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After I wrote a post sharing how Mrs. Superhero and I paid off over $17,000 of student loan debt in only 54 days, I received many congratulatory comments, e-mails, texts, and phone calls. Something about sticking it to Sallie Mae really fires up people, apparently!
On the other hand, several readers wrote to me and asked about my thoughts regarding a recent Forbes article, 5 Reasons to Stop Prioritizing Student Loan Payments. I had not read the article at the time, as it was published on May 16, 2016, one day prior to the publication of my article, so I sat down and read it over a cup of coffee the next day.
The article’s author, Shahar Ziv, is a smart individual. An alum of Cornell and Harvard Business School, Ziv is currently part of the Global Corporate Strategy team at PayPal and a Forbes contributor. I, on the other hand, am an alum of far-less prestigious universities and will not likely be writing for Forbes any time soon (though I’m ready to sign on the dotted line whenever you would like, Forbes editors).
Mr. Ziv clearly wins the battle of credentials.
As I read, I found myself agreeing with some of the points Ziv made among what he labeled Five Key Insights. After all, personal finance is math, and math is pretty straightforward.
While I agree with Ziv’s math, I strongly disagree with the presumptions and logic which underpin his rationale for prioritizing retirement investing over paying off one’s student loans.
I will do my best to articulate the reasons for my position with the remainder of this post.
Personal Finance is Ultimately Personal
If you spend some time reading any of the many quality personal finance blogs today, you will certainly encounter conflicting opinions on a variety of subject matter.
Why? Personal finance is much more than addition and subtraction, algorithms and projections. It is not just math.
Dave Ramsey consistently states that personal finance is 80 percent behavioral and 20 percent head knowledge, and I believe he is correct. Knowledge without application is wasteful.
Furthermore, decisions in personal finance are not made in a vacuum. They are made by individuals who find themselves in varied and unique circumstances, the holders of dreams and goals.
I am certain that Mr. Ziv understands this. Again, in case you misread the intent of my earlier statements, he is far smarter than I am. Yet, I strongly feel that he undervalues the personal aspects of personal finance.
Responses to the Five Insights
As mentioned above, Ziv shares Five Insights regarding why he believes one should prioritize retirement investing over accelerated student loan repayment. Key Insight #1 states,
If you are lucky enough to work for a company that offers a match, it is a no-brainer to contribute extra dollars to your retirement plan instead of diverting them towards student loan payments, at least until you take full advantage of the free money.
Again, I do not disagree with the mathematical conclusions contained within this insight. However, the underlying presumptions are distressing.
Consider the following data from a US News report from April 2010:
Workers with a 401(k) or pension plan at work are among the more fortunate half of the population. Only 51 percent of all Americans worked for an employer that sponsored a retirement plan in 2008, and according to an Employee Benefit Research Institute analysis of Census Bureau data… This lack of access to any sort of retirement plan at work is not a recent trend. Only about half of private sector workers have been offered any sort of employer-sponsored retirement plan in a given year between 1979 and 2008, according to a Center for Retirement Research at Boston College analysis.
While these numbers have surely improved in 2016, it is important to note that it truly is “lucky,” as Ziv says, to work for an employer that offers a match. In the previous thirty years, we might even say that it is “lucky” for one to have the option to participate in an employer-sponsored retirement plan. With so few workers today in position to take advantage of an employer match, Key Insight #1 loses some of its luster.
Let us examine Key Insights #2 and #3:
Key Insight #2: To get an extra “doubling” of your account – the equivalent of your penny going from $5 million to $10 million – you have to start earlier. It is the early contributions that matter the most, even if they are small, because they have the most time to compound and grow.
Key Insight #3: Delaying early retirement savings to pay off more student debt may seem attractive in the short run, but is quite costly in the long run because it will be harder to catch-up on savings later.
Again, I will not argue with the math nor the logic behind these statements. Clearly, time and compound interest form one of the most powerful partnerships in the universe. However, I would like to poke at these insights. The above statements neglect perhaps the most important and unquantifiable factors of all: risk and timing.
