With student loans rocketing through the roof and millennials everywhere seeking an escape from the drudgery of nine-till-five employment the big question hovers over everyone’s heads – should you be saving for retirement (traditional or early) or should you be crushing your student loan debt?
When it comes to knocking out student debts there are few stories more inspirational than Joe over at No More Harvard Debt. Joe took a look at his student loan payments one year and realised that he had paid $22,000 towards his student loans, but less than half of that amount had been taken off the principal, the rest was eaten up with interest. Joe worked out that over the life of the loans he would be paying over $42,000 in interest, on a $100,000 worth of loans – that’s 42% interest over the life of the loan. While the average student leaves college with only $25,000 worth of loans, rates vary from 4.45% up to 7% and often take more than 10 years to repay.
By knocking down your loans early you can reduce the amount of interest that you will pay. You can also consider refinancing those loans with another lender for a lower rate to crush them faster.
Saving, investing and retiring
While saying goodbye to debts is a great feeling, there are many investments available that might return more than your loans are costing you. On average the stock market will return 7% per annum. Peer to peer lending can offer 5 – 9% depending on your risk tolerance. A savvy property investor can find real estate deals that will return 12% per annum.
With so many options for investing that offer better returns than the rates on your loans it can seem like a no-brainer to be investing rather than paying off loans. Many people choose to invest while having mortgages because their investments return more than their mortgage.
However this approach has the potential to be riskier. While you can guarantee that paying your debts means they will go down, you can’t guarantee that investments will go up. While the share market has constantly climbed and is sitting almost 50% higher than pre-Global Financial Crisis peaks, there is always the risk of another market crash.
And the winner is..?
It turns out, it doesn’t matter if you pay down debts or save first. If you’re chasing early retirement with a laser focus then investing is technically better because interest rates are lower than stock market returns (if you chose to go that way). However if you’re following a more traditional path, then both options are reasonably equal.
If you prefer stability, and hate seeing those loan payments each month, then knuckle down and destroy your debts. If you don’t mind the ongoing loan payments and are confident your investments will grow faster than your loans, then your overall net worth is best served investing.
What really matters is that you get started sooner, rather than later while time and compound interest are on your side.