Ramit Sethi: Should You Save for Retirement or Pay Off Student Loans?
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Cindy Lamothe
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Amber Barkley
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When you have student loans, saving for retirement can feel like some far off dream you only aspire to. Having debt can make it seem like these goals are impossible to reach, but according to money expert Ramit Sethi, it is possible to create a plan for investing even while you have debt.
In a recent newsletter, he hashed out exactly how to achieve this. Read below for his advice.
3 Strategies for Paying Down Your Loans
Sethi offered three strategies to choose from to balance your student loan payments and your retirement savings.
First Option
This is the aggressive retirement planning approach. Here, Sethi explained how you can make the minimum monthly payment on your student loans and then channel any additional funds towards investment opportunities.
Second Option
Prioritize paying everything off before investing anything. After aggressively paying your loans, Sethi suggested taking that money you would have used to pay them each month and use it to start investing.
Third Option
“Do a hybrid 50/50 approach.” Here, he suggested allocating half of your designated funds to consistently meet the minimum payment — or more — for your student loans while directing the remaining half into your investment accounts.
Deciding Which Option Works Best for You
Sethi outlined different things to factor into your decision for which strategy to employ.
The Case for Option 1
“If your student loan has a super-low interest rate (like 2%), you’d want to pursue Option 1.” He said even if you opt for paying your student loans off as slowly as possible, you can still make an average of 8% by investing in low-cost funds.
That said, the finance expert noted that money management isn’t always rational and a lot will come down to how comfortable you are with maintaining a high level of debt.
The Case for Option 2
If you can’t stomach those numbers, your best bet is to go for option two — where you pay off your loans as soon as possible.
That said, he said to keep in mind that you could be “losing lots of growth potential just so you can be more comfortable.”
Sethi said to also consider student loan forgiveness. “Especially if you work for a non-profit or government organization, you may be able to get your student loans forgiven.”
The Case for Option 3
Mostly, the money guru recommends the third route — paying off your loans while simultaneously investing.
“Here’s why: First, I want you to build the habit of investing, even if you have debt,” he explained. “Investing is very hard to start doing later in life, but if you’ve been investing even $50/month, you can simply ‘turn the dial up’ once you have more money available.”
Second, Sethi said that if your loan interest rate is close to the appreciation you’d see in your investments — 7%-8% — “it’s a mathematical tossup.”
“Technically, if your loan is 7% and you can get 7% in the market, you could choose one or the other. Of course, research shows that most individual investors get less than 7%, because they time the market, withdraw their money randomly and make all kinds of behaviorally boneheaded moves.”
If you’re struggling to choose which option to go with, Sethi emphasized that being proactive is what matters most. “The key is to avoid putting your head in the sand. Go on offense.”
Things To Remember After Choosing
One of the biggest things Sethi pointed out in his newsletter is to always make at least the minimum payment every month.
If you’re having trouble paying the minimum, he said to look for areas where you can cut back or ways you can earn more. And if you still struggle to afford the minimum, check out the Consumer Financial Protection Bureau, which has resources that can help you negotiate with your lenders.
Sethi also emphasized that “making on-time payments is a win-win-win for you.”
“Not only are you getting out of debt, you’re also establishing credit history, and your student loan interest payments may be tax-deductible if your adjusted gross income is less than $85,000 ($175,000 for joint returns).”
Finally, he highlighted that you should start investing as early as you can. “When you invest early in life, you get huge benefits from compound interest. If you wait until you’re older to invest, it’s unlikely you’ll be able to catch up on those earnings.”
Plus, he added that tax-advantaged investment accounts, like 401(k)s and Roth IRAs, offer additional tax benefits.
All in all, instead of worrying about all the different investing options available to you, Sethi noted that choosing a course of action and actively trying to manage your money in a way that works for you is what ultimately makes you successful.
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