Suppose you took Ziv’s advice from October 2007 to March 2009, when the S&P500 absolutely plummeted, losing approximately 50% of its value. Over a 17 month period, you could have paid off a $20,000 student loan with monthly payments of approximately $1,200. On the other hand, had you invested a similar monthly amount, you would have been raked across the coals due to your negative investment returns. To make matters even worse, you’d still have a pile of student loan debt!
Of course, I must acknowledge the flip side: you could have accepted Ziv’s advice beginning in mid-March 2009 and ridden an incredible bull market.
My point is this: when you invest while you still have lots of debt, you are exposing yourself to increased risk while hoping that your timing is right.
Even with an employer match, there is no such thing as a guaranteed investment return when you are investing in the stock market.
On the other hand, dollar for dollar, paying down student loan is a guaranteed boost to your net worth, assuming no other financial changes. But when you invest, there is always a chance you could lose it all.
Ziv’s lack of consideration of risk is troublesome. His article makes no mention of an emergency fund. Funneling your extra dollars into investing rather than first paying off debt or building an emergency fund exposes you to very unnecessary risk. Obviously, if you have an emergency, you will have to raid your retirement accounts or take on further debt.
To quote Warren Buffet, “Only when the tide goes out do you discover who’s been swimming naked.” Anyone can look like a genius by following Ziv’s advice in a strong market. When the tide turns, this advice is revealed to be unsound, in my opinion.
While timing and risk are the most significant variables overlooked within Key Insights #2 and #3, Key Insights #4 and #5 overlook the realities of living in the present while balancing the priorities of the future.
Key Insight #4: The tax-advantaged status of retirement accounts and the ability to lower your tax burden by deducting student loan interest are additional reasons to funnel extra funds towards retirement and not your loan balance.
Key Insight #5: Even after you are maximizing your employer’s retirement match and even if the interest rate on your student debt is higher than the rate you expect your retirement savings to earn, you are still better off concentrating on retirement contributions over student debt repayment in all but the most extreme cases.
Yes, the ability to deduct student loan interest is a nice benefit when facing student loan debt. I will not deny that. However, continuing to carry one financial obligation (student loan debt) for the purpose of reducing the size of another financial obligation (taxes owed) smacks of silliness. Furthermore, the $2,500 student loan interest deduction is both limited and not available to everyone. See this article for a thorough explanation.
Further Thoughts
In his article, Ziv highlights that some student loan payments are just as burdensome as second rent payments, yet he still advises that you keep these student loan payments and focus on your retirement accounts.
What about when the time comes to stop renting and buy a house? That $900 per month student loan payment hanging around your neck will significantly harm your debt-to-income ratio and hinder your ability to purchase a home.
Take, for example, a couple who earns $5,000 gross income per month and does not carry student loan debt or any other debts. They are seeking to buy a home with a 30 year mortgage at 3.5% with a $10,000 down payment and have gone through the pre-approval process. They have been told that they can afford a maximum monthly mortgage payment (including principal, interest, taxes, insurance, association dues, and private mortgage insurance) of $1,400. Their calculation was developed using the top formula below.
- Monthly Income X 28% = monthly PITI
- Monthly Income X 36% – Other loan payments = monthly PITI
Now, let us compare this couple to another couple who earns an identical income but carries collective student loan obligations of $900 per month. Their situation requires utilization of the second formula below, which places their maximum monthly mortgage payment at $900 per month.
Which couple is going to be able to afford the better home?
The Final Word
Ultimately, the decision to prioritize accelerated payoff of student loan debt or retirement savings is not a “right vs. wrong” issue. It is a matter of personal preference. The Know Thyself Principle indicates that you should examine your values and goals to determine what is ultimately best for you.
Only you understand your values, goals, and dreams.
Only you know what level of risk with which you are comfortable.
Mrs. Superhero and I paid off over $17,000 of student loan debt in 54 days because we abhor even small risks. Paying off student loans represented a guaranteed boost to our net worth, while investing that $17,000 presented a risk that we were not comfortable taking given the presence of student loan debt. For us, prioritizing our student loan repayment was the right thing to do.
Our life experiences have taught us that tomorrow is promised to no one. With this truth in mind, we aimed to balance our future goals with our desire to live purposeful, fulfilled lives in the present.
