“After today, the fortune fan will find you… look out, after today.“- David Bowie
Last week I wrote about confronting your net worth, which hopefully wasn’t too disheartening an experience. If you’re a negative or low net worth person, I’m in the same boat. At this moment, my net worth hovers around $2,000- the positive value attributed to my young, but growing 401(K), and my shrinking credit card debt. My $9,800 student loan is mostly what is dragging me down.
I can either choose to feel crappy about my low net worth and do nothing about it, or I can take action to further reduce debt and build wealth. Here’s what I decided. I thought about what my finances were like one year ago, and I compare them to now. In only 8 short months, I’ve turned my negative ($10,000) net worth into a positive value. There was no secret, magic or easy-fix: just hard work, a plan and a budget. In the near future, I’m going to use this same tactic in my wealth-building plan. But first, I need to sort out how I want to make my net worth grow.
Now I find myself grappling the age-old debate of what’s the better option: paying down the student loan or investing and saving. There’s so much back and forth on this issue, I’ll repeat the wise words of Dr. Don at Bankrate.com who says, “Personal finance is called that because it’s making financial decisions that are right for you.” Here’s my approach to handling the student loan after all the credit card debt is gone. We may disagree, but I’m open to hearing your approach.
Joshua Kennon at About.com laid out a rule of thumb for debt vs. investing that chimed best with me: “If you can earn a higher after-tax return on your investments than the after-tax interest rate expense on your debt, you should invest. Otherwise, you should pay off your balance.”
The rate of return of my 401(K) consistently beats out the 6.8% interest rate on my student loan. I don’t plan on touching the money in my 401(K) until retirement, so the after-tax rate of return will only get better as the interest compounds. I feel good about my progress towards retirement savings, so I won’t make changes to my 401(K) once all the credit card debt is gone.
At some point I’ll want to consider other retirement plans to boost my net worth, with a Roth IRA for instance, but I’m not quite there yet. I’m anxious to have a house and business, which means I need to start saving money soon. The simple math solution works for the retirement aspect of my wealth-building plan, but what about accomplishing other financial goals when I have a student loan to pay down?
Cost of Priorities
The best high yield savings account I can find is 5.05%, which is less than what I’m paying in student loan interest. While I could probably get a better return on various other investments, I’m not ready to handle greater risk with my money since I don’t have much to start with at the moment. By going the conservative route in sticking to a savings account initially, it seems that it would cost more for me to save money for a house and a business instead of paying back my student loan faster; especially considering that the benefit of deducting interest paid on my student loan is phased out for my income bracket.
However, it’s my goal to own a house by the time I’m 35- a milestone that is only five and half years away. And since I want to live in an urban area, I’ll have to be prepared to put up a large down payment for a house.
A balanced approach is what works for me, even though it is costlier in the short term. I decided that once the credit card debt is gone, I should evenly redistribute money in my debt reduction budget to savings and student loan payments. So the $1,000/month that was going to credit card payments will go one half towards a high interest yield savings account and the other half towards my student loan.
That’s just how I anticipate starting my savings for now, and I may change how I distribute discretionary income later as my income increases, or as my student loan decreases. There are plenty of great strategies, but the best one is to make a plan that works best for you. For example, I read about one strategy that involves consolidating student loans and using the money saved in reduced interest expense and putting it towards investments. If that were an option for my student loan, that would have been one strategy I may have considered.
The best I tip I picked in my research came from Ray Martin of The Early Show. He suggests that you learn how your student loan is structured, and choose a payment plan that works best for you. That’s exactly what I did. I studied my student loan, compared payment schedules to my financial goals, and came up with a way to direct money to both.
Martin also points out that in a recent study of college graduates up to age 35, “44 percent said they delayed buying a house, 28 percent postponed having children, 27 percent skipped medical or dental procedures, and 32 percent said their loans forced them to move back into their parents’ home or live there longer then they expected,” as they try to pay back their student loan.
Math can’t solve all problems, but it can help you figure which problems to tackle first, or simultaneously. In some cases, it may be better to make sacrifices and pay back a student loan before investing or saving, and other cases not. It all depends on what’s best for your available funds and how you want to live. For me, I’ve been kept in holding pattern for too long because of credit card debt. I’m not going to let that happen with my student loan.