I'm currently 23 and deciding if I should pool my extra income every month towards my retirement or student loans.

My situation:

I believe between saving for retirement and student loan debt I have about ~1,100 I can contribute a month.

Original plan: Contribute ~800/mo for student loans, $300/mo toward Roth IRA. Aside from the ~$1,100, I also currently have about ~5%(with company match - not great) of my income going toward my 401(K) with a employee sponsored Pension Plan(makes up for low 401(k) match) as well.

My student loans are ~$54,000 with a weighted average IR of 5.325%. EDIT: Monthly payment is ~$325. I set my self up with the 25/yr repayment plan SOLELY to be able to pay down extra on principal of my highest loans. I also want the flexibility in case of emergency, so that my payment will not be significant for a month or two (if needed), but do plan to pay as much as I can outside of that. I understand the value of payments on principal well.

Should I be putting my extra income down toward student loans? I have a mix between 6.8% and 3.8% interest student loans. One of my thoughts was to pay the 6.8% off as fast as possible and after that save the max for a Roth IRA.

Thoughts on retirement savings:

  1. Vanguard S&P 500 ETF (VOO)
  2. Vanguard Total Stock Market ETF (VTI)
  3. Vanguard Total International Stock ETF (VXUS) OR Vanguard FTSE All World Ex-US Small-Cap ETF (VSS)

I also have considered doing a Vanguard Target Retirement Fund (2060) and then to keep re-adjusting my "target" into older accounts (2065, 2070..) to keep the highest stock/bond mix until I feel I want to re-adjust, at which time I can sell my shares and buy into different ones. That, or control it myself with Mutual Funds or ETF's at a later date. Also, not sure I want to deal with keeping track of my basis, dividends paid out for tax purposes, etc.... since the DRIP with ETF's wont be enough to directly buy a new share of any of these funds.

In order for this question to be answered we need an assumption: average Rate of Return: 6%. This is lower than the 6.8% that ~half of my loans consist of. Should I be pooling money towards the loans?

It's also important to note that I am paid bi-weekly, meaning I'll have ~$3,000 to contribute to my payments a year, plus my tax-refund, annual pay raise (~2-3%), and bonus (~4-5k before-tax, conservatively). Assuming nothing major comes up I plan on putting all(or most) of this money towards my student loans. This may change some answers considerably since I'll most likely have more than $800/mo going toward it, but it's not guaranteed.

EDIT: My concern is that I will miss out on years of investment interest, etc...

EDIT: Currently in the 25% tax bracket at 58k/yr. 10k off the top + $1,400/year on Health/Dental/Vision will not bring me down to 15%...even with $5,500 contributed to Traditional IRA...

Looking for multiple perspectives on this question..

  • Investment interest == interest paid on loan, so don't worry about that - they're effectively equivalent (as both compound the same way). – Joe Mar 18 '16 at 18:36
up vote 4 down vote accepted

You can play with the numbers all you like (and that's good), however, here is a different way to look at it.

The debt you have is risk. It limits your choices and eats your cash flow. Without the debt, you can invest at a much greater rate. It frees up you cash flow for all the things you might want to do, or decide in the future you might want to do.

Right now is the easiest time for you to focus on debt repayment. It sounds like you are not married and have no children. It is much easier now to cut back your lifestyle and concentrate on paying off this $50k of student debt. This will get harder as your responsibility increases.

Build up a small amount of cash for emergencies and put the rest at the debt. You can keep contributing to your 401k to the match if you want.

This will give you 2 benefits:

  1. Patience. When you actually DO start investing, you will have a new appreciation for the money you are using. If you sacrifice to pay off $50k now, you wont look at money the same for the rest of your life.

  2. Drive. If you see the debt as a barrier to achieving your goals, you will work harder to get out of debt.

These are all things I would tell my 23 year-old self if i could go back in time.

Good luck!

