Should You Pay Off Student Loans Before Investing?

Should You Pay Off Student Loans Before Investing?

Millennials who have been out of college for a few years are starting to wonder if they should start investing before they’ve paid off their student loans. There is no one-size-fits-all answer to this question, but each person should be able find the best path forward.

Investment and debt-repayment are two sides of the same coin. Most people with student loan debt pay interest and annual fees totaling 4-6% of the balance of their loans. This is in addition to the premium payments made every month. This percentage is a loan’s APR, and it is an immovable object. Unless you look into student loan refinancing, this APR represents the annual cost of the money you borrowed for your graduation. This rate will stay the same for the entire term of your loan.

Investment portfolios bring in returns that vary year by year. If the economy is active and healthy, you could see returns of 7-9% or even more. Some years see investors receiving enormous returns that far exceed 10%. The thing is, these returns are unpredictable. Unlike your student loan APR which never changes, investment returns go all over the place. Some years, your portfolio may even lose money.

In years where your investment return percentage exceeds your loan APR, you will make more money than you lose, making investment a worthy pursuit, even if you haven’t paid off your student loans yet. But on years where your portfolio brings in less money than you lose in student loan interest payments, your investments won’t be “worth it” in a way that is easy to appreciate.

However, investing has one advantage that makes this decision a little more complicated than subtracting interest payments from investment returns. When people start investing at an early age, compound interest kicks in earlier, greatly amplifying the overall growth potential of your investments over your lifetime.

Most readers will already be familiar with this concept, but it’s worth a review. If you make regular payments into an investment account for your whole life without withdrawing funds, the dividends that your portfolio earns will also be added to the pot. In this way, a successful investment pays into itself. This creates a snowball effect. As time goes on, you’ve got more money, so it grows faster, so it gives off higher returns, which makes your money, which can then grow faster, etc.

With compound interest, the sooner you begin the better. Therefore, a lot of advisors consider it prudent to start investing as soon as possible, even if the return you expect from your investment is nearly equal to your student loan APR.

However, you shouldn’t begin investing if you don’t have certain financial details worked out. If you have no savings to cover you if you lost your job or experienced a personal emergency, you shouldn’t put aside money to invest. Instead, create an emergency fund. You may also have personal preferences that motivate you to pay off your student loans as soon as possible. Some people find a lot of personal comfort in being debt free, and may invest with more fervor once the debt is cancelled. Finally, explore investment acceleration options, like employer matched 401(k)s.

Hopefully this has given you a clear way of figuring out how to prioritize your investments and student loan repayment. Simply giving these concepts clever consideration indicates that you are careful about your money, a trait which will serve you well for life, long after your student loans are paid off.

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Jeremy Biberdorf

About the Author:

Jeremy Biberdorf is the founder of Modest Money. After working many years in the website marketing industry, he decided to take on blogging full time and also get his finances headed in the right direction. Also check out his contributions to Equities.com and Benzinga.

5 thoughts on “Should You Pay Off Student Loans Before Investing?”

  1. Avatar for Mark Ventrone

    Very good article. When it comes to debt and getting home loans or any other type of long term loan it is interesting to look at how it affects one’s FICO score and other qualifying factors. One must look at the interest rate they can receive on an investment vs the interest rate on their student loans PLUS their stage of life.

    Keep publishing the great content!

  2. Avatar for James

    While it might be easy to look at the cold, hard returns and then make a decision, it also depends on one’s personality. If someone is conservative and doesn’t want to take the risk for the 8% market return over the guaranteed 6% student loan payoff, sacrificing that 2% might be worth it to them.

    I wholeheartedly agree with you on the emergency fund! Life will have bumps in the road, and when they happen, all of the sudden the investment portfolio AND the student loan debt don’t seem so important. You need that emergency fund!

  3. Avatar for Investing Online Report
    Investing Online Report

    This is true. You must settle all your obligations beforehand if you wish to invest. This helps you to focus on investing and not on paying your debts back.

  4. Avatar for Jess @ Best Credit Cards Canada
    Jess @ Best Credit Cards Canada

    For me the answer is always to pay off loans first.I find it really motivating to watch debt dwindle which then encourages me to throw more money at it. I know interest rates should be taken into consideration, but so should your motivation. I would never borrow to invest, so maybe it’s the same principle?

  5. Avatar for Dave

    Great article Adam! While it may be nice to be able to invest and pay off student loans at the same time, I think it is really risky. If you have a solid income and can afford to, maybe not so much. For those who don’t have a solid income, however, might end up losing twice with their investments and student loans.

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