As a senior in college, should I focus on investing into my Roth IRA, or save for my student loan debt?
I am only two semesters away from receiving a BBA in Finance. I'm having issues on whether to invest for my retirement, or save for my student loans.
In general, the decision to invest for retirement or pay down student loan debt depends in large part on how your loan terms compare to the returns that you assume the market will provide, based on your risk tolerance. At the very least, most people will want to make the minimum loan payment to avoid additional loan costs. On the investing side, the impact that compounding can have on an account makes any contribution (even, for example, $500) highly valuable. As a result, any additional money that someone can save and divert to any investment account can help to make meaningful progress toward a retirement goal.
Feel free to contact me if you would like to discuss your specific circumstances. Best wishes!
First, before doing either of these, make sure you keep cash reserves (in the bank) of 3 - 6 months’ worth of living expenses (net of taxes and savings). Then, if your student loans are costing you 5% or less, pay them down as slowly as you can and invest your discretionary income towards your long-term goals (5 years or more). If your loans are at 6% or higher, then you might want to pay them-off sooner, as it possible to make 6%+ investing, but only with a significant amount of risk. If your loans are at 8% or more, then absolutely pay them off as fast as you can.
Don't fall for the animosity and hype about how 'horrible' student loans are.
While it's currently trendy for gurus and media pundits to advise people to pay their student loans off immediately, the math doesn't work out in favor o this strategy. This article explains the math of why focusing on rapidly paying off your student loans is a bad idea. Focusing exclusively on paying off your student loan debt will leave you less money in retirement, and place you at greater risk if a job loss or other emergency were to occur.
Assuming you have Stafford loans, your interest rate is likely around 4% - 5% for your student loans. At these rates, there is no financial need to pay them off any faster than required. Make your minimum payment and use the rest of the money to fund your other financial goals. If your loans are PLUS loans or private loans, they may carry significantly higher interest rates and you might want to pay just those loans down quicker.
Making minimum payments on low-APR student loans will free up more money to invest in your Roth IRA, your 401(k) at work, an emergency fund, and for major goals like buying a house. If you have funded most of your goals, then paying back your student loans faster can make sense.
At the same time, if you become stressed or anxious about your student loans, then paying them down faster can provide a significant non-financial benefit.
It's a balancing act. You have to consider the interest rate on your student loans and what you expect to earn over a long investment horizon. Equity markets historically have returned between 8-10% depending on the time periods you look at. So if your student loans are 5-6%, you can see your money would be better off in the retirement account. Of course that's not to say you should do one or the other, you shouldn't ignore the loans simply because you expect to earn more in your Roth. You should make progress towards both goals simultaneously.
Hope that helps.