After I finished my 8 years of college, I was very lucky to find a job in my field, making a nice salary ($80,147 plus benefits, $160,000 with my wife’s), and living in a reasonably affordable city (Houston, TX). I had everything I needed in life and almost all of what I wanted, even if it wasn’t necessary at the time. Life was good.
However, it all came crashing down six months after graduation when I got my first student loan statement. I plugged it into my Mint.com account, along with some credit card debt and an auto loan, and the total was shocking. After 8 years of bad financial habits, I had a total debt of nearly $110,000.
Needless to say, I was in complete shock. Every year, I mindlessly signed student loan papers at the beginning of the school year, and voila, money appeared in my account. Never did it occur to me to keep track of the money that I owed, nor consider the return on investment of the education itself. Thankfully, my beautiful wife made it out of college without any debt whatsoever (Aside: Thank you for staying with me, Mrs. MBF).
Starting in January 2016, I found myself at a turning point. The minimum payment on the student loan balance was only (ha) $1,070. At this rate, we were left with ~$2,000 every month if we behaved financially (hint: we didn’t, more on that in later posts).
We were met with a question: Should we pay off student loan debt or invest in the stock market?
I jumped into several financial blogs, read books, listened to podcasts, and watched YouTube videos. I asked friends and family what they would do in the same situation. The answers I received were almost completely split down the middle — half recommended investing, and half recommended paying off the debt. I was thankful for the insight, but I still didn’t have my answer. So, I made a comparison with all the information I was given.
The Case for Investing
Almost every person I spoke to who recommended investing uttered the word “compounding.” For those who are unfamiliar with the term, it essentially means that any reinvested growth, dividends, or interest you make off of your investments will continue to make money as well. Basically, the money you have will grow at an exponential rate rather than a linear one.
Although the debt came with a cost of 6.147% in interest per year, the argument for investing was that if I started early enough, I could benefit from the long-term effects of compounding over the course of my life. There was certainly some risk involved, but as of January 2016, the market had been on an absolute bull run since mid 2009 following the financial crisis. There was no end in sight for this run, so the financial advise seemed solid. Sure, markets have their ups and downs, but I was young, so I could weather the lulls a bit better than someone nearing retirement age. Now, onto the other option — paying off debt.
The Case for Paying off Debt
As I said earlier, the average weighted interest rate for all 19 of my student loans was 6.147% (ranging from as low as 3.4% to as high as 6.8%). This didn’t even account for my credit card debt, which was an interest rate of 18.02% (!!!). Paying off the credit card was a no brainer, so we will focus on the student loan debt for now.
In terms of the risk associated with either investing or paying off debt, the latter is certainly less risky. In fact, I would argue that paying off the loan debt has negative risk, in that it guarantees you from incurring a financial loss. Sure, there are opportunity costs associated with paying off the debt instead of investing, but even those opportunity costs weren’t certain.
When you pay off the debt, you guarantee a reduction in loss. Which doesn’t sound that sexy at first, but then again, no one said it would be sexy.
The Final Verdict
When it came to weighing the advice of others, I had to take into consideration the long-term success of those advisers. Sure, your cousin Cletus may have won big on the stock market once, but even a blind squirrel finds a nut every once in a while. I wanted to find a squirrel, I mean financial guru, who had found success year after year, decade after decade. Mr. Buffett was at the top of that list.
Almost everyone knows who Warren Buffett is. He is the Michael Jordan of the financial world.
No. Michael Jordan was the Warren Buffett of basketball.
So I did what any Millennial would have done, I Googled him — and when I did, I was confronted with his number one rule of money:
Never lose money. It’s so simple, it’s genius.
I know, I know, you can’t guarantee that you will never lose money. However, I think the advice is holds water. By reducing your odds of bad things happening, you can reap the rewards of good things happening. In finance, it is a zero sum game, so why not cut your liabilities that would otherwise kill your assets? In the case of debt, the odds of bad things happening (losing money) are 100%.
The answer was simple for me. Pay off the debt first, invest later.
There are only two exceptions to this rule, for each of which I will give a reason:
Exception #1: Have an emergency fund in place for the unexpected. It doesn’t have to be much, but it is helpful to have a little bit of money sitting around in case the unforeseeable happens. For example, one of our cats got very ill, and we had to take her to the emergency vet for her to make it. Next thing we know, we had a bill for $800. It wasn’t a happy experience, but it would have been worse if we had to put that on a credit card because we didn’t have any liquid savings.
Exception #2: If your employer offers 401k matching, TAKE IT! If you don’t invest that money (pre-tax, by the way) you are leaving an immediate 100% return on investment on the table. As Hank Hill would say, “That’s just asinine.” The gains may seem modest if you don’t make a lot of money, but it adds up very quickly, and you will thank yourself in retirement.
Agree or disagree? Let me know in the comments below, Facebook, or Twitter.