Investment v. Debt

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karim
Posts: 59
Joined: Sat Oct 01, 2011 6:40 pm

Post by karim »

I've been having a conflicting internal debate as to whether I should pay off student loans that are 2.8% or instead invest.
It's "safer" I imagine to be debt free, but from a math standpoint, investing would earn me more money.
I keep flip flopping back and forth with no real conclusion!


Chad
Posts: 3844
Joined: Fri Jul 23, 2010 3:10 pm

Post by Chad »

You already know the math, so you have the logic answer. Now you need to figure out your emotional answer. Are you personally comfortable with debt? If so, how much? How much risk do you like? Because, investing money instead of paying off debt increases risk slightly compared to if you had no debt and were investing the money.


JohnnyH
Posts: 2005
Joined: Thu Jul 22, 2010 6:00 pm
Location: Rockies

Post by JohnnyH »

Reasons to pay off:

*Your investments might earn less than 2.8%, even lose money.

*One less account owed and monthly bill.

*You have to pay taxes on investment gains.
Reasons to not pay off:

*If you're earning money you can write that interest off your taxes, reducing your effective rate.

*If you're not earning money you can have the payments reduced to almost nothing and forgiven after 20-25 years (IBR).

*Numerous forgiveness/incentive programs, scholarships, savings accounts can be used against loan balances.

*Political hot button that might get a bail out ;(

*Increases your credit score if you care.
I'd invest, unless the rate gets too high.


Hoplite
Posts: 489
Joined: Sat Dec 04, 2010 1:03 am

Post by Hoplite »

Good advice above; I add my own perspective:
Apart from your personal feelings on debt, the debt you have is defined and if you can't also define the investment then the risk increases, since time is the enemy on debt.
I would consider investing if I had a specific investment in mind; particular stocks (or types of securities), a rental property, something. But I would be very uncomfortable holding debt without a specific objective, and have no faith in investing as some vague activity because I can't really assess the risk at all and the clock (interest) keeps ticking.


Mo
Posts: 443
Joined: Wed Jul 28, 2010 1:35 pm

Post by Mo »

Karim, I paid off my student loans, over $100k at peak. That tells you what I would do. I have never regretted paying it off. It felt great to pay it off. I don't think there is anything wrong with spending money to feel better (in this scenario at least).
There are many ways your money might be taken from you or lost. There is only one way to get rid of your student debt.
As pointed out above, if it were only math you'd never ask the question or have doubt.
Reasonable questions:

Do you still want to be paying this loan off 25-30 years from now?

Exactly how much more money do you project to end up with if you invest instead of paying down debt?

When will you have this money, and what will it be worth in real terms?


George the original one
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Joined: Wed Jul 28, 2010 3:28 am
Location: Wettest corner of Orygun

Post by George the original one »

For an experienced self-directed investor, a loan at 2.8% is not worth paying off early. However, do you have the experience?
And before you go with "pay it off ASAP", also ask the question of whether an acclerated payment schedule will leave you illiquid. Make sure you have enough leftover to stay solvent in case life happens... I've known several people who aggressively pay off their moderate debt only to see them borrow more money when stuff happens before the loans are repaid.


DutchGirl
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Joined: Tue Sep 06, 2011 1:49 pm
Location: The Netherlands

Post by DutchGirl »

My boyfriend has paid off minimum on his student debts for ten years. He still owes 18k euros and will be paying for two more years. I have paid mine off ASAP and had them finished off five years ago. I have never looked back and I have enjoyed being debtfree for three years now (got into some stupid consumer debt as soon as I had my student loans paid off, silly me).
If I would have been excellent at managing my money back then, I might have made a few more euros by keeping the debt and investing the difference, but I love the peace of mind and the fact that I don't have anything to do with my student loan provider anymore.


