Should You Pay Off Student Loans or Invest for Retirement?

Ben Luthi Published on October 9, 2019

pay off student loans or invest for retirement

Student loan debt can be an incredible burden for recent graduates and young professionals. You may feel like you’re often giving up certain things to make sure you can still keep up with your student loan payments.

However, when it comes to deciding whether to pay off debt or invest in your retirement, it’s important to avoid deciding until you’ve thought it through completely. If you’re wondering, “Should I pay off student loans or invest?” here are some things to consider.

How to decide whether to pay off student loans or invest

For many young professionals, taking on student loans was their first major financial decision, but it’s far from the last. Buying a car or home, applying for a credit card, saving for vacations and investing for retirement are all milestones you’ve either already experienced or will shortly.

In the long run, the most important consideration is deciding when and how much to save for retirement. And the decision to invest or pay off debt can be a tricky one. Here are some things to think about as you determine the best path for you.

Always take the 401(k) match

If you have a job with a 401(k) or similar retirement plan, your employer may offer to make matching contributions based on how much you save in the account. For example, if you save 3% of your gross salary, it may match your contributions dollar for dollar.

If your employer offers this arrangement as an employee benefit, it’s virtually always a good idea to take them up on the offer. This is because it’s essentially an immediate 100% return on your investment. For instance, if you’re saving $100 per month of your own money you’re actually saving double that without needing to save the full $200 yourself.

Run the numbers

Mathematically, it’s best to make the decision that’s going to net you the most money, in terms of either interest savings or investment gains.

According to YCharts, the long-term average investment return of the S&P 500 — a stock index that’s often used as a representation of the U.S. stock market as a whole — is 8.18%.

Of course, the stock market’s past performance doesn’t guarantee the same results in the future. But if your weighted average interest rate on your student loans is below that mark, there’s enough of a history with the market that it might make sense to focus on investing rather than paying down your student loans more quickly.

For example, let’s say you have $20,000 in student loan debt with 10 years left on your repayment and a weighted-average interest rate of 5%. In this scenario, your monthly payment would be $212.

Now, if you add an extra $200 to your monthly payment, you’ll pay off the debt in just over four-and-a-half years and save $3,070 in interest. In contrast, if you invest the $200 per month and earn 8.18% annually, you’ll have $9,600 after four years, plus about $1,243 in investment earnings.

While that’s not as much as the amount of interest you’ve saved, that $10,843 will continue to work for you and earn interest over your lifetime. If you keep saving $200 per month, for example, you’ll have $395,720 after 30 years. In contrast, if you wait until after your student loans are paid off to save $200 per month, your balance after 30 years would be roughly $281,021 — that’s a whopping $114,699 in lost gains.

Think about your peace of mind

Depending on your situation, having the math working in your favor may not be as important as gaining peace of mind by knowing that you’re debt-free. This is especially the case if you have other financial goals you want to work toward but can’t because your student loan balance is so high.

Investing for the future can bring some peace of mind, but it may not be enough to eliminate the anxiety over your current situation.

The best solution is likely a balance

As you try to decide whether to pay off debt or save for retirement, you may have already realized that focusing wholly on one or the other may cause undue stress. You may feel like you’re ignoring either the burden that’s weighing you down or the bright future that awaits.

The correct path may be to find something in the middle. Experts at Fidelity Investments recommend saving at least 15% of your gross income toward retirement. But if you don’t think you can achieve that while also paying down student loans, 8% is better than 0%.

On the flip side, putting as much money toward your student loans as possible will pay them down the fastest. But as long as you continue making at least the set monthly payment, you won’t run into issues with late payments and it won’t damage your credit history.

If you’re in a situation where you’re struggling to get by and aren’t sure whether you can achieve one of these goals, let alone both, consider relief options that are available to you. If you have federal student loans, for instance, consider applying for an income-driven repayment plan to reduce your payment to a certain percentage of your income.

And if you have high-interest federal or private student loans, refinancing your debt with another private lender may help you get a lower interest rate, monthly payment or both.

Whatever you do, take some time to think about your situation, research your options and find the right balance for you.

Find a Lower Student Loan Rate

The bottom line

Choosing whether to pay off debt or invest isn’t a decision to be taken lightly, and there’s no one-size-fits-all solution for everyone. As such, it’s essential that you take the time to find the best path for you, balancing the desire to eliminate your debt with the need to start saving for retirement as early as possible.

Whatever you decide, find the balance that’s best suited for your current situation and your financial goals.