Pay off remaining student loans or invest?

[bjclifto]

Hey guys,

Just started reading MMM a few weeks ago and have tried implementing as many ideas as possible to start growing the stache.  My wife and I have paid off $15k in debt over the past 2 weeks.  $10k was from Sallie Mae loans ($5k at 6.8% and $5k at 5.12%) and remaining was to pay off the wife's car ($5k at 7.9%....yeesh I know).  It feels great to chip away at our debt and gain a better understanding of where our $$$ is going through tracking purchases through Mint.com and trying to be more frugal.

I'm now wondering if we should pay off the remaining student loans in full or start investing while still aggressively paying off the loans.  Here's some additional info and overview of debt, expenses, income, and investments:

Remaining student loans: $16,000 ($8k at 5.12% & $8k at 2.39%)

Income: $6,000 after taxes (put 10% in 401k & 10% in stock purchase plan)

Expenses:
   Rent: $1440/mo
   Student loan minimums: $350/mo
   Life insurance: $118/mo (parents set up whole life insurance some time ago and took over payments last year)
   Car insurance: $95/mo (2009 Camry that was just paid off and 2004 jetta)
   Cable/Internet:$110/mo
   Gym: $105/mo (total for both wife and I)
   Utilities: $50/mo
   Gas: $275/mo (live in Chicago and commute 34 mile round trip); wife work 2 miles from work & bikes
   Food/dining out: $500/mo

Investments:  we're both 28 yrs old
   401k: $70,000
   Stock: $28,000 (all tied up in company stock)
   Roth IRA: $7500 (haven't contributed in 3yrs)
   Cash:$20,000 (sitting in bank earning nothing)

So....we were house hunting just 3 months ago and had $35,000 (part of downpayment) sitting in Chase.  Thank goodness I discovered MMM! After reading through the majority of blog posts we decided it would be best to attack the debt so we could start accumulating more wealth before considering purchasing home. 

Do we just pay off the remaining $8k at 5.12% and continue with minimums on the $8k at 2.39%?  Or do we start investing in a Vanguard index fund then just pay off the student loans over the course of next 2 years?
 
I know we still have plenty of improvements (find cheaper rent, cancel cable, change life insurance to term or eliminate altogether, switch car insurance, cheaper gym, shorten commute or bike 1/2 week, and work on food budget) to make to optimize our financial situation, but wanted to see if we were headed in right direction.  Any advice would be greatly appreciated.  Thanks!

[Iceplant18]

Welcome!  I just joined myself only about an hour ago so I'm hardly an experienced mustachian.  I've often contemplated the same thing myself so I figured I'd give my input anyway. 

The financial advisors recommendation would probably be, if you feel you can invest your money in a place that will yield you a better return than the interest rate on the debt then you'll end up with a net gain.  In other words go for the investments.  It's exactly what the banks do.  They borrow money at a low interest rate and invest it in something that has a higher rate of return for a profit.  You'd essentially be doing the same thing by investing the money that you would have otherwise used to pay off the debt. 

The frugal responsible type (which I tend to be) would say to pay off the debt first so that you have less risk.  It's generally safe to say that paying off debt is less risky than taking on new investments.  But that's investing 101.  More risk = more reward. 

So I say pay off the debt first unless you are 100% confident that you'll get a better return by investing the money in Vanguard. 

[icefr]

Congrats on paying off the debt you've gone through so far!! I would probably pay off the 5.12% loan and then just do the minimums on the 2.39% one.

Are you sure you need to be spending $118/month on life insurance? And is there any way you can take transit to work part of the way? That's an insane amount of money to spend on gas each month. Also - that company stock. Do you need to keep it? What are the rules on it? That's a good amount of money to hold in your company.

[bjclifto]

Thanks for the feedback, icefr & Iceplant18.  Both comments make sense and it's nice to get reassurance that we're on the right path.

Yea, the $118/mo for life insurance is a bit high ($93/mo for my whole term life insurance and $25/mo for wife's).  My wife does not have any 401k benefits and all the medical/dental comes out of my pay.  My company provides the standard/basic life insurance policy of $50,000.

