Wiser Use of Money: Pay Off Student Loans / Invest

Jurollo · #1 04-13-2007, 02:34 PM

Hello all,
So I have a, possibly interesting question. I would like to preface it first though.

I have about 55k to invest / use. I have 35k in student loans and am 23 yrs of age.

My question is simply this. What is the more prudent investment, paying off student loans or investing in mutual funds or a spider that tracks various indexes. I have begun looking into obtaining some real estate, however, as a recent graduate without a legitimate (in the eyes of the IRS) occupation it has been very tough to obtain a mortgage. So what is the best move here aside from real estate, paying off student loans or investing?
~Justin

disjunction · #2 04-13-2007, 02:38 PM

What's the interest rate on your student loan?

Most likely, the answer is going to wind up being "invest", by far.

jzpiano · #3 04-13-2007, 02:44 PM

I'm in a very similar situation right now, where I have 20k invested but will be picking up my fiance's 14k in student loans that are going to be at 6.8%. Better to pay off or leave it invested

Also, Jurello I think this topic might be better in the finance forum maybe...

disjunction · #4 04-13-2007, 03:08 PM

[ QUOTE ]
I'm in a very similar situation right now, where I have 20k invested but will be picking up my fiance's 14k in student loans that are going to be at 6.8%. Better to pay off or leave it invested

Also, Jurello I think this topic might be better in the finance forum maybe...

[/ QUOTE ]

Whoops I thought it would be a trivial answer because my student loan interest rate was much less, less than the 5% you can get interest on a savings account. Since I am not a financial guy I'll just give an educated guess for now and wait for reinforcements.

I still think it's going to turn out that you should invest, based on the fact that savings account interest rates are a gross underestimate of what you can get from investing, that you can deduct student loan interest from your income tax, and also logic says that if the economy does good your investments will return high %, and if it does bad you will need the money. Also if it's a fixed rate you could always pay it off if it became way favorable to do so. And historic returns of the market.

But I am not a financial guy, so I'll be interested in the answer as well.

dethgrind · #5 04-13-2007, 03:10 PM

Something to keep in mind is that a lot of your investments will be taxed, so you'll need a higher return on an investment than interest rate on your loan to make the investment the correct choice. At 6.8% you should almost certainly pay off the loan before investing.

I have a student loan at 7.2% that I'm aggressively paying down before I start investing. I'm pretty sure I'm making the right choice.

Kneel B4 Zod · #6 04-13-2007, 03:14 PM

[ QUOTE ]
so you'll need a higher return on an investment than interest rate on your loan to make the investment the correct choice.

[/ QUOTE ]

that's the short answer I think. basically if the loan is below 5% I would invest the money. 5 - 6% it's close. 7% pay the loan down.

but those are just offhand guesses

disjunction · #7 04-13-2007, 03:15 PM

[ QUOTE ]
Something to keep in mind is that a lot of your investments will be taxed, so you'll need a higher return on an investment than interest rate on your loan to make the investment the correct choice. At 6.8% you should almost certainly pay off the loan before investing.

I have a student loan at 7.2% that I'm aggressively paying down before I start investing. I'm pretty sure I'm making the right choice.

[/ QUOTE ]

Good point about taxing investments. But dethgrind can't you also deduct student loan interest off of your taxes, to the point where the effective interest rate is much less?

RoundTower · #8 04-13-2007, 03:25 PM

I know that investing in this case often turns out to be the right choice in practice. But I don't understand why this is the case. If there is an investment vehicle that pays better than lending to students at 6.8% (minus some amount for guys that never pay back), why doesn't the bank put its money there instead?

danzasmack · #9 04-13-2007, 03:37 PM

Figure out the rate you can invest at (muni bonds aka tax free $ ftw)

Take the rate on the loan + i dunno but is the interest tax deductable?

Then decide

Arnfinn Madsen · #10 04-13-2007, 03:37 PM

[ QUOTE ]
I know that investing in this case often turns out to be the right choice in practice. But I don't understand why this is the case. If there is an investment vehicle that pays better than lending to students at 6.8% (minus some amount for guys that never pay back), why doesn't the bank put its money there instead?

[/ QUOTE ]

Because they aren't allowed. Banks aren't free to maximize EV, they have very strict anti-risk restrictions. The amount of risk-averse capital in the market is so big that there are a lot of +EV-situations if you are willing to take a risk, the markets do not reach an equilibrium which rules out these opportunities.