| Pay off student loan vs. saving or investing? |
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Buffalogirl
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| Pay off student loan vs. saving or investing? |
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Hello,
Thank you very much in advance for your advice. Here is my situation:
I am 31 years old with a bachelors degree, My NET monthly income is $3,840.00
I live by myself, and am fully responsible for all of my bills, such as rent, utilities etc. I come from a close, lower middle class family, so if I lost my job I wouldn't be homeless, but there is no way I would feel comfortable asking for financial help from my family.
I have a student loan balance of $8,180.00 remaining from that bachelors education. It is at a fixed interest rate of 2.875%. I've been making automatically deducted minimum payments on this loan since 2002 when I graduated. It started at $50.00 a month, and now is at payments of 81.00 a month.
Other than the above student loan, I have no other debt. I have $27,000 in a 401k.
I currently have $5000 in savings, and I figure I could have $8,000 saved by October, and I would love to pay off this student loan, but figured it would be smart to at least explore other options, like continuing to save or investing some of it. But if I paid off this loan I would be completely debt free, which is extremely attractive to me.
One last thing, is that as of this year I started a new job, and in my state my new salary just hit the minimum level at which I can no longer deduct the interest of that student loan from my taxes, which I had been doing since 2002. I know its a low interest rate, but its still money that as of this year will go out the window. Argh, I don't know what to do, lol.
What do you guys think?
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Sat Jul 16, 2011 1:38 pm |
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coaster
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Please clarify for our members: the term "net income" has no meaning unless we know what you're subtracting out of the gross to come up with net.
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Sat Jul 16, 2011 6:00 pm |
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Buffalogirl
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Oops sorry bout that. By net, I was referring to my take-home pay after state and federal taxes are taken out, as well as the other usual suspects such as health insurance, social security, etc. The typical payroll taxes. Or it might be easier to just say I make 75,000 a year, gross. Hehe 
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Sat Jul 16, 2011 6:26 pm |
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coaster
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Even without the offset for tax deduction, it's still extremely cheap money. Keeping that money for yourself and investing it in something that grows 10% average over the long term, you still net 6% or so. The general principal of income vs. debt allocation is to direct your resources toward where the net is positive. If that were credit card debt costing you 12% I wouldn't hesitate paying it off ASAP. But not this. Keep the loan. 
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Mon Jul 18, 2011 6:09 am |
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Buffalogirl
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That does make sense when u put it in terms of that probable 6% positive difference. Hadn't thought of it like that. I've been able to save about a thousand dollars a month since march, by living very frugally (not easy to do in NYC!) I think I'll continue doing that as I originally planned til October when I should have $8000 saved and then maybe go to 500 a month for a few months to give myself a bit of a break, especially over the holidays.
When I get to that 8000 mark, what would u suggest I invest it in? I'm currently keeping the $5000 (soon to be 6000) in a regular savings account that gives me just a few dollars a month in interest. Also if there's anything else about my situation you'd like to advise me on plz feel free. thanks!
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Mon Jul 18, 2011 11:41 am |
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littleroc02us
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Two positive things working for you, you have only 8k in student loans left and you have 5k in the bank. Since your only 31 you have tons of time to invest money and have a good retirement. I would take 4k of your savings and put it towards the student loan leaving 1k for emergencies. Then how long would it take you to pay off the 4k with the nice salary you have? Also, if you start to invest 5k a year maxing out your Roth IRA for 30 years by the time your 62 you could easily have 1.2 million for retirement, plus whatever you have in 401k.
Romans 13:8 “Owe no man any thing, but to love one another: for he that loveth another hath fulfilled the law.”
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Mon Jul 18, 2011 1:20 pm |
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oldguy
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I would never prepay a <3% loan, I would keep it full term, that is very inexpensive capital. (In fact I borrow against our rental houses and invest the equity - I would love 3% loans, I pay over 5%).
Put the $8000 out at 11%/yr in long term products - the $8000 would be $23,000 in 10 yrs, $65,000 in 20 yrs, and so on. And you're only paying $200/yr for the use of that $8000.
More importantly to your future - what is your $27,000 invested in? Hopefully, with your $75k income, you (and your employer match) are adding $10k/yr to the account?. (BTW, a $10k contribution will cut your taxes by about $3000, way more important that getting to deduct that measely $200 - that only cuts your taxes by $60)
1. $27k plus $10k/yr at 3% = $530,000 in 30 yrs.
2. Or, $27k plus $10k/yr at 11%/yr = $2,600,000.
The power of compounding can be pretty surprising - one outcome is a modest savings account at age 61 and the other outcome is a legacy for a family. So for a young person with time on their side, it's an extremely inportant decison. 
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Mon Jul 18, 2011 9:57 pm |
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Buffalogirl
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First of all you guys are awesome. Thank you so much littleroc and oldguy (coaster too!) for writing me back and with such thoughtful answers. I really really appreciate it.
I actually should correct something I said above, the 401k isn't really a 401k, its a 403b with Tiaa-Cref. Not sure if that would change any of your advice or not.
The consensus seems to be to keep the loan for now, which I've decided to do. You all made some really good eye opening points about that.
Oldguy, here is some info about my 403b with Tiaa-Cref. Let me know if you think I should change any of these allocations. Its been set like this for a few years.
Guaranteed 8.62%
Equities 61.24%
Real Estate 7.15%
Fixed Income 14.53%
Money Market 1.42%
Multi-Asset (breakdown) 7.04%
Asset Class Allocation
Total 100.00%
This Tiaa-Cref account is from when I worked from 2006 to 2011 for a college. I was doing an employee match at the time. Since I no longer work for that college, I was told I could no longer make contributions to this account.
