Should You Pay Off Student Loans or Save For Retirement?

Should You Pay Off Student Loans or Save For Retirement?

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Congratulations! You’ve just graduated from college, you’ve landed that first big-boy (or girl) job, and now you’re riddled with the question of which one is more financially sound. Reaching the point to where you have enough extra cash flow to even be in this situation is something that should make you want to jump for joy.

But it’s still a tough place to be in for a lot of people.

When you’re dealing with something, such as credit card debt, which rarely has an APR lower than 10% (and often times much higher), the answer is simple: Pay off the credit cards. Chances are you’re not going to be making over 10% in your investments.

On the opposite end of the spectrum, if you’re dealing with debt that has a low APR, such as 2-3% on student loans, the answer too becomes very simple: Invest. It’s very easy to make more than 2-3% in mutual funds, the stock market, or company-supplied 401k’s.

It becomes a little more tricky, however, when things fall right at the 5-7% mark. What to do then?

Let’s take a real-world example from one of our readers, Shane:

“I have a little under $15,000 in student loan debt with an interest rate of 6.5%. I am 28 years old, and will getting married later this year. My fiance is 26 years old. Fortunately for us, we do not have any other debt besides my student loans. At the same time, neither of us have any retirement savings. We will have about $1600 per month in disposable cash starting this Fall. Would it be better for us to place this money towards student loan debt or towards a retirement plan?”

While many do not even begin to think about retirement by your ages, 28 and 26 still seems a little troubling to me to have nothing saved. Sure, Shane and his fiance have plenty of time to catch up, but there’s still something to be said about cultivating that habit of continually saving for the future.

On the other hand, 6.5% is an enticing number in the unsure markets that we have currently.

Neither. Start an Emergency Fund.

While I’m not a complete advocate of Dave Ramsey’s Baby Step program, I almost always agree with him on Baby Step #1. Building an Emergency Fund first and foremost is absolutely essential. Personally, I think $1,000 is a little bit weak. This should be upgraded to $3,000 or $5,000 as a minimum.

Shane mentioned that he will be getting married soon. There’s no worse way to begin a marriage than by being stressed financially. Having a little nest-egg set aside will allow you and your wife to rest easy at night.

Begin contributing to retirement

Next, begin building up the Retirement Fund. If nothing more, contribute just enough to get the required match from your employers. The average savings rate in America is a pitiful 5.7%. By contributing at least the standard (for most employers) 3%, along with their match, you’ll be right at that 6% mark. More never hurts either. 10% would be ideal.

Time is one thing that can never be underestimated. I love compound interest.

If nothing else, as I mentioned earlier, this begins your marriage on the right foot by establishing a pattern of saving for the future. Until you have both your Emergency Fund established, and are actively contributing to your 401k, pay only the minimum payments on your student loans.

Begin paying off the Student Loan

Once a solid Emergency Fund exists, and at least 10% of your salary is headed for retirement, then, and only then, focus on the attacking the student loans. Plus, in the long run, after the tax deduction, the total amount of money made investing vs. paying off debt isn’t going to be significant that significant.

Building good habits, in the long run, pays dividends for a lifetime.

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