Invest or pay off student loans?

[Cubswin]

Heres the deal... i recently got a nice raise. I know myself so i immediately set it up so that the percentage increase of the raise would be deducted from my paycheck and sent to my savings account. I know people adjust their spending when their income rises and i was already living quite comfortably and did not want to fall into this trap. So my paycheck is the same and i now have some money building in my savings account. Additionally, i put my excess poker money into my savings account.

I have a decent 401k... 100% match on the first 3% and 50% match on 3-5%. I take advantage of this nice deposit bonus and put 5% of my paycheck toward it. I laugh at the people who i work with that dont take full advantage of this.

Now, I have about 14k in student loans remaining and about 7 years left of payments. I guess i was sleeping for the last 3 months because i didnt realize that student loan rates were set to increse...FUG. So instead of the 3% APR im now paying 5ish. Lesson learned. Beside my student laons, i am 100% debt free.

I am 27 and would like to buy a house by the time i am 30. Should i be paying down my student loan now that my rate increased? Is it reasonable to get a 5+% return without too much risk? I dont have the boku bucks to invest in bonds and get those nice 6%+ returns so i am left to ponder whether to pay down my laons or attempt to find a return of greater then 5% to outpace them. Also, as a 27 y/o who is looking to buy a house within the next few years, should i even bother to put anything more then 5% of my income into some sort of retirement account?

I know I have lots of questions but i really need to plan for the future... i just dont know what to do and dont feel like contacting suze the money nazi.

thanks in advance,
cubs

[Sniper]

At 27, why is your free cash sitting around in a savings account?

Open up an online brokerage account and put your $$$ to work for you.

Assuming you are actually investing the $$$ you are putting into your 401K, you should have at least a bit of experience with investments.

Don't be in any rush to pay off your student loans, you should be able to easily outperform the low interest rate you have on there.

Congrats on the nice raise... may there be many more of those in your future!

[TStoneMBD]

im going to do my best to answer these questions as i have some understanding of finance but am not sure what the current market rates are.

if you can find an investment with over 5% returns and no risk, or returns greater than 5% worth the risk, then certainly use your loan money to invest.

an important thing to consider however is whether or not you will qualify for a mortgage on a home. i recommend that you look into your price range and find out whether the banks will want collateral, what LTV ratio they will offer you along with interest rate and points.

if you cant get a mortgage for 5% interest then clearly its a good idea to simply put cash down on your place to save on the interest rates.

when buying your home, you are essentially either going to have alot of equity in your home, or you are going to have little equity but alot of investments. if you apply ev principles, either way you are going to be investing money with 5% interest rates. if you cannot find an investment worth paying 5% interest on, then it all comes down to mortgage rates/loan rates.

i recommend that you reconsider purchasing a home for the time being. the real estate bubble is a serious concern and many people fear that homeowners are going to go into considerable debt when the rupture occurs. even real estate book-writers like robert kiyosaki admit to the real concerns of the bubble and has said that the profitability of the real estate market is currently over.

before purchasing your home, you should strongly consider reading some books on the real estate bubble. when and if it happens, real estate prices will decline significantly and you can jump on your own home with very little interest rates. the real estate bubble will be a period in which rich people profit off the losses of the poor. you want to make sure that you are in prime situation to take advantage of epidemic.

[Cubswin]

Thanks for the input. I have cash sitting in my savings account because i dont know where to put it /images/graemlins/smile.gif Actually, its earning 3.0% and i have been happy with that up to this point... but now i want to earn more than this. Yes, my 401k investments are mutual funds... so i am not totally green when it comes to investing.

My bigger concern was whether to pay off the student loan early or use that money to invest. Since i have my 3-year plan to get into a house, i guess i was worried about the variance of some forms of short term investments. I guess earning a 5%+ is fairly realistic long-term .... i just dont want to be caught on a downswing in the market when i go to buy. I was leaning toward not paying down my loans and i think this is the way i should go...

thanks,
cubs

[Cubswin]

i recommend that you reconsider purchasing a home for the time being. the real estate bubble is a serious concern and many people fear that homeowners are going to go into considerable debt when the rupture occurs.

I have no plans to purchase where im current living or within the next couple of years. I think northern virginia is the biggest housing bubble in the country right now. Our 2br, 2ba 1100 sq ft apartment went condo and we had first right to buy at the bargin price of $460k... with a $500 a month association fee to boot. I will not buy a condo here for that insane price... i making my money here and moving back to sweet home chicago /images/graemlins/smile.gif Hence... im not really even considering buying until I leave this area or the housing market does a belly flop.

cubs

[DrewOnTilt]

Get a consolidation loan from Fannie Mae or another loan provider to lock in the student loan interest rates while they are still relatively low.

[Sniper]

[ QUOTE ]
I guess earning a 5%+ is fairly realistic long-term .... i just dont want to be caught on a downswing in the market when i go to buy.

[/ QUOTE ]

If you do your homework, you should be able to realistically easily beat 5% long term.

At 27, you also shouldn't be so worried about inevitable downswings in the market.

If you really want to turn investing into another stream of income, you could also do some reading on how to profit from those market downswings.

[alekhine8]

I wouldn't bother paying off the student loans. I am in almost exactly the same boat (wife has the student loans) - same balance and term left, more or less. Unless you absolutely hate being in debt and can't sleep at night, just keep paying the $180-$200 a month or whatever for seven more years and be done with it. Your interest rate is 5% and its most likely tax-deductible.

