Should you pay off student loans or invest? 8 things to consider

“Should I pay off student loans or invest?” is easily among the most common questions I’ve seen while browsing online personal finance discussions. While there’s no universal answer, keep reading as I provide 10 points you should consider before making this decision.

Should I pay off student loans or invest? 8 important points to consider

As always, keep in mind I’m not a financial advisor. The following points are merely food for thought as you ask yourself “should I pay off student loans or invest?”

1. Paying off debt is an investment in and of itself

Here’s an interesting point people don’t always think about. Whenever you put money towards paying off debt, you’re actually generating a return equivalent to the loan’s interest rate. For example, let’s say the interest rate on your student loan is 4.30% (the current U.S. federal rate for graduate students). By kicking an extra $1,000 towards the balance each year, you’re saving yourself $43 in interest.

Now, because most student loans in the United States use simple interest, this growth likely won’t compound in future years as it would with traditional investments (i.e. stocks). Check out this article from NerdWallet for a few notable exceptions.

Still, though, a guaranteed 4.30% return ain’t shabby at all. Most other “guaranteed” investments (i.e. savings accounts and bonds) don’t pay out anywhere near that much.

Paying off debt faster can also be an investment in your mental health. For example, a student debt balance can keep you trapped in a job you hate for fear of falling behind on payments if you switch and things don’t work out. Getting out from under such dread is priceless.

2. Sheer returns shouldn’t be your only consideration

To build on that last paragraph, sheer returns shouldn’t be your only consideration when deciding whether to pay off student debt or invest.

If sheer returns were all that mattered, paying off federal student loans faster wouldn’t make much sense. In 14 of the last 20 years (based on MacroTrends data), the S&P 500 has generated returns far exceeding the typical interest rate on currently-held federal student loans (2.30% to 5.30%, according to Bankrate). It often hasn’t even been a close contest, with the S&P 500 generating returns as high as 29.60%.

There are two important points to consider here, though. In some situations, they could make paying off student debt the wiser call.

The first point is that stock market returns aren’t guaranteed. In any given year, your profits could fall short of what you’d have gained by paying off student debt faster instead. Meanwhile, the return you’ll generate by eliminating debt is guaranteed. That counts for something, even if your profits would be relatively low.

The second point is that eliminating debt faster could generate greater returns in the long run. For example, getting rid of student debt faster could free you up to take career-related risks that pay off big-time. You could take a lower-paying role at a company with better long-term prospects, for instance.

This is true of anything related to personal finance, by the way. Numbers should rarely be your sole consideration when making decisions.

3. Are you carrying private or federal debt?

So far, I’ve assumed your student loans are (like 92% of educational debt in America) federal, which comes with two very important implications:

  • low interest rates
  • simple (rather than compounding) interest

If your loans are private, however, both of these benefits likely go out the window. According to Bankrate, average fixed private student loan interest rates range from 3.34% to 12.99% annually. Additionally, this interest compounds in some cases, which can be devastating on such a large balance.

Consequently, getting rid of high-interest private student loan debt almost always makes more sense than investing in stocks, which (despite stellar performance over the last 10+ years) return an average of roughly 10% over the long haul.

Even if your private student loan carries a lower interest rate, consider whether it compounds. If it does, that’s more inventive to eliminate the debt faster. Even 3.34% on a substantial loan balance really starts to add up with compounding after a while.

4. What regulations govern student loans where you live?

Another assumption I’ve made in this article thus far is that you live in the United States. Most Rinkydoo Finance readers do!

If you’re among my non-American readers, though, the incentives regarding paying off your student debt early or investing are likely different.

For example, as Stephen over at Finance55 pointed out in a recent Twitter exchange, student loan repayments in the United Kingdom are automatically deducted from your salary once you make over a certain amount (see confirmation here). While you can still make extra payments, the government will write your loan off after 30 years (see this page). The government also affords you some flexibility if you’re living abroad.

Stephen argues these factors give British students less incentive to rush paying off their loans. If you live in Britain (or some other country with relatively lax student debt practices) and feel the same way, that may settle the debate for you.

5. There are other important financial priorities besides paying off debt and investing

Another important point to keep in mind is that paying off debt and investing aren’t life’s only important financial objectives. In other words, the answer to this article’s central question (“should I pay off student loans or invest?”) could be “neither.”

