Author Topic: To pay the debt or to invest more?  (Read 2514 times)

sununderwood

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To pay the debt or to invest more?
« on: June 17, 2013, 09:44:36 AM »
Hi! I am 22, no debt other than 14k of federal student loans. Walk to work, bike in town, low rent, eat at home, boyfriend and I have one 1994 clunker, no cable or internet at home, don't buy stupid things, perfect credit card payment history, have a $4k Vanguard index fund, keep heat at 52 during Montana winters, etc., always learning and working at things I can do, but I'm frugal and happy. I make around $24.5k a year (first year working a real job), free health and dental insurance, and save $600 per month and apply $100 a month toward loans.

I apologize if this question has been asked before. I've seen MMM touch on it briefly on some comments but I was hoping for some analysis based on my situation...

I did AmeriCorps for 2 years and thus had a large education award that I applied toward my loans, around 10k. Because I did this all in one shot, I don't have a loan payment due until 2015. Right now per month I'm saving $500 in a savings account (about 4 more months until I reach my goal of 5k), invest $100 in my mutual fund, and put $100 to loans. $3k of my loans are at 6.4% interest rate and $11k are at 5.6%.

So my question is, when I finish building up my emergency fund, how much of my $700 would you put to loans and how much would you invest? I feel like, long-term, given my age and situation and the small amount of debt I have, it'd be better to invest $500 in the mutual fund, $100 in savings, and $100 to loans until 2015 when the minimum payment goes up to $200 or something and then pay that all the way until my loans are paid off, instead of aggressively going for the debt. In other words, I think my debt is a slightly less emergency than everyone else's............?......like maybe just one hive of bees instead of ten hives of bees stinging me relentlessly?..... I took a giant whiteboard to do the math over 30 years, both in the situation of paying the loans off faster and having more to invest sooner or investing a larger amount over a longer period of time. Investing earlier won out by about $5k, obviously though there are many unknowns of the future. MMM mentioned that he used to think the way I do with his mortgage, that he could just have it forever because it was at such a low interest rate, but then he changed his mind and paid it all off for the psychological factor of getting out of debt. What exactly are the benefits of that factor? I've talked to financial advisors and they have told me it's a bad idea too, for no reason other than the average American will likely let a monthly payment slip here or there and think it's not a big deal, yadda yadda. I'm torn, because it seems like even the most savvy of money folks would advise against what seems to me the most fruit bearing option. Am I missing something? Thank you for your perspective, informed outsider!

Rebecca Stapler

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Re: To pay the debt or to invest more?
« Reply #1 on: June 17, 2013, 09:56:29 AM »
6% and 5% don't seem like really low interest payments to me. They may seem low now, while the stock market is doing well, but we don't know what it will be doing in 5 or 10 years. You may find that you're not making enough in your index funds to justify keeping those loans open.

Here is the psychological joy of paying off those SLs: When you look for your next job, you will not have to consider whether it will pay those bills. I had to pass up a few job offers because they wouldn't pay my bills, and I'm pretty sure I would have liked those job. You will be freeing yourself from constraints with each debt you have paid off.

I would pay those off now, starting with the 6.4% one. You can pay it off in 5 months with $600/month. In fact, your payoff is probably lower than $3k, because you paid your principal and interest forward 2 years.

rollie

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Re: To pay the debt or to invest more?
« Reply #2 on: June 17, 2013, 10:00:31 AM »
I agree. 5 and 6 percent loans are expensive! It is hard to beat that return in a mutual fund in the short term (5 years). You will easily end up behind rather than ahead. Pay them off.

.22guy

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Re: To pay the debt or to invest more?
« Reply #3 on: June 17, 2013, 10:11:03 AM »
Make sure you have a very healthy emergency fund (if I were you I would continue to add to it and grow it a little, like 50-100 bucks a month) and throw the rest at the loans.  You will feel much better when they are gone.

twinge

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Re: To pay the debt or to invest more?
« Reply #4 on: June 17, 2013, 10:34:13 AM »
My advice would be to max out your Roth IRA while you're young and your income is low enough not to need a 401k tax break.  You can put in 5500 year, so that would be about $460 month.  The remainder I would throw at your 6.4% student  loan (the interest on which is also tax deductible).  I'm not sure how hefty of an emergency fund you need at 22 with no dependents and good health insurance, but the Roth IRA contributions can also double as an emergency fund since they can be withdrawn without penalty.  The Roth IRA will give you many, many years of compounding.  As your income increases, keep maximizing the Roth IRA but direct more money to paying off the loans (and don't give in to lifestyle inflation).