Should I Eliminate Student Loan Debt or Invest?

College Graduation

by Ryan

I faced a dilemma upon graduating college. Having entered the working world making decent money (not great by any means) I had a few extra bucks a month and I had to decide whether I would.

1. Eliminate student loan debt.
2. Invest the money.

Either choice was a good financial decision, but which one is better for the wallet? As economist would say: “which one would maximize my utility?”

The answer it turned out was quite simple: If the rate of return on my possible investments was higher than my interest rate on student loans, I’d invest. If not, I’d pay down my loans.

This works because I’m able to make a higher rate of interest on my dollar than the interest I pay on my debt. Student loans are around 6% while I knew the average for the overall stock market was a little below 10%. It’s pretty simple to follow, but of course it’s not as easy as it sounds.

The problem with this decision.

In a word – Risk. You’re never exactly sure how much your investment will produce. Last year the market tanked so this would have been a horrible decision in the short term.

However, I didn’t need my money in the short term so it didn’t really hurt. I decided it’d be best to use the money to put in my Roth IRA since I won’t be touching it for the next 40 years. The long term market average of the past would beat my current debt rate so hopefully in the future that also holds true.

What are your thoughts on this? What affected your decision to invest or eliminate student loan debt after graduation?

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{ 2 comments… read them below or add one }

Simon Zhen December 18, 2009 at 9:17 am

I had the same predicament upon graduation this year. Since I had two federal loans: one at 2.48% and another at 6.44%, I decided to make larger payments on the one with higher interest and use the lower interest loan to build credit.

I didn’t throw all my money into student loan repayment because I believe it is really foolish to not invest while the market is shot. We’re young, so why not add a little risk!?

I’ve been saving in a Roth IRA too just like you. Guess we are thinking alike.

Ryan December 18, 2009 at 11:50 am

Wow, 2.48% – that’s practically free money!

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