aussierogue
Posts: 379
Joined: Thu Nov 10, 2011 1:02 pm

Post by aussierogue »

i also think it depends on how much your debt is..
the bigger it is and as others have pointed out the length of the loan play a big part...psychologically they will be on your books for years and whiclst atm it doesnt matter in 10 years time it might.
any debt also reduces your ability to borrow further...
pay it off NOW if you can afford too...


tac
Posts: 79
Joined: Tue Mar 15, 2011 5:54 am

Post by tac »

How much debt are we talking? Could you write a check and pay it all off tomorrow?
If you will ACTUALLY diligently invest the money, might be best to keep the loan and pay off at the proscribed rate. As has been pointed out, you can get a tax break on the interest, there is the possibility of a forgiveness program coming into play, etc. 2.8% is really low interest.
However, if it's a relatively small amount of $$, you might want to go ahead and pay it off, just to get the monkey off your back, so to speak.
I paid, in total, around $12k in loans for university. I took what I would consider a semi-aggressive stance in paying them off--I made sure I was building up savings and investing, but I always chucked a bit of extra $$ into my monthly payments. If I received extra $$ unexpectedly, I always directed some of that to the loan repayment. I had the whole thing paid off within 4 years of graduation, which is not an insanely fast rate, but is much faster than I was "supposed" to pay it off. I always made sure I had some cushion of savings, in case a huge unexpected expense came along--I didn't want to get stuck with a high-interest CC debt just because I had been so good about paying off my low interest education debt.


Dragline
Posts: 4436
Joined: Wed Aug 24, 2011 1:50 am

Post by Dragline »

Without knowing anything about the proposed investment, I would say "Don't do either -- instead do both." You'll reduce your debt load and get some experience with investing without risking everything.
Now how much to allocate to each one? Old-time rule of thumb advice (see "The Richest Man in Babylon") would suggest 2/3s to the debt and 1/3 to the investments until the debt is paid. That's assuming a 30% savings rate. Add more investments if your savings rate is higher.


anastrophe
Posts: 27
Joined: Fri Jul 08, 2011 7:47 pm

Post by anastrophe »

@Dragline, this is what I have been doing, mainly because I am both risk-averse and indecisive. I have student loans at a similar rate, and almost enough cash to pay them off entirely, which would be very nice because it's guaranteed, but the flip side of that is opportunity cost, what if something good comes up? On a near-daily basis I change my mind about whether I want to just kill them, and tell myself "sleep on it," and by the next day I think the opposite thing!
@karim: one thing to consider, what is your monthly cash flow like? If they are impeding your ability to do other things with money, that's a different question than if you have the cash sitting around.


Chad
Posts: 3844
Joined: Fri Jul 23, 2010 3:10 pm

Post by Chad »

Remember when you are doing the math that taxes may need to be taken into account. If it's a 401k or IRA then you get a small tax savings right now. But, if the investment is in a taxable account your total return will be reduced by your tax rate. This will lower your actual return, as will brokerage fees or fund expenses.
Also, if you decide to invest, but think there is chance you will change your mind you might want to just pay it off now. This way you will get more interest savings. Don't wait a year or two and then decide to pay it off.


karim
Posts: 59
Joined: Sat Oct 01, 2011 6:40 pm

Post by karim »

@Chad: By interest savings, I assume you mean from paying down the student loan.
Everyone raises good points. To answer some questions: I definitely could not pay off the loans tomorrow and the interest rate is soon to drop to less than 2% (through multiple incentives). I also would not be able to write off some of the interest payments on my taxes. I figure that at <2%, which is less than inflation, every year the loan becomes devalued and the creditor loses money. I don't think I want to stretch it out until I'm 60, but I may stretch it out for the next 10 years and focus on other financial goals.
Thanks for everyone's advise!


Aesops
Posts: 6
Joined: Sat Apr 28, 2012 7:18 pm

Post by Aesops »

Just a thought: in a deflationary environment, debt in general becomes more onerous as it takes up a larger % of your assets and income. In the depression, 70% made it through OK. The 30% that did not had debt that became quickly unmanageable. Based on the macro picture, just get rid of the debt.


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