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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.
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.