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Should I Save, Invest or Pay off Student Loans?

Sept. 6, 2016
Financial Planning, Investing, Retirement Planning, Student Loans
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“Arielle Answers” is an investing and retirement Q&A column for all ages and life stages. I’m here to help you save more and reach your investing goals, whether that’s retirement, a house down payment or college for your kids. These are things I’m saving for, too.

If you have a question, I’d love to answer it. (The disclaimer: I won’t tip you off to the next hot stock or the best mutual fund because I can’t predict the future.) Send a question to and it may appear in an upcoming column.

Q: Should I save, invest, or pay off my student loans?

In certain corners of the internet, student loans are Mount Everest. Google a phrase like “how I paid off my student loans” and, well, you’ll probably close your browser by Page 3 like I did, because the results all look the same: There are a lot of people out there who are paying off massive amounts of student loan debt in short amounts of time by side hustling, giving up cable and eating food that comes in cans.

There is no doubt that the level of commitment in these tales is admirable. Student loans are draining, both financially and psychologically. Paying them off early feels very, very good. Not that I’d know: I’m making the minimum payments on mine.

That’s a calculated decision because I prioritize the three things you asked about — saving, investing and paying off student loans — in exactly the order you listed them, and I’d argue that you and most other people should do the same. Here’s why.

A little money in the bank goes a long way

Ever look out the window during a rainstorm to find that the roof on your front porch has turned into a waterfall? Tried to replace a light fixture only to realize that your 100-year-old house has 100-year-old wiring? I have, and I can tell you that an emergency fund will come in handy in these and many other situations. If you’ve sent all available cash to your student loan provider, they’re not going to be super receptive when you call to ask for it back.

Putting away the recommended amount for that fund — typically three to six months worth of expenses — is about as intimidating as paying off student loan debt, though the process doesn’t get nearly as much internet play. So instead, aim to get enough money in the bank to make you feel comfortable for now, but not so much that it kicks your other goals down the road for years. If all you can afford to put aside right now is $500, that is enough to get you out of many common jams; you can go back and add more once you’re in a better financial position to do so.

Investing for retirement comes next

The people who triumph over their student loans and live to write about it frequently do so at the expense of investing for the future. In the scientific research I did for this post, reading 20 or so accounts of student loan debt wiped clean, only two or three even mentioned saving or investing.

This is a mistake for a few reasons. The first: If you’re knee-deep in student loans, you’re likely also knee-deep in the middle of the most important time to invest for retirement. When you’re young, your money might have 40 years to grow. You can save less and rely more on investment returns thanks to compound interest, which means that over time, those returns start earning a return of their own.

The second reason is math: Undergraduate federal student loan interest rates have ranged from 3.4% to 6.8% over the last decade, plus you may be able to take a tax deduction on up to $2,500 of the interest you pay each year. When you pay off your student loans faster than you have to, you’re essentially earning a return on that “investment” that is roughly equal to the interest you don’t pay. If your interest rate is, say, 4.5%, you earned a 4.5% return — a little less, due to that tax deduction — by skipping out on that interest.

That sounds … not bad, until you compare it with the average annual return of a long-term investment portfolio, the kind you might build in a retirement plan. History says 6% to 7% is a fair expectation, which means there’s a good chance that over the long term, you’ll probably come out on top by investing.

This is true if you’re investing in an IRA, and it’s especially true if you have a 401(k) with matching dollars, which amount to a guaranteed return on your own contributions. Even if your loans are at the top of the above interest rate range, or you have private loans that are even higher, you should get that match before you pay more than the minimum toward those loans (you should also look into refinancing to see whether you can bring that rate down).

Once you’re on track for retirement — you can check your progress with a retirement calculator — you’re free to whale on those student loans all you want.

Arielle O’Shea is a staff writer at NerdWallet, a personal finance website. Email: Twitter: @arioshea.