Given you would like to get into a house in about three years, I wouldn't go completely bonkers in the market. If you would like to get into picking stocks, do your homework and give it a shot, but it sounds as if you want to earn a decent return without incurring a ton of risk. If that is you, a nice 50/50 mix of a stock fund and bond fund would probably work. You'd shoot for earning 5%+ in interest on the bonds and have some upside potential with a diversifised stock fund.

If losing 10%+ of your money is unacceptable, lower your allocation of stocks or just go all bonds. If losing 5% or any of your money is unacceptable, stick with the 3% savings account or invest in government bonds.

Good luck - you are doing great with the 401(k) and overall mindset.

[lu_hawk]

You can't get better than 5% risk free, so if that is your criteria then pay off the student loans. risk-free is money markets or CD's. Best you can do with those right now is somewhere in the 3-4% range.

You don't need boku bucks to invest in bonds. You can invest in a bond mutual fund. Mutual funds do have minimum investments but most funds have minimums around $1000-$2500.

If you are saving towards a downpayment for a house in a few years then you would want to keep everything in something risk free or very low risk.

And finally, you will probably get a lot of advice to put your money in the stock market. For someone that really knows what they are doing then this is a good option. But you really need to educate yourself over a period of time. There are lots of people on this board who agonize over whether the optimum play on a certain 3/6 hand is to bet-fold or check-call, but then they go and put thousands of dollars into the stock market without really haveing a clue other than 'it's supposed to go up over time'.

[Sniper]

For anyone willing to invest the time to do their homework (and people reading these boards have certainly shown an inclination toward doing their homework with regard to poker), investing in the stock market is +EV.

[TN_POKER_MAN]

I would not "invest" the cash that i was planning on using for a down payment on a home inside of 3 years.

Sure, go ahead and invest for growth inside your 401(k)and other long-term accounts. However, money that you plan to use inside of 3 years does not need to be invested.

One other thing to consider: I don't ever recall a person saying that paying off their debt was a dumb move. I've met plenty of folks that have invested money instead of paying off debt and felt it was quite dumb. I think it has something to do with the psychology of risk-aversion.

[Sniper]

3 years is a long time and there's no reason why he should forgo 3 yrs of market returns just because he's going to buy a house.

I dont recall saying paying off debt was dumb, though paying down debt and investing at the same time is better, especially when the debt is only low rate student loans.

I'll refer you to Automatic Millionaire by David Bach as an example of one of many authors suggesting that.

[Maulik]

[ QUOTE ]
3 years is a long time and there's no reason why he should forgo 3 yrs of market returns just because he's going to buy a house.

I dont recall saying paying off debt was dumb, though paying down debt and investing at the same time is better, especially when the debt is only low rate student loans.

I'll refer you to Automatic Millionaire by David Bach as an example of one of many authors suggesting that.

[/ QUOTE ]

while doing both is good advice, reading David Bach isn't good advice.

[wildwood]

[ QUOTE ]
3 years is a long time and there's no reason why he should forgo 3 yrs of market returns just because he's going to buy a house.

[/ QUOTE ]
With all due respect, I have to disagree with this for several reasons (based on where we are in the current intermediate and long term cycles):
1. OP doesn't have alot of market experience.
2. Current market upcycle began approx mar03. I'm not so sure the next 3 yrs are looking up, but of course anything can happen. (buffett has said that the kind of mega bull we had in the 90's only happens about every 50 yrs or so) That means bull market time frames will tend to revert back to the mean which is about 3 to 4 years in length and the gains will be smaller.
3. I believe we are in a commodity bull that began in 99, and historically they last an average of 18 years. Based on history, stocks don't tend to do all that well during these time periods although they will have periods of outperformance. Of course there will be exceptions such as energy, natural resources etc. Buffett is investing heavily in energy and non-dollar investments. He is bearish on the dollar, and it's always dangerous to bet against this guy.
4. House prices are high. Of course they can go higher, but I expect they will be lower in 3 yrs so OP's money will buy more house.
5. On a historical basis, the market is overvalued. Of course that dosn't mean it couldn't go up and become more overvalued, but at least some caution is warranted.

A few more comments. I generally like to stay away from giving financial advice specific to any individual because I don't know their experience, total financial situation, risk tolerance, etc. and I certainly have no financial advisor qualifications. I also don't want to get into a food fight like I see so often on these forums. Just wanted to give everybody some fat to chew on. fwiw

[Sniper]

What didn't you like about David Bach's books?

[Jim Kuhn]

I would strongly suggest a Roth IRA if you have the cash. You can place up to $4000 this year in a Roth. You pay taxes on the money up front but withdraw all without paying taxes (earnings are tax free). The principal can be withdrawn at any time but the earnings must be kept for retirement or a penalty is assessed.

The Roth is also a good place for an emergency fund. Experts suggest you keep 3-6 months expenses in case something comes up. This is also a good place to start saving for a down payment on a house.

IRA's and 401k's are non-liquid in that you must keep all money in until you reach retirement age (I think 59 1/2) or pay penalties and taxes. Those accounts you fund tax free but pay taxes on principal and earning upon withdrawal. A Roth you pay taxes up front but withdraw principal and earnings tax free. Thus, the earnings are never taxed and principal can be withdrawn at any time.

Thank you,

Jim Kuhn
Catfish4u
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