A recently-graduated student asks:
What would be a better investment than paying off $30K of subsidized low-interest student loans?
Money available: 30k
Interest on subsidized student loans: 3-4%
Do I pay them off, or look for a better investment, and keep the spread? What would be a better investment?
If you’re also trying to decide whether you should pay off debt or start investing, here’s what you need to decide right now:
Do you want to live debt free or do you want to live financially free?
If you choose the former (debt free), you may make some GREAT investments: eg paying off your 19% credit cards (probably the best investment you will ever make in your life; avoiding this kind of debt will be your second best investment).
But, if you blindly pay off ALL of your debt, you will also make some TERRIBLE investments: eg paying off your student loans will only ‘return’ 3% – 4%.
So, let’s list all of the debt (and their interest rates) that you may have on one sheet of paper, and all of the investments that you may like to make – with their likely (historical) returns – on another.
Now, on a third sheet of paper, put the items from BOTH other lists into one new list, strictly in descending order of interest rate and/or return.
THAT’S where you should allocate your money … from the top down.
Here’s a practical example for you:
Your current student loans are costing you 3% – 4%, and I presume you have no other debt (or, I assume you would have mentioned it).
The Dow Jones (i.e. the top end of the US stock market) has NEVER had a 30 year period where it has returned less than 8%.
So, provided that you are in this for the long term …
Put your money into a low-cost index fund, until you learn the skills to reliably invest at even greater long-term returns than 8%.
What do you do with the student loans? Pay them down slowly (safest) or let them sit until you have to pay them off (more risky).
Now, that’s how to start the process of becoming financially free.