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How should I balance investing with paying off student loans, credit card debt and a mortgage, as a 25-year-old?

I am 25 years old and I earn $90,000 per year. I have $30,000 in student loans (12% APR ), $10,000 in credit card loans (19% APR) and about $400,000 in a mortgage (4.75% APR). I also have $50,000 in stocks that are performing very well. I would rather invest my money than pay off my debt, but I know that's not an option. What's the best way to manage my debt? I could make the maximum contributions to my 401(k) early every year, then take out a 401(k) loan and "cycle" it to pay off debt, starting with my credit card, then my student loan. Or I could use post-tax money to pay down my debt. Using a 401(k) loan is more appealing because interest returns are lower than my stocks and post-tax money.

Debt, Investing, 401(k), Stocks, Taxes
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May 2018

This is a great question and one that comes up often.  There is an optimal path here in paying down debt and investing, and you're smart to think you should be doing both because you're right.  Here is the order:

1. Emergency account (3-6 months of living expenses)

2. 401(k) savings to maximise employer match if available

3. Additional payments on higher interest loans (loans above 6% interest).  For you this is your credit card and student loans.  I would follow the Dave Ramsey waterfall plan and focus on your credit card first.  Once you have the credit card paid off take that amount and apply it to your student loan payment plus whatever minimum you were already paying.

4. Additional 401(k) savings up to the maximum contribution

5. Additional payments on lower interest loans.  This typically does not include a mortgage, but you could add extra here to the mortgage if you wanted.

6. IRA contributions

7. Taxable accounts

You mention having $50,000 in stocks.  If that is in a taxable account instead of a Roth or Traditional IRA then I would start using those funds to make your Roth IRA contributions every year.  You still have access to your Roth IRA contributions if you get in a bind, and it's much more tax efficient then leaving it in a taxable account.  

When you're considering taking a loan on your 401(k) I would encourage you to instead pay down your debt with post-tax money from your income.  You are right in that the interest is low on the 401(k), but while it is part of the loan that money is not invested in the market.  In addition, as long as you're working for that company your employer will take part of your paycheck to pay down your loan.  If you leave that company then you typically are only left with the option of paying back the loan in full.  That could limit your flexibility if someone else approached you with a nice job offer.

You may want to consider refinancing your student loans if you think it will take some time to pay them back.  Here is a great resource that we provide to our medical students.

Hope that was helpful.  Feel free to email me if you have follow-up questions.

Good luck!

Matt Ahrens, CIMA®

May 2018
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