I started a new and better job for a more prestigious Uni about 4 months ago. One of the retirement choices they have is also a 403b with Tiaa-Cref. However i'm not allowed to start making contributions to it until i've been employed there six months (which will be sept., so soon). I know this Uni also does an employee match, (but I cant remember right now exactly what percentage they put in.) I'll check when I go to work today.
I think I asked when I started this new job a few months ago, if I went with TIAA-CREF again, if I would be allowed to keep putting money into the account I already have, and I think I was told no, that I would have to start a new (2nd) tiaa account. So unfortunately I wont be able to compound upon that 27,000. I need to check that again, but I believe thats what I was told.
Now a few questions:
For the Roth IRA littleroc mentioned, is $5,000 a year the max you are allowed to put into it?
Oldguy, when you mentioned putting in at least 10k a year, you were speaking of the sum total which would include any employer contribution? Not 10k on my own, plus any money from the employer? I know of course the more I can do the better, but if thats the minimum you were suggesting, (which might end up being 6 or 7 on my part, I know I could do that without feeling too strapped.) Thank you also for the point about the 3,000 tax deduction in your example, I forget sometimes to think about that in my calculations.
Lastly, when you mention investing in long term products, i'm sorry, I don't know what that means. Do you mean like in bonds and cds? Could you give me some specific examples of those kinds of products? I belong to a credit union, and I know they offer some things like that, do you think I would be better off doing that with my credit union, or is there a company you would recommend?
I know I just made you wade through a lot, you have all of my gratitude for your advice with this. Thanks!
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Tue Jul 19, 2011 11:58 am |
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littleroc02us
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Yes $5,000 is the most an individual can put into a Roth IRA a year. My wife and I have been maxing out our Roth's for years and we both will have a combined total of around 2 million by the time I'm 67 and she is 59 all tax free. Plus by that time our 401b and 401k will have grown quit well by then. As for the 403b that is free money from the employee that they are contributing so it is wise to keep that flowing. Good luck!
Romans 13:8 “Owe no man any thing, but to love one another: for he that loveth another hath fulfilled the law.”
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Tue Jul 19, 2011 1:27 pm |
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oldguy
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quote:
So unfortunately I wont be able to compound upon that 27,000. I need to check that again, but I believe thats what I was told.
The $27,000 will still compound wherever you put it, as long as you invest it in 11%/yr products. You can leave it in equities where it is, you can roll it to a IRA Fund at a no-load company such as Banguard, etc - but the common denominator is always what it is invested in. Eg, $27,000 at 11%/yr for 30 yrs is $620,000 (that would be a component of the $2.6M that I mentioned).
Not much difference between a 401 & 403, both can accomplish the same goal.
The two appreciating assets are real estate and equities - those are the wealth-building tools. The wealth-preservation tools are savings accounts, CDs, bonds, money markets, REITs, etc. In your current allocation you have only 61% in equities and 38% in income tools - for you age, I would be alost 100% in equities.
As for the 8.6% 'guauranteed' account - avoid those. Risk and return are directly proportional. A no-risk product is designed for safe storage of money, it tracks inflation, ie, it does not grow in real terms. And high risk products (options, derivcatives, etc) are a gamble, traders often lose their principal and must start over again from scratch. That leaves moderate risk (funny how 'moderation' keeps popping into our lives?). The successes of the last generation invested steadily and incrementally, never sold or traded, just accumulated. And they beat the professional fund managers for 3 decades.
quote:
Lastly, when you mention investing in long term products
I use mostly the SP500 index or the total market index. The no-load companies such as Vanguard or Fidelity have them (as do most other brokers). A more recent product is target funds, eg a Target 2045 for your age. It starts with nearly 100% equities (maybe 80% US, 20% int'l) and slowly re-allocates over the years until it is maybe 2/3 bonds in 2045. That's about what I did myself, before target funds were invented, but that is probably what I would use now.
As for $10k/yr, that's just an example - you can ratio off of it directly - if you want $1.3M, put in $5000/yr, if you want $3.9M put in $15k/yr. The current limit is $16,500/yr plus the company match.
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Tue Jul 19, 2011 3:51 pm |
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littleroc02us
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Just a quick question: If my wife and I are already maxing out our Roth's each year, I put 6% in my 401k and they match 6% and she put's in 9% and her employee matches 4% are you saying we can only invest 16.5k a year plus the employee match or how much more can we invest in long term growth funds?
Romans 13:8 “Owe no man any thing, but to love one another: for he that loveth another hath fulfilled the law.”
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Tue Jul 19, 2011 5:18 pm |
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coaster
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quote:
Originally posted by Buffalogirl
its a 403b with Tiaa-Cref.
Clark Howard has had only good things to say about TIAA-CREF. I don't see any reason why you shouldn't just keep that account where it is. However, as far as the allocation, my opinion is that for your age the fixed-income piece of the pie is too large. 
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Tue Jul 19, 2011 6:54 pm |
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Buffalogirl
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Thank u all again so much for this info. I'm going to bookmark this page for future reference. Also tomorrow I'll call tiaa cref about increasing that equities allocation. I will definitely be taking your advice about the other items as well. Thanks tons!
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Thu Jul 21, 2011 1:06 am |
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coaster
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Thanks for the kind words, and feel free to stick around if you want and put in your two-cents worth on any other topics.
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Thu Jul 21, 2011 1:25 am |
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Buffalogirl
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Thanks coaster, I plan on sticking around. Reading some of these other threads has been very educational as well. I know I'll eventually have more questions too, one of these days I'd like to buy a house but that's a whole other ball of wax I can't think about right now lol.
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Fri Jul 22, 2011 12:27 am |
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