Read any personal finance site and you’re going to find the same piece of advice over and over again: Start saving and investing as early and often as possible.
But it’s not always easy advice to follow, especially if you’re a recent college grad with student loans and an entry-level income.
I’ve talked to a lot of people in that exact situation who are understandably stressed out. They want to be saving and investing, but that student loan obligation stands in the way and they feel like they’re falling behind.
So, what do you do? How do you balance the need to invest with the need to pay down your student loans? How should you prioritize these two big goals?
Let’s walk through it step-by-step together.
Step 1: Know Your Investment Options
Before you can make any kind of decision, you have to know what your options are. Let’s start on the investment side of things.
The first place to look is your employer. Does your company offer a retirement plan? Is there an employer match on your contributions? Are there good, low-cost investment options? You can ask your HR rep for answers to these questions, and you can also request a summary plan description to dig into the details.
No matter what your employer offers, you likely have access to some other tax-advantaged investment accounts as well:
- IRAs and Roth IRAs: Individual retirement accounts are like a 401(k), except that you open them yourself.
- Health Savings Account: Possibly the best retirement account available, if you qualify for one.
- Self-Employed Accounts: If you earn any money on the side, you may be able to open your own retirement account for extra contributions.
Step 2: Organize Your Student Loans
There are three critical pieces of information you should know about each of your student loans:
- Your outstanding balance (how much you owe)
- Your minimum monthly payment
- Your interest rate
For federal student loans, you can get all of this information through the National Student Loan Data System. This will also give you information about the type of student loans you have, which will be important later as you look into repayment and consolidation options.
For private student loans, you can get this information by pulling a free copy of your credit report at annualcreditreport.com.
Step 3: Pay the Minimum on All Student Loans
No matter what, pay at least the minimum on all your student loans. This keeps your credit history in good shape, keeps you out of default, and maintains your eligibility for potential loan forgiveness.
Automate your minimum payments so that it happens every month without you even thinking about it.
Quick note: This would be a good time to look into your eligibility for income-driven repayment. Even if you can afford to pay more each month, enrolling in one of these repayment plans can give you added flexibility that may be valuable down the road.
Step 4: Maximize Your Employer Match
If your employer offers a match for contributions to your company retirement plan, you’ll want to contribute enough to get that full match.
Let’s say your employer matches 50% of your contribution up to 6% of your salary (pretty typical). That means that if you contribute 6% of each paycheck to your 401(k), your employer will contribute another 3%.
That’s a 50% immediate and guaranteed return on your investment every time you make a contribution. You won’t find that kind of return anywhere else, so it’s something you should take advantage of while you can.
Quick note: Your employer match may be subject to something called vesting, in which case that return wouldn’t be 100% guaranteed unless you meet certain requirements — for example, working at the company for at least five years. You can find out whether your company does this by asking your HR rep or reading the plan’s summary plan description.
Step 5: Prioritize High-Interest Debt
The first four steps here are pretty cut-and-dry. But this is where it starts to get a little less certain.
There isn’t a clear cut right path from this point forward, so the best you can do is understand the trade-offs between your various options and make the best decision for your specific goals and needs.
A good place to start is by targeting any high-interest student loans first. There’s no definitive cut-off point that defines “high interest,” but 7% is a good benchmark.
Here’s the reasoning:
- Over the long term, the stock market has produced an average return of about 9.5%. It’s been slightly lower recently though, and many experts expect long-term returns to be in the 7%-8% range going forward.
- Though the stock market has always gone up over the long term, it’s still not guaranteed and there will be many bumps along the way.
- Any extra payment toward debt with a 7% interest rate represents a guaranteed 7% return on investment.
- That guarantee, and the fact that it’s comparable to what you might expect from the stock market anyway, makes it hard to pass up.
One other option you have for dealing with high-interest loans is refinancing, but you need to be careful. Refinancing a private loan for a lower interest rate can make a lot of sense, but refinancing a federal loan means giving up a number of valuable protections. Just make sure you understand all the trade-offs before signing on the dotted line.
- Related: Student Loan Consolidation Guide
Step 6: Mix and Match
From this point on, instead of thinking about this decision as either/or, why not try both/and?
Take any extra money you have and put 50% toward your investments and 50% towards your student loans. That way you’re making steady progress toward being debt free AND taking advantage of the stock market.
Of course, it doesn’t have to be 50/50. It can be any proportion you want, and I would encourage you to think about the emotional impact of your decision in addition to the math. If one route would lead to more happiness or less stress in your life, don’t be afraid to tilt things in that direction.
Any Progress Is Good Progress
It’s stressful to have to pay down your student loans when you feel like you should be saving and investing. I know a lot of people who feel like their debt is making them fall further and further behind.
The key thing to remember is that investing and paying down debt are two sides of the same coin. Both efforts get you closer to financial independence, so any progress you’re making on either front is good progress.
Matt Becker is a fee-only financial planner and the founder of Mom and Dad Money, where he helps new parents take control of their money so they can take care of their families. His free book, The New Family Financial Road Map, guides parents through the all most important financial decisions that come with starting a family.