My wife and I gave up social media (specifically Facebook, Twitter, and Instagram) for lent. It was difficult at first, but after breaking the habit on constantly checking it I found that I had quite a bit of free time. This means more time to write blog posts and reflect on what I’ve learned. It also means more time to read books. I finally got to reading a short little book called Invest Like a Pro: A 10 Day Investing Course. It is a great short little read and I highly suggest it for the investing beginner like myself.
In short, the author talks a lot about passive investing, which I strongly believe in. Furthermore, there was a short chapter in the book that talked about paying off debt as a way of investing. The book didn’t go into great detail, but from what I read it made me more curious. Was I directing my additional income to the wrong place? The more I thought about it, the more sense it made. The basic principal is this: paying off high interest debt early is like earning money at that interest rate. I never thought of it this way. Essentially the interest you avoid paying can be viewed as “investment income”. I had always figured I’d be better off just making my monthly loan payments and contributing a little bit extra every now and then to my loans with the highest interest rates. This also would allow me to invest my money. Every month I would budget about 48% of my savings goals money in “investments” and 45% in “student loan payments” and about ~7% in “future car replacement”. After thinking about it more, I think I might change my allocation to 75% student loan, 20% investments, and 5% future car replacement.
We already have a healthy emergency fund saved up in a Capital One 360 Savings Account and invested via Betterment. My wife just recently got a job, which now means were earning two incomes now. Initially I had planned on fully setting aside my wife’s paycheck to save for a down payment on a house. However, I think we may start putting 45% of her paycheck towards student loans and 55% towards a house down payment. As we start to eliminate our higher interest rate student loans, we’ll slowly start to decrease this percentage. Hopefully by January 2016, her paycheck allocation will be 5% (Student Loans) and 95% (Future Down Payment).
All this to say, you may be better off paying your student loans early than investing. The average return rate for investments is somewhere around 2-3%. Compare that to my high interest loan rates, which are charging 6.8%. I’m effectively earning ~3.8% more just by paying my student loans off early as opposed to investing. (side note: this is a difficult concept for me since investing still feels like it is “my money” whereas money toward student loans just feels like money out the door). I know there are factors like compounding interest and tax advantages, but from a basic, economic standpoint I think I am going to shift my focus to primarily paying off my student loans then investing the remaining money.