Loans vs index fund

[Jacobi]

- I have 10,000 in student loans at 4.5%
- I am already maxing out a Roth IRA (don't have a 401k)
- I have about $1,500/month in discretionary income

Should I power through the rest of the student loans, or just keep paying the minimum on those and start up a Vanguard index fund account with the extra monthly income?

[Mighty-Dollar]

It's a simple question. Are you going to earn better than 4.5% with stocks and bonds? With bond yields so low it's going to be a close call. I would just pay off the loan rather than gamble at trying to beat 4.5%.

[PizzaSteve]

I agree with mighty.  Be loan free, then invest.

[smallstache]

Fully deductible interest rate of 4.5%. Why pay that off early???

[PizzaSteve]

Fully deductible interest rate of 4.5%. Why pay that off early???

My rational is mostly behavioral. It is a small small debt amount, the return is guaranteed, and the action creates the right behavioral precedent.

When ready, they should also invest some amount for the long term, but not until they are ready.   By asking the question, the OP presents the impression of a fairly new,  young, and less educated investor.  IMHO, no one should invest in stocks without 1) knowing the risks fully, and 2) forming an asset allocation plan with the idea thar that part of assets will be held for at least a 5 years + timeline.  An IRA or 401k generally enforces the long term.

So my interpretation is that this person would be better off killing the loan first, as habits trump what might be a slightly higher expected return (but not a guaranteed return, risk adjusted).   They are already maxing the ROTH IRA,  so getting some long term stock exposure, i assume in INDEX funds.  Once loan payments are gone, more to invest.

[acanthurus]

I strongly agree with the reasoning laid out by PizzaSteve. I would like to augment it with my own personal, less reasoned take:

FUCK DEBT! What the hell man, pay that shit off ASAP! Ain't nothing guaranteed in the investment world, you got a solid 4.5% return by paying it down. Don't ever let anyone own you. You got debt, you are someone's bitch. Their beast of burden. Their indentured servant.

Pay it off. You want extra investment returns, lever up a portion in your Roth (DITM LEAPS options, 2x leveraged ETFs, whatevs, anyway you can lever up without an actual margin account). If you're young and starting out, it's probably smart to do anyway:

http://faculty.som.yale.edu/barrynalebuff/LifecycleInvestingLeverage_v2008.pdf

But start with paying down that debt.

[rugorak]

Do you not have a 401k available or just do not contribute? If you have one available but are not contributing is there any reason why not?

Math wise if you have a 401k (or some other tax advantaged account) available max that out. $1500 a month will get you to the IRS limit of $18000 a year. But the best part since it comes out pre-tax you would only lose around $1000 of your take home. Giving you about another $500 to put towards the loan.

But as the others in this thread have said there is the psychological side of things. I got out of debt first myself (although I was not aware of the math side of things at the time). Today I might have maxed out retirement earlier knowing what I know. But I have no issues with being frugal and saving.

If you have no tax advantaged way to invest I would pay off the debt. For me it is a guaranteed return and you will have one less thing you have to pay every month. And math wise it isn't as big of a gap as with the tax advantaged ones.

But at the end of the day as long as you aren't wasting the money on frivolities you are making a good choice and one most others are not making.