Paying off your debts can provide significant peace, freedom, and opportunities. I sleep much better at night since I have paid off my student loans. Without the obligation of student loan payments, Mrs. Superhero and I are free to tell our money where to go and what goals to accomplish.
In the end, when it comes to all money matters, you have to decide for yourself. To let Shahar Ziv, Dave Ramsey, Suzie Orman, or (especially) FinanceSuperhero decide for you would be a colossal error.
Dividendsdownunder says
May 31, 2016 at 1:49 AMHey Hero, you make good points and it’s worthwhile the consideration.
Firstly, our household doesn’t have student debt and never did, so we are fortunate so that we can invest straight away without any worry (well, we’re having to pay for IVF treatment costs, so I suppose that is our student debt; our future student lol).
I suppose ultimately it’s a choice of guaranteed return (no more interest) / no more debt, OR thinking you can get a better result by investing.
We are strong believers in investing, which is part of what our blog is about. If the market drops, we think that’s an even better time to buy, not a bad one. It accelerates your overall return. So, if student debt was charging 5% interest, I’d want to put a large amount of finances towards that. If it had a really low interest rate, I’d be less inclined to repay it so quickly.
In Australia, we don’t have interest on our student debt, it goes up with inflation each year, the debt is recovered through the taxation system on each year’s tax return. I think that’s a pretty good system 🙂
Tristan
Hero says
May 31, 2016 at 8:39 AMTristan, thanks for stopping by. I am very intrigued by the student loan system in Australia; I had no idea it was different than here in the US.
I fully agree with your points regarding investing. In some ways, I do wish I had excess cash sitting around, as right now would be a decent time to invest. On the other hand, I still feel very good about our decision to wipe out the student loan debt.
ZJ Thorne says
May 31, 2016 at 12:35 PMMoney is so personal. Some folks cannot stand having anything over their head. Some folks feel no pressure from being heavily leveraged. Doing what makes you sleep better at night is so important.
For me, right now, I’m not focused on paying down student debt, in part because it is so big. My head is not wrapped around it. I also have cc debt with higher interest. I know that paying off the $150k of student loan will take many years; I decided to start investing in 2015, because I know that I need these years of returns. I also think I’ll figure more things out as I learn more – hopefully I’ll be able to focus on those loans then.
The Millennial Budget says
May 31, 2016 at 2:12 PMForbes ring you up yet? This was quite the debate and I agree with all the points you said. It is easy to look at personal finance through numbers on an excel sheet or whatever may be used to get the numbers. But there is a second part that you pointed out with Dave Ramsey, behavior. Numbers will always be assumptions unless action is taken. The only point I even agree with Mr. Ziv is #2, doubling of your account. Starting early is always better but the argument is that this is not always reasonable for some.
All of his other points I disagree with especially #4. I was going to write an article in the coming weeks on a similar topic to this point (not student loans) but here is the rational. You have students loans, interest is tax deductible. AWESOME. But wait, even with the deduction you are still paying a large sum of additional money you could have put to extra use. Paying down the principal on loans that are greater than 5%, in my opinion, is an absolute must as it can be challenging to earn more than that in the market, currently. That tax deduction he speaks about is you essentially pay a dollar extra but you get 30 cents off so it must be a good deal. The feeling of being debt free is greater than tax deductions from student loans. Bare in mind everything I spoke about assumes an interest rate that will be hard to beat on the market.
Enjoyed your argument!
Hero says
June 1, 2016 at 9:26 AMI’m still waiting for that phone call, haha. You raise some strong points and present nuances that I hadn’t fully considered. I may need to go back and revisit Ziv’s math.
Andrew @ DebtFreedomJourney says
May 31, 2016 at 3:51 PMFinancial decisions must be your own, but be based on sound financial teachings. No everyone agrees with Dave Ramsey but by and large I follow his principles–not blindly but because I understand them and fundamentally agree with them.
That said, putting off paying one’s student loans may be beneficial for some, but for me I have just one singular goal in life: pay them off as soon as possible. They are cripplingly large and I’m not interested in a lifetime of being indebted.