  • I think one advantage I have over people my age is valuing the benefit of early pay-offs..too many of my colleagues who are 50k+ in debt and accounting/finance/economics majors don't even care they are basically paying a mortgage at 25/yr minimum payments.. – DukeLuke Mar 18 '16 at 19:50
  • Exactly. Early payoff is the way to go. I am also a big fan of simplicity. If you can cut back and kill this debt in a few years, do it. You will never have to think about it again. – jkuz Mar 18 '16 at 20:00
  • I think your point of view is a good one - though I would say the 401k match is a must, that's free money. Contributing a bit to retirement though is a good habit-forming process; that's why I like a small amount there. (And he is even at the lower $800 level paying off almost 8k in principal the first year and more beyond - so within 6-7 years paying it all off vs. ~5 years at the $1100 level.) – Joe Mar 18 '16 at 20:08
  • I'm adding another important note in my question that I had just realized. – DukeLuke Mar 18 '16 at 20:15
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    @DukeLuke right on. I made some ball-park assumptions, and $3100 is tighter. Still, imagine being debt free by age 26. I think you can do it. ;) – jkuz Mar 20 '16 at 2:17

Your plan sounds quite sound to me. I think that between the choices of [$800 for Loans, $300 for Retirement] and [$1100 for loans], both are good choices and you aren't going to go wrong either way.

Some of the factors you might want to consider:

  • $800 for loans, what does that mean in terms of extra beyond the minimums? You get better results if you have extra you can contribute to paying down the higher rate loans, as you note. If your minimums are $500, then $300 per month to the higher rate loans is pretty reasonable. If you're putting $700 to minimums, you might want to move more to the loans at first. Since your minimums are only $325, you'll be able to quickly pay down those higher rate loans ($500 extra per month means $6k per year to higher rate loans - should be able to wipe them out within a few years easily).
  • Making a habit of saving a bit for retirement is a good habit to get into. Paying off a 6.8% loan is probably similar to the gain you get from retirement savings; retirement savings is tax-deductible while paying off the loan isn't (your interest is deductible, but that's what your minimums cover), but you're not exactly paying a lot of tax right now.
  • Consider whether to use Roth versus Traditional. If you're at the 15% rate (either now or in the future), that is the perfect time to be using a Roth IRA or 401k; when you're in the 25% bracket, you get significantly lower gains from that. If I'm right and you're in that 15% marginal income bracket (taxable income of $37k or less), do what you can in Roth; if you're above 15% by a little bit, put some into an IRA first to get down to that number. If you're over by enough, consider moving your 401k to a Roth 401k if your employer offers that option. Roth is also good for the income levels between 61k and 116k, as the deduction starts phasing out for a single person at 61k and is totally gone by 71k.

I like your retirement savings choices - I myself use the admiral version of VOO, plus a slightly specialized but still large ETF that allows me to do a bit of shifting. Having something that's at least a bit counter-market can be helpful for balancing (so something that will be going up some when the market overall is down some); I wouldn't necessarily do bonds at your age, but international markets are good for that, or a stock ETF that's more stable than the overall market. If you're using Vanguard, look at the minimums for buying Admiral shares (usually a few grand) and aim to get those if possible, as they have significantly lower fees - though VOO seems to pretty much tie the admiral version (VFIAX) so in that case it may not matter so much.

As far as the target retirement funds, you can certainly do those, but I prefer not to; they have somewhat higher (though for Vanguard not crazy high) expense ratios. Realistically you can do the same yourself quite easily.

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    Edited my question. – DukeLuke Mar 18 '16 at 18:37
  • Isn't the purpose of the Roth IRA and regular 401(k) part of diversifying...not sure if I should do a traditional IRA and Roth 401(k). – DukeLuke Mar 18 '16 at 18:54
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    @DukeLuke The great thing about Roth vs Regular is you can switch at any time (subject to income levels/etc.) By the time you're retired, you'll have contributed a lot to both. But, with Roth what you want to do is contribute while you're at a lower income tax rate - meaning, now. Look at site moderator Joe Taxpayer's article on the matter; it does a good job explaining things. Basically, though, you want to contribute 15% taxed money to Roth, and 25% would-be-taxed money to Deductible IRA. – Joe Mar 18 '16 at 20:11
  • So at 23 you are probably at 15%, contribute 100% to Roth if you can. Then when you start earning more, you'll end up in the 25% bracket, and that money should go to Deductible IRA - and for a period in the middle you'll want some to both (contribute to deductible IRA the amount that would be taxed at 25%, and the rest of your contribution should be Roth.) – Joe Mar 18 '16 at 20:12
  • I'm at 25% now.... hard to tell what bracket I will be in when I retire, but I plan on having a pension (~50k/yr), maybe SS?, 401(k), IRA... please see my question as it is updated now.. – DukeLuke Mar 18 '16 at 20:13

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