275 from compound interest. After 25 years, that’s $150,013 with $26,491 compounded interest — free money!
Balance out.
Student loan investing is viable and smart. Every dollar will bring financial success.
Pay off loans, invest, or do both responsibly. Help? Learn how to budget and prioritize debt using our financial plan.