Sometimes people focus too much on the analysis and can’t get their head around passing up “free” money. Sorry, but I’ll invest like crazy once my student loans are paid off. The 4% match I’ll lose out on in the next 3-5 years is nothing compared to what I can invest when I’m out of debt.
Mrs. Superhero says
May 31, 2016 at 3:52 PMWhen it comes down to it… The less debt we have the more flexibility we will have. Plus I hated the fact that as the days went on we were not just paying back money that was borrowed but so much interest! In our situation it truly did make the most sense. I do understand that people with larger amounts of debt may have to divide and conquer due to their personal situation. Well done sweetie. I love how you think critically and stand up for what your convictions are.
Hero says
June 1, 2016 at 9:28 AMThanks for commenting, Mrs. Superhero! You are wise to highlight the value of flexibility.
Apathy Ends says
May 31, 2016 at 8:12 PMI see both sides of this issue and have tried to find a happy medium between saving/investing while paying extra down on my student loans.
If I wanted to we could pay the balance in the next 7-8 months and be done with them, but we invest a higher proportion for a lot of the reasons highlighted by Ziv – I look at it more from the math side than anything else (hence my decision to invest a lot more now vs rapidly paying off our loans)
If I wouldn’t have refinanced last year I probably would be more balanced (my interest rate was about 6% down to 3.85% after the refinance)
Hero says
May 31, 2016 at 10:25 PMThanks for sharing your approach, AE. I think striking a happy medium, as you suggested, is very reasonable. Mr. Ziv seems to advocate for keeping student loans around for as long as possible, and I just can’t get behind that strategy, even when presented with pretty compelling arguments, due to the risk.
Thias @It Pays Dividends says
May 31, 2016 at 9:24 PMIt seems like he completely ignores the benefit of clearing fixed costs by paying off the debt. Once your debt is gone, so is the monthly expense that you need to pay. This opens you up to much more flexibility if something unexpected, such as job loss or illness, occurs.
Hero says
May 31, 2016 at 10:27 PMThias, you’re exactly right. Throwing every extra dollar toward the 401k is a scary proposition for the reasons you outlined, even if it makes sense in a mathematical vacuum.
Chris @ Flipping A Dollar says
June 1, 2016 at 8:17 AMGreat post! Another thing to add to the risk is that student loan debt isn’t absolved if you go bankrupt. It’s ALWAYS THERE.
Additionally, for the people who don’t have a 401k, I wonder if those people also don’t have student loan debts? I’m thinking workers at jobs that don’t require a degree.
Either way, you’re right there’s a lot of “personal” in personal finance that gets ignored. I think the best you can do is understand your situation and accept risk. If you’re just going blindly, you’re going to have a bad time no matter what!
Hero says
June 1, 2016 at 9:30 AMThanks, Chris. You are absolutely correct in all of the points you raised.
Risk will always be present, and it is up to each of us to weigh out the risks and rewards before making financial decisions. In many ways, I feel that a key to reaching financial independence is minimizing risk and loss. It may even be more important than maximizing returns.
Andrew Findlaytor says
August 10, 2016 at 10:41 AMSorry, I know we are a little late to the party, but we still wanted to jump in, because this topic is so incredibly important. The cost/benefit of paying off your debt vs investing in your match is one of the mostly highly debated topics discussed amongst our internal staff. The numbers do point to a trend that it is more profitable to invest in your future rather then paying down your past. However, from my perspective I feel it is a large gamble at best. I am hoping (on a very reasonable and likely hope) that by investing my money wisely, it will out-grow the 6% monster that is my student debt. However, every day that I drag that out, I worry that something (global or personal) will disrupt the plan and allow my loan beast to grow ahead of any lead I may have had on it. I can hope the market goes up each day, but I know for a fact my debt is there for me every single day. Is it wise to consider the stress reduction as a factor decision making? Or is it better to “Trust in the numbers”?
Hero says
August 10, 2016 at 6:48 PMVery good thoughts and even better concluding questions, Andrew. I think the answer, ultimately, is one that is based upon personal convictions. I also believe that the projected time in which a person can pay off student loan debt is a big factor. We were fortunate to be able to blaze through my debt in a hurry.