Those who buy stocks, especially at a younger age, have a great opportunity to build wealth and secure their financial future. Unfortunately, student debt is often an obstacle for aspiring investors. Many borrowers face the same difficult question: should I buy stocks or pay off my student loans?
Not surprisingly, there isn’t an easy answer.
However, there are times where investing is the preferred choice, and there are times when getting rid of student debt is the obvious route. The stocks you want to buy and the student loans that you have will make a big difference.
The Advantages of Buying Stocks
The significant advantage to buying stocks is the potential upside. For example, if you purchased $1,000 worth of Tesla stock just one year ago, it would be worth nearly $5,000 today.
Even if you don’t pick a huge winner, the average S&P 500 stock gains about 8 to 10% per year.
Additionally, because stocks can be easily bought and sold, stock ownership is flexible. Assuming your stock purchases haven’t gone to zero, you can always sell shares if you are strapped for cash. If you pay extra on your student loans, that money is gone forever.
Educational Value: Many Americans rely upon the stock market for their retirement. Even if you don’t make any major investments soon, it might make sense to do a little. Learning about how investments and the market work may prove to be valuable in the future. Doing a little investing could be an excellent educational experience.
The Investment Strategy Matters
It isn’t easy to compare buying stocks to paying down student loans because buying stocks can mean many different things. Your strategy has a massive influence on whether or not investing is a good idea.
Risky investments may have the potential for huge returns, but they also have the potential for huge losses. Going all-in on Gamestop is riskier than buying a diversified mutual fund.
In general, the following items help reduce risk:
- Time – On a day-to-day basis, the stock market may move up or down. Some years are good, while others are bad. However, the longer you are invested, the less risky the stock market becomes.
- Diversification – Holding a variety of assets also reduces risk. Investors should look to diversify in many different ways.
A lot has been written about different stock investment strategies. Some “strategies” are pretty much gambling. Don’t gamble away student loan payments. Other investment options seek to minimize risk while providing a high upside. A smart investment may be much better than paying down student loans.
The Reason Most People Opt to Pay Down Student Loans
Despite the high upside for purchasing stocks, most student loan borrowers choose to eliminate debt.
Each borrower has their own unique priorities, but most will point to one of two reasons for focusing on paying down student debt:
- Guaranteed Return – All investments come with some risk. Paying down student loans is a guaranteed return. If you have a student loan with a 7% interest rate, the extra payments you make are essentially earning 7% interest. At a time when most banks don’t even offer 1% interest on a savings account, a 7% return is tempting.
- An Aversion to Debt – If you have been dealing with student loans for a long time, there is considerable value in eliminating debt. I’ve personally made extra payments on a student loan at 3% interest. From an accounting perspective, it probably was not the most efficient option. However, there is a comfort that comes from eliminating debt and ending a monthly bill.
The Best of Both Worlds – Using Retirement Account Advantages
Frequent readers of this site know that my favorite student loan hack is to use retirement contributions to keep federal student loans manageable.
Certain retirement account contributions lower monthly payments on income-driven repayment plans. Additionally, some federal borrowers can even use retirement contributions to increase the amount of debt that is eventually forgiven.
If you are a federal borrower, clever use of retirement accounts may tip the scales and make buying stocks a better choice than paying extra on student loans.