Should I pay off my student loans or invest?
By ATB Financial 27 November 2019 4 min read
Student loan debt is a reality for many. Paying it off should be a priority, but with smart budgeting and financial planning, you can still invest in your future while paying off your debt. Every person’s situation is different, so it is important to do your research and seek help from a financial advisor.
Why is investing early a good idea?
The short answer: compound interest. Most people are in their twenties when they complete their post-secondary education. If that’s you, it means you’ll have decades of investing ahead of you. Investing in your early years will add up to decades of interest compounding, building wealth over 30 or 40 years.
Decades of compound growth, even at the most conservative rate of return, is significant. Plus, that investment can grow tax-sheltered or tax-deferred and have lucrative benefits in a long-term savings plan.
“The years you spend only paying off student loans are years you’ve lost substantially investment opportunities,” said Desmond Chow, Senior Financial Advisor, ATB Securities Inc. “If you’re able to do it, starting to invest while paying off your student debt is the best way to grow your savings for the short and long-term.”
In many cases, the interest on a student loan will be less significant than the rate of return you could earn through investing. Once you can see what those investment contributions can equal in 10, 20 or 30 years, you’ll see that the trade-off for slowing down on debt repayment can greatly benefit your future financial situation.
Read more in Paying Off a Student Loan Early: Pros & Cons.
Invest when student loan interest rates are lower than the rate of return on investment.
In many situations, a federal student loan will have a lower interest rate than the average rate of return over time on a typical investment product, like a mutual fund for example. That means you can take advantage of those early investment years and earn more while still making student loan repayments.
“Most student loans are relatively manageable and will have a lower interest payment over a period of time,” said Chow. “In those cases, taking your time to pay off the average student loan in order to invest will be more financially beneficial.”
For graduates of a doctorate program or long-term post-secondary schooling, you might find yourself in much larger debt than the average student grad. If the debt is considerable, like in the six-figure range, you should concentrate on lowering your debt amount first. This is because the interest on your loan will be a substantial number and could potentially impact your ability to qualify for financing or other priorities, such as buying a home or vehicle.
Creating a budget for sustainable debt repayments that allows for investing.
“Depending on your income, I would generally coach someone to meet their commitments and then ‘pay yourself first’ by contributing extra funds to an investment portfolio,” said Chow.
‘Pay yourself first’, in this instance, means to make your minimum student loan debt repayment and then see what you can set aside for an investment contribution. Make sure that the minimum repayment amount is paying down the principal, or you’ll end up paying more interest in the long run. Even a small amount contributed to an investment, when compounded over several years, can result in considerable returns. Your future self will thank you!
Plus, making a regular loan payment and investment contribution can help beginner investors develop a strong discipline when it comes to managing finances. It might be a debt payment now but knowing how to put money aside each month can help with future expenses like mortgages or a retirement savings plan.
“We live in a society that demands instant gratification, and this can make paying off debt and investing difficult for some. I try to teach my clients that are new to investing that in order to accumulate sizable wealth, you must give money today so you can get it back in 30 or 40 years.”
When your income increases, reap the tax benefits of investing.
As investors advance in their careers, we can assume that their income will increase. That increased income will make contributions to a Registered Retirement Savings Plan more advantageous. This is because you can take advantage of the tax benefits. When you have a lower income, you pay far less in taxes, so the tax benefits of that type of investment isn’t as great. Therefore, it’s a wise idea to put that extra income into your investments as the benefits of the return, combined with tax benefits, will outweigh your lower student loan debt interest.
Depending on your budget, that higher income will allow you to pay off any remaining student debt in larger chunks. You can increase debt repayments and continue to contribute to that investment savings plan, which will have already started to see compounded returns.
ATB Prosper offers a digital investment platform, making investing simple and quick to start. You can consult with an ATB Prosper advisor, and start building a portfolio for your short-term savings and long-term retirement savings plan. You can get started in as little as five minutes’ time, with an investment as low as $100.
If you found this article helpful and are looking to buy a home or currently have a mortgage, check out ‘Should you pay off your mortgage or invest?’ for more investing advice.