A new year is upon us, and with it the new beginnings that can only come from turning the calendar from December to January. And so, for the second year, my Motley Fool compatriots and I are endeavoring to broadcast to the "Fooliverse" our financial resolutions for the new year. The benefits are twofold: We are fulfilling the Motley Fool's mission to "Help the world invest, better" while simultaneously adding a bit of accountability to our own lives by broadcasting our intentions publicly. And so, with this spirit in mind, my New Year's resolution is to invest in the stock market instead of paying off my student loans.
Nobody likes being in debt. But we do it because it allows us to consume something today that we can't afford given our current resources. While it wasn't necessarily the case 30 years ago, the cost of attending college in the United States has become quite expensive:
What's worse, these figures do not include the cost of room and board.
I won't bore the reader with the details of my life, but let's say that someone age 30 has $10,000 in school loans left. They have a career and a family and know the value of investing. What is one to do? We are told all our lives to pay down debt. In fact, the one and only Warren Buffett says, "Debt is bad, cash is good." On the other hand, school loans frequently have low interest rates, and all the data in the world have proven that the stock market is the place to be over the long haul. What's a conscious, Foolish investor to do?
As with most things in life, the problem I (and so many in my generation) are confronted with is one of expected returns. Fortunately, the problem is solved with a simple comparison: the after-tax interest rate cost of ones' student loans versus the after-tax potential returns in the stock market. Unfortunately, comparisons such as this require estimates. After all, who knows what the stock market will return over the next 10 years?
The average interest rate across all of my student loans, both public and private, comes to just about 4.2%. However, this rate is tax deductible to an extent. On $10,000 in loans, this equates to $420 in interest per year -- and, lucky me, the interest on student loans is tax deductible. According to the IRS, the cost of one's student loans can reduce one's tax burden by up to $2,500. Unfortunately, this means one's student loan tax deduction is the smaller of $2,500 (in case you have a lot of student loans) or the interest you paid in the tax year.
To anyone who's ever filled out a tax return, these figures are likely to be a bit disappointing. If you make $50,000 gross income during the tax year in question and deduct a hypothetical $420, this yields an adjusted gross income of $49,580. Obviously it doesn't take an advanced math degree to see that the decrease to one's tax burden is not large.
On the other hand, there's something to be said about paying down debts. It truly is difficult to estimate the value of eliminating monthly student loans payments, the pride you feel when paying off education debts, and the flexibility that can only come from not having a bill from a student loan lender. This, of course, leads us to the inevitable conclusion.
Life is a wager, and I'm betting on the market
It's not easy to vote in favor of the stock market over paying off student loans a full eight years into a secular bull market. We've come a long way since the depths of the Great Recession, and to expect anything like the returns investors have been showered with over the past eight years would be absurd. On the other hand, the subsidized interest rates that can only come from student loans tip the scale. The deal is just too good to pass up. The merits of compound interest are self evident, and given the very decent odds of earning a return larger than the interest rate cost of my student loans, I have to choose to invest any and all excess cash in the stock market.
The option to increase my student loan payments above and beyond the contractual monthly payment amount is a tempting one, fueled by the desire to rid myself of these liabilities. Alas, I will only be making the stated required payments and no more. We are all told the same tale: the rule of 72. That Einstein said the greatest miracle in the universe is compound interest. These are hard points to argue. The bet I'm making is that the stock market (or at least the stocks I pick) will earn a greater return than the after-tax cost of my student loans. While nothing is certain in life, I like my odds.
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