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Ask a Financial Planner: Should I Invest if I Still Have Debt?

January 29, 2020 · 4 minute read

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Ask a Financial Planner: Should I Invest if I Still Have Debt?

It can be confusing to know what to do with this new financial bandwidth (say you just refinanced your student loans). The feeling is often amplified when you have multiple financial goals you’re saving toward.

The first step is to look at the numbers, then to consider your preferences. There is no one “right” answer to this question.

Anyway, let’s dive in, starting with the numbers.

How much will each of the following cost you, between your student loan, a home, and retirement? Let’s say your student loan will cost $120,000. Let’s say your home will cost $350,000 and retirement $2,000,000. (One conservative way to estimate your retirement expenses is to take your annual spending and multiply that number by 30, or the number of years you plan to be retired.) Everyone’s numbers will look a bit different, so feel free to take some time to put yours together.

Once you’ve put your numbers on a page, what jumps out at you? Perhaps you’ve noticed that retirement is quite a bit more expensive than the others. This isn’t too much of a surprise if you consider what retirement is: living for decades in retirement with no salary.

How much do you spend in one year? How much would you spend in 30? For many people, retirement will be one of the biggest expenses of their lifetime. This may be our first clue about where it could make sense to place your focus first.

Considering Interest Rates

Next, consider interest rates. This is a necessary exercise whenever you’re making a tradeoff decision about money goals. With debt, look at the interest rate you’re paying. With investing, it’s the interest rate that you could potentially earn in a given asset class.

Comparing interest rates is an exercise in opportunity cost. As you’ve already picked up, any decision to pursue one goal means you’re missing out on something else. Ideally, we look to minimize opportunity costs when assessing financial trade-offs. In this instance, the opportunity cost is leaving potential investment earnings on the table.

If you are currently paying 3.5% on your student loan. Given the competitive rate on your newly refinanced student loan, you could consider continuing to make the monthly payment on your loan and allocating the extra cash flow elsewhere—investing for retirement or buying a home.

Remember, we want to think about interest rates in terms of opportunity cost. Your student loan costs you 3.5% annually, and that’s what you’ll “save” if you accelerate your payoff by $500 per month.

Instead, you could invest your money in an asset class—such as the stock market—with the potential to earn a rate of return that’s higher than 3.5%. Historically, the stock market has returned an average of 10%. This investing can be done within a retirement account, whether a 401(k) or an IRA.

That said, stock market returns are erratic, and the annualized return figures you often hear quoted are just that—an average. Investing is risky, and there is always a chance that returns over the next five, 10, or 20 years will not outpace the interest that you are currently making on your student loan payment.

The unpredictability of future returns is one reason that your question does not have a perfect answer. No one, not even a financial planner, has a crystal ball and can see into the future. This is why we also need to take into account your personal preferences.

If you feel like you are truly missing out on investing in an IRA or saving for a home, then investing in those things might be the right path for you. If your student debt makes you feel crummy, you could focus on it. That said, you could allow your personal preferences to be shaped by your realistic financial needs.

Here are a few ideas to consider as you spend some time connecting with your goals:

Contributing to a Retirement Account

Most financial planners would agree that Americans are vastly under-saving for retirement. So, I am happy to hear that you’re taking advantage of your 401(k) match. What I don’t know from your question is how much that match is, and how much you’re contributing to your 401(k) overall.

There is no standard—match programs can range from meager to generous. Between your contributions and your employer’s, it is often recommended that you save between 15% and 20% of your salary for retirement.

You can do this by contributing the full allowable amount to your 401(k), which is $19,000 in 2019, or by utilizing other investment accounts like a online IRA or a brokerage account. No matter which account you use, you might want to consider putting that money to work with a long-term investment strategy. For example, you could consider deploying a strategy of low-cost mutual funds that invests in stocks and bonds.

Buying a Home

Financial planners don’t all agree on whether a home is a good “investment.” That is not to say that a home is not a good financial goal; if it’s a priority to you, then it’s great. This is simply a commentary on whether a home produces a good return on investment.

While home values do typically grow over time, you must also take into consideration the costs of buying and owning a home, such as the interest paid on the mortgage, property taxes, repairs and maintenance, and so on. That said, homeownership can be rewarding, and can pay major dividends down the line. One big benefit is having no monthly housing expenses (like rent or a mortgage) in retirement.

As you’re likely starting to catch on, much of the decision to buy a home is a deeply personal one. Although a house may not have as high an investment return as other asset classes, such as the stock market, a house provides something that a stock or bond cannot—immediate utility. You cannot sleep and eat inside a stock or a bond.

Saving Is Personal

Still struggling to make a decision about where to send your new cash flow? Remember, financial tradeoff decisions don’t always have to be all-or-nothing. Split the difference! You could put a little here and a little there! For example, you might send another $300 per month to your 401(k) and $200 to a high-yield savings account for your down payment.

As long as you are putting your money towards some financial goal, you should feel proud and relieved to know that there is no one right answer to this question—do what feels best for you!

Have a financial question of your own? SoFi Invest® is here to help. Schedule a complimentary personal consultation with one of our licensed financial advisors who can help you plot the best path forward.

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Third Party Trademarks: Certified Financial Planner Board of Standards Inc. (CFP Board) owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design), and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board's initial and ongoing certification requirements.
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