The commute is a royal pain.  I've contemplated riding my bike (34 miles roundtrip), but it's a bit outside the distanec I'd feel comfortable with especially living in humid Chicago and having no shower at my work.  My gas budget of $275/mo may be a bit inflated, but it's been the average over the past 6 months.  I've noticed significant (15-20%) improvement in gas mileage just by changing my overall driving style and implementing some hypermiling techniques so hopefulyl this number will come down a bit.

The stock purchase plan is something I've always put 10% into since joining my company in 2008.  The returns have been substanial (20%/yr) and I get a 15% discount on shares bought.  I'll probably continue with this and try to increase my 401k to $17,500 as the wife doesn't currently have these benefits.

[Rebecca Stapler]

You know what you have to do with that whole life insurance, so you don't need to hear it from me. But is the value of it big enough to pay off a loan or two? That would motivate me to get rid of it sooner rather than later. Also, set up your term life policy now while you're young and healthy, to lock in a good rate. Your wife too, especially if you plan to have kids in the near future (a c-section counts as major surgery, and might raise her life insurance rate).

I'm not clear on why you're prioritizing your 401k over your Roths. Does your company provide a match?

I agree with prioritizing paying off that high interest SL.

Your budget looks like you have $3k/month to save. Is that right, or have you left things out of your budget? (house supplies, personal care, gifts, etc.) If you have $3k/mo, I would use it to pay off both SLs and fully fund your Roths for 2013 -- which you could do in 10 months, just in time to meet the April 2014 deadline for your Roths. 

[bjclifto]

Hey stan,

Yea, the wife and I will most likely start a family in the next 1-2 years so looking into life insurance and car insurance is on the agenda for this weekend.

About the 401k, I honestly haven't put much thought into in until recently (which is a bit scary) so that's a good point.  My company provides a match up to $1750/yr.

Our budget is fairly stable at $3k/mo.  There's somethings outside of that that are variable (gifts, car repair, etc.), but nothing too substantial.  I work in sales so the commission fluctuate month-to-month, but on average we can save $2-$3k based on sticking to a strict budget.

I need to work on transitioning over and consolidating our roth IRAs (currently in UBS) to Vanguard and setting up a more reasonable savings account (Ally or ING instead of Chase).  If we do plan on purchasing a home in the next 1-2 years and putting down 20% is the best place for our funds to be tied up in roth?

[Rebecca Stapler]

Because your employer matches $1750 in your 401k, contributing up to the match is a given -- it's a 100% on your investment the day you put the money into the account.

Whether you want to put the rest of your retirement contributions into your Roth or your 401k depends on your current tax bracket and what tax bracket you expect to be in when you withdraw the funds. This differs for everyone, depending on their expected retirement expenses; but for us, we max out our Roths before putting more money into our 401k. The other reason is that our 401k does not have the investment vehicle we prefer -- low expense index funds.

How much is 20% down in your area? This amount varies greatly, so whether you can get there while maxing out your retirement contributions and paying off SLs depends on how much $$ you're talking about. Regardless, I don't recommend withdrawing funds from your Roth to pay a down payment. You can withdraw principal, but you lose your contribution for that year -- you can't put money back in your Roth for past years.

[rugorak]

Pretty much what everyone else said. You say whole term life which is confusing. Whole life is one thing. Term life is another. I am assuming you have whole life. In which case see about getting rid of your whole life and getting a good term life policy. I like Dave Ramsey's explanation - http://www.daveramsey.com/article/the-truth-about-life-insurance/

I have a few other savings ideas that you may want to consider. Dump the cable half of your cable/internet and just go with Netflix/Hulu/Amazon Prime instant watch (lots of overlap so whatever you feel like). Even if you pay for all 3 it still should save you some money. Plus you can always use over the air channels too which will cover most of your local news/sports. Gym seems a little high to me but may be normal for your area. But could consider doing other things. You don't say if the car insurance is an average or if you do pay it every month. Usually there is a discount (or at least lack of extra tacked on fees) if you pay it in full up front. So if you are not doing that already you probably should.

As far as the house I'd say don't touch the roth. Use outside money. You don't want to lose out on the tax advantaged growth. Especially with only $7500 in there. Sell the company stock if you really want to buy. You might want to read this too before you buy - http://jlcollinsnh.com/2013/05/29/why-your-house-is-a-terrible-investment/