Check out my second point in this article for a list of financial priorities in the order experts generally recommend keeping them. You’ll notice that paying off low-interest debt (including student loans) and investing come after purchasing essentials, building an emergency fund, and getting rid of high-interest credit card debt.

In general, you’d be wise to avoid shuffling these priorities around. By definition, you’ll always need essentials. Additionally, unexpected expenses have a way of popping up occasionally. If the money for covering these important costs when they arise is tied up in investments and student loan repayments, that’s no good. Be strategic in balancing your concerns.

6. What would you be investing towards?

If you plan on investing towards. say, retirement or something like Barista FIRE, you’ll benefit from tapping into compound growth sooner rather than later. In my opinion, investing consequently gets a leg up on paying off low-interest debt in this scenario.

If you’d be investing in Dogecoin with the goal of buying a Lambo, though, I’d recommend paying off your student debt instead. The same goes for any other short-sighted goal that may not work out.

It all comes down to risk vs. reward. In the first scenario, you have a very high probability of success. As Investopedia points out, U.S. stock market investors have virtually never lost money when staying invested for 20 years or more.

Plenty of people lose money on short-term gambles, though. If that happened to you, you’d certainly regret having not used your money more wisely.

Given how much of a sure thing paying off debt is, don’t squander your opportunity to do so on crapshoots.

7. How exactly do paying off student debt and investing fit into your financial picture?

Having a financial plan is very important. It will keep you on track and provide benchmarks by which to measure your progress and make confident decisions. On the flip side, without a solid financial plan, you’ll struggle to make the right call.

Start by carefully considering and listing your important financial goals. Here are some ideas to help you brainstorm:

  • retiring at 40
  • buying a house within 10 years
  • earning $500 monthly in passive income
  • helping your children pay for college

Once you’ve listed your goals, consider which of the two activities we’re discussing in this article (investing or paying off student debt) would move you towards the finish line efficiently.

If your important financial goals require significant assets (as is the case with early retirement), for example, investing may be the better call. If your goals require cash flow, however, getting rid of debt could help you free up hundreds (perhaps even thousands) of dollars every month.

These are just examples, mind you. There are many ways to evaluate either option (paying off student debt vs. investing). Maybe you feel like getting rid of student debt faster would actually help you retire earlier, for instance. Whatever the case may be, it all starts with identifying your goals and planning accordingly.

8. You can do both

Last but not least, it’s worth highlighting that the “should I pay off student loans or invest” debate doesn’t have to be black and white. You could, for instance, take the money you’re debating what to do with and split it 50/50 between investments and paying off student debt. You could also split it 60/40, 70/30, 80/20, or a number of other creative ways.

This may seem obvious to some. However, I know I’ve been guilty of black and white thinking when it comes to my finances. While there are certainly advantages to focusing on one goal at a time, though, there’s no shame in multitasking if both objectives are more or less of equal importance to you.

“Alright, Brandon… What should I do?!”

Now, it’s possible all this food for thought has left you even more confused than before regarding whether to pay off your student debt or invest. Sorry!

While I can’t tell you exactly what to do, I can tell you how I’d handle the situation personally. I’d prioritize investing if the interest rate on my student debt were below 5%. This is how I’ve approached my five-year 1.09% interest car loan. While I could certainly power through repaying the loan much faster, I’d rather keep that money working for me in my stock portfolio, which has returned an annualized rate of 10% since I’ve held it.

Additional factors that make me lean this way include:

  • my goal of becoming financially independent by 50, which will be much easier if I get money compounding for me sooner rather than later
  • my moderate risk tolerance, which leaves me with no qualms about investing with borrowed money (which is ultimately what investing instead of paying off debt amounts to)
  • the fact I have enough money to pay off the debt at any time if I ever needed to for some dire reason

Again, this shouldn’t necessarily influence your decision between investing and paying off student debt. But in an article filled with “perhaps” and “consider,” I thought it might be helpful to share how I’ve approached a similar scenario.

About the author

Brandon-Richard Austin

Brandon-Richard Austin is the founder of Rinkydoo Finance. He is an avid investor and digital marketer for startups and publicly-traded companies alike.