How to Invest When You Still Have Student Debt
Published on November 10, 2017
When you have a student loan balance, it can feel like a dark cloud hanging over you. Many of us have grown up believing that all debt is bad, and we understandably want to get rid of it as soon as possible. We also assume that paying off loans will lead to financial freedom and that we should be completely in the black before committing money elsewhere.
But paying off your student loans as quickly as possible isn’t always the smartest choice financially. Most lenders don’t consider student debt a black mark, and it might also offer you a tax deduction. Plus paying off loans too aggressively could cause you to miss out on other opportunities—like investing for retirement or a home purchase. In many cases, keeping up with payments while making smart investments might be a faster way to reach your goals.
Here’s a guide to investing responsibly when you still have student debt.
Get Your Debt Organized
Before you even think about investing, you must have your most important financial bases covered. That means: First, make sure you’re never at risk of defaulting on your loans. Pick a repayment plan that works for you, and don’t miss a single monthly payment. Defaulting can ruin your credit, and student loans can’t be wiped out even in bankruptcy, in most cases.
Next, if you have credit card debt, it’s often better to pay that off before considering other investments since those interest rates are typically sky-high. After that, if you have some extra cash on hand, your next step should always be building an emergency fund of three to six months’ living expenses.
Finally, take a look at your debt-to-income ratio. It’s not common, but if your student loans are impacting this ratio in a way that precludes you from a goal like taking out a mortgage, that’s a reason to focus on paying down your debt before anything else. (Not sure where you stand? Set up a complimentary appointment with a SoFi financial advisor, who can give you a personalized recommendation.)
Understand the Idea of Opportunity Cost
Once you’ve got your financial house in order, you can start thinking about whether investing makes sense for you. One way to think about the decision of whether to invest or pay down debt is to think about what you’d be missing out on.
Most student loans have relatively low interest rates, and refinancing can get you an even lower rate. Say your student loan interest is 4%, while the stock market has (hypothetically) yielded average returns of 7% over the last five years. Generally speaking, earning 7% interest makes more financial sense than paying down debt at 4% interest.
Of course, investing always entails the possibility of loss. In our hypothetical scenario above, we assume you would have been entire invested in stocks, which is probably not ideal and depends on your unique appetite for risk. Additionally, when you invest with a longer time horizon, you’re more likely to weather the market’s ups and downs and earn an eventual return. If you have two years of student loan payments left, that’s quite different than having 10 or 20 years left.
Invest Money to Save Money
“Saving” for retirement is a bit of a misnomer. Retirement accounts, such as 401(k)s or IRAs, are actually funds that let you invest in a wide variety of assets. Since retirement is likely your largest financial goal, investing through a retirement account is often a good place to start putting your extra dollars to work.
Assuming retirement is still a long way off, you probably don’t want to let your retirement savings sit in cash or a low-interest money market account. Instead, consider investing in a portfolio of mutual funds, exchange-traded funds, and other assets that match how aggressive you want to be at the moment. Stay on top off your retirement and see if you are on track with SoFi’s retirement calculator.
If you’re saving for a home but are at least three years away from buying, investing those funds might be a good idea. You can take out up to $10,000 penalty-free from an IRA to defray first-time homebuyer expenses. If you’re planning to buy sooner than that, the risk of investing might not be worth it. But at least try to make sure your money is in a high-yield savings account (which are currently paying an annual percentage yield of up to 1.5%), rather than in a checking account.
Get Your Money into the Market
For a more flexible investment option, consider opening an individual brokerage account at a financial institution. If you don’t know what investments to pick, the easiest and likely least risky option is a diversified, low-cost portfolio of exchange-traded funds. SoFi offers such investment portfolios based on your risk tolerance and time horizon. Setting up automatic deposits from your checking account will put your investment plan on auto-pilot and ensure you don’t spend that extra cash.
While it may be tempting to run out and buy the latest hot tech stock, this is generally a risky strategy for new investors, since your money is concentrated in a single company, and you have no control over its leadership or market dynamics. People who are passionate and knowledgeable about individual companies like to buy stock directly in specific firms, but for the rest of us, diversifying is usually a better way to go.
Keep Investments and Emotions Separate
Of course, just because something makes financial sense, doesn’t mean it resonates emotionally. Only you know the psychological cost of carrying a heavy student debt burden—it’s not quantifiable. If the mental weight just isn’t worth it, getting rid of your debt as quickly as possible might be the right path for you.
Curious about investing, but not sure where to start? SoFi Wealth is all about empowering you and your financial future, and we’re here to help. Schedule a free personal consultation with one of our licensed financial advisors who can help you plot the best path forward.
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