As Seen On Reddit: Pay Off Your Loans or Put Money in an IRA?
by Dean Praetorius
Reddit may be the “front page of the internet,” but the fact that anyone can answer your questions there means the quality of advice you might get can range from hilarious to hilariously wrong. This is especially true when it comes to questions about finances. To make sure you’re getting the actual best answers to your financial questions, we’re starting a new series to address some of the most asked questions we found on Reddit, with answers provided by our network of fee-only financial advisors who are Certified Financial Planners.
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I am planning ahead for graduation and I was wondering if it is a better idea to max out my Roth IRA contribution before starting to worry about student loans? I have 13k at 4.5% Federal loans.
Paying off student loans is certainly a noble goal, and will benefit your portfolio and credit score. However, the answer to your question is all about getting probabilities on your side. Here’s one way to think about this – making $1000 of your 4.5% student loan debt go away is EXACTLY the same, from a net worth standpoint, as investing $1000 and getting a guaranteed 4.5% annual return on the investment. As part of a long-term financial strategy, that’s not a huge return.
My advice would be to go with the Roth IRA, which is projected (based on historical data) to give you more than a 4.5% return per year over many, many years.
One caveat: If you are carrying any credit card or other high interest (10%+) debt, make that go away first before the Roth and certainly way before the student loans!
In a Roth IRA, your money may well remain untouched until retirement and experience tax-fee compounding growth for maybe 40 years or so, especially if you start investing early. Based on historical rates of return and a much lower investment cost environment than ever before, expected returns over a multi-decade timespan on a tax-free account, like an IRA, smartly invested in a diversified portfolio of low-cost index funds are considered likely to be much higher than that 4.5% return in the above example.
In growing your net worth, there are a lot of considerations to be made. Both investments and debts will contribute and impact your net worth, so it’s best to choose a strategy that will benefit you most long-term. With that in mind, your priority list should look something like this: 1. Get rid of high-interest debt (10%+) as soon as you can 2. Begin investing in a good Roth IRA, letting it grow over a long period of time 3. Get rid of any other debts you have, including lower interest student loans.
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