In my first post, I addressed some good reasons to prefer liquidity over aggressive student loan debt repayment. But, you might be wondering, how much should I allocate towards student loans versus investment accounts. Well, here’s a nifty calculator to give you a general idea of how your net worth grows under 100% allocation towards student loans and 100% allocation towards investment after making the minimum loan payment.
While this is a nice way to visualize the difference, I don’t think it’s helpful in figuring out how to allocate your savings. It doesn’t take into account your savings rate – the percentage of your takehome pay after taxes that you don’t spend – nor does it break out tax-advantaged savings (401(k), HSA, Traditional and Roth IRAs). The Mad Fientist gives a great overview – The Triple Value of Income – on how to supercharge your early retirement/financial independence using these accounts. It’s amazing how much of a difference this makes, particularly if you have a high income or live in a state with income tax.
As a rule: always max out your tax-advantaged savings accounts. This should be a major priority. Unless you have credit card debt (WHYYYYYYY??!!!) or other high-interest debt, throw everything you’ve got into your 401(k) up to the $18,000 annual limit. This is $1500 a month, but I suggest front loading if you can. As 2017 has begun, I’m diverting 50% of my $7500 biweekly pay before tax to my 401(k). At a rate of $3750 every two weeks, I’ll max out my account for the year in just under ten weeks! If I had taken this money after tax, I’d have $7200 less, or a mere $10,800, eeeeesh. You’re a fish in a barrel if you’re not juicing your savings with all that free money.
You should max out your HSA (if you’re in a high-deductible health plan – and you probably should be), and your Roth/Traditional IRAs if available. I’ll cover more on that strategy in a later post. Now that you’ve done that, you need to consider the trade-off between the guaranteed return of paying off your student loan debt (the interest rate) and the highly volatile but ever-increasing equity index fund possibly rounded out with a bond index.
I use Vanguard’s Total Stock Market Index Fund Admiral Shares. You basically get to own a little slice of every single company that’s traded on U.S. exchanges. It’s a super low annual expense of 0.05% for administration and tracks basically all equities en masse. They report a 7.23% return over the last 10 years. But, you would’ve had to ride some horrifying giant losses in the interim, and if you sold at the bottom, you would’ve been sunk. Don’t try to time the market…it’s for CNBC-watching losers.
In general, you’re going to be better off diverting your savings to your equity/bond portfolio, as long as you’re willing to hang on tight – and keep buying – during down markets. However, if you can’t get your student loan interest rate low enough, you may want to consider splitting your savings between loan repayment and investments.
Student loan balance: $200k
Interest rate: 4.75% (consolidated with Earnest – disclosure: I’ll get compensated if you use this link, but you’ll also get $200)
Payoff timeline: $1725/month for 13 years (oooooooooooooooof damned loans)
After making this payment, I’m diverting 90-100% of my monthly take-home pay into my 80/20 equity/bond investments with Vanguard. However, I allow myself to build up temporary large cash reserves ( currently sitting on $40k in cash) when needed. Right now I’m holding cash for two reasons, which I will detail in later posts: 1) super secret awesome business plan that will require about $15k in upfront investment and 2) paying down my mortgage balance from $640k to $625k to score a sweet deal on a refinance and lock in about $950/month in savings(!!). I used Better.com to reduce my interest rate by about 2%. I’ll write an in-depth review of my experience with Better when my refinance closes.
Happy New Year’s!