Pay loans or invest? I’m torn!

[GoldenPA]

I’m buried in loans. $160k to be exact. Ball n chain! If I tack an extra $200/month on my payment, I calculated I would save approx $7,500 in interest over the 10y life of the loan. The alternative is to throw that $200/mo into a good index fund (which over the past 75 years has an average return of 11.9%) yielding approx $82,500 in 10y!! Dang, it seems obvious but what would you do? Am I missing something here?

[Walkoffshot]

What is your current term set at? 10 years? If you continue down your $200/month path then you will have paid that loan off faster than the original term (if set at 10 years). Once finished then you have your regular payment + $200 you can now put towards investment instead of the loan... which you would then have to do the math see how long it would take to get to your projected 82,500 going that route. For example, if you pay your loan off in 7 instead of 10 years, you have 36 months of cash money going to investment. If your monthly loan payment is 1200 + add'l 200 = 1400 x 36 = 54000 (or 16,800 per year).. add on said 11.9% return. With a 11.9% return it would take you more than 3 years to reach 82,500, but I also think 11.9% is kind of a stretch and many factors involved. 

I think it also comes down to what do you want the most... 10 years of payments (plus investment) or financial freedom sooner. Only you can answer that. I just paid off my loans and i'll tell you a little secret... it's freakin glorious. 

[rev ronin]

Loans.  Paying off loans gives you freedom in the here and now. investments? Not so much.

[AbeTheBabe]

What's your interest rate? That's the key question here.

[GoldenPA]

6.4%

[LT_Oneal_PAC]

Pay off loans.

[AbeTheBabe]

3 hours ago, GoldenPA said:

6.4%

Just pay off the loans, at that interest rate is not worth investing. Make sure to get any employer match though.

[beattie228]

11.9% is definitely a stretch in terms of return on investment. Also, there's an age old saying about the stock market: "past performance does not predict future performance". I am a firm believer in investing in low cost ETFs as historically the stock market eventually goes up, but not at the expense of school loans at 6.4% interest. Paying your loans aggressively is a guaranteed 6.4% return on investment. Contribute to your 401k up to the maximum needed for your employer match and hold off on investing until your school loans are done.

 

Different conversation if you refinance to a lower interest rate but even then the freedom of having that loan monkey off of your back often works more to your advantage than investment returns.

[GoldenPA]

Thanks. Those are some great points.  A guaranteed 6.4% return is better than a gambled 11% return.

[mgriffiths]

3 hours ago, GoldenPA said:

Thanks. Those are some great points.  A guaranteed 6.4% return is better than a gambled 11% return.

This!!!  and while mathematically it doesn't make sense, having the stress/aggravation/etc. of student loans gone is massive.  But, I would search high and low for any way to increase the extra monthly payment - cut back on monthly expenses, second job, sell stuff, etc.  Because the longer you stay in debt the longer you pay someone else's income.

[lkth487]

Yeah if you have very low interest student loans (less than 4%), then it makes sense to invest.  But at 6%, pay the loans and be free sooner!

[Guest UVAPAC]

I don't know who threw out the 11% annual return for the stock market, but historically returns are much closer to 7%.  Therefore I think the safest bet is paying off the loans with a 6.4% interest.  

 

HOWEVER, I don't see anything wrong with paying a few hundred extra towards the loans each month, while investing a small portion as well.  Compounding interest plays a HUGE role in net-worth as you get older.  If you start investing in retirement at 21 years of age versus 31 versus 41, the expect payout at 65 is a MASSIVE difference.  

[GetMeOuttaThisMess]

One needs to factor in whether the ROR includes investment fees as well.  If you earn 8% but your management fees are 2% then your net is 6%.  A lower ROR with lower costs may actually pay out better.  Me?  Loans back in the stone age which were paid off in pelts and brontosaurus meat were paid off first.  There is nothing better than not owing anyone, especially while on vacation.  

[mgriffiths]

1 hour ago, UVAPAC said:

I don't know who threw out the 11% annual return for the stock market, but historically returns are much closer to 7%.  Therefore I think the safest bet is paying off the loans with a 6.4% interest.  

 

HOWEVER, I don't see anything wrong with paying a few hundred extra towards the loans each month, while investing a small portion as well.  Compounding interest plays a HUGE role in net-worth as you get older.  If you start investing in retirement at 21 years of age versus 31 versus 41, the expect payout at 65 is a MASSIVE difference.  

The 11% is a commonly quoted number based on averaging the annual return over a period of time, but it doesn't take into account the true market change.  For example, if you make 10% return year 1, and lose 10% year 2 it initially sounds like you broke even over 2 years, but in reality you lost money:

Example: start with $100,000, after year 1 you have $110,000, after year two you only have $99,000.

In other words, just averaging the annual return every year doesn't work, there is correction that must factored in.

[Anachronist]

So it depends. Lots of good info here already but reiterate some and add some, here I go.

As mentioned before, index funds quoting 11% can be misleading, true ROI investing moderately to conservatively is closer to 6-8%. That is kind of the make or break between loans vs investing. If a loan is in the 6+% range, paying it off becomes more beneficial than investing the money. As mentioned before though, you can contribute to a 401k match, get that return instantly, then put the rest toward loans.

Also worth noting, the more you invest, the better services you may be offered. Merrill Lynch Edge for instance I believe requires $200,000. But the benefits of a 1 on 1 with a high quality, seasoned, financial advisor are significant IMHO (timing, taxes, borrowing against investments, etc).

And finally, from both my personal financial advisor and a friend who is an advisor in a different firm (they agree with each other), the market is winding down on an almost decade long bull run. Predictions that 2018 will be another bull market are about 50/50 (as of May), and historically we have a long bear market (or relative flatline) coming. The stock market is more or less fully valued, interest rates are increasing, and though it hasn't happened yet, bonds may start competing with stock dividends. The next 5-10 years likely will not be as advantageous for investors as the previous 10, again reducing your ROI.

At this time, with your loans and interest rates, I would match 401k if it is there, and then put the rest toward loans. If history is a predictor for the future, you'll pay them off just in time to catch the upswing of another bull market in 5-10 years time. And with loans, the faster you can pay them off the better.

Investing for most people in a strategic sense is a very long term game, think in decade increments rather than shorter term gains. Every now and then yes, people catch a big boom, but big falls are often mixed in, 2001 and 2008 ruined a lot of people.