Invest or Pay Off Student Loans: A Closer Look at the Numbers

One of the most pondered questions in personal finance is whether you should pay off low interest debt quickly or take the extra money and invest it.  While the discussion usually revolves around the pros and cons of paying off your mortgage quickly, for this post I’ll focus on another common scenario with which I’m familiar:  a new physician and their student loan debt.

Regular readers of this blog know that I am not a fan of debt and that I’m on a mission to pay off my loans by the end of the year.  Mathematically, you will come out ahead if you invest rather than pay off low-interest debt quickly.  However, I wanted to actually do the math and see how much that difference is.  What follows is a little experiment in numbers.  I decided to keep the values exact to the decimal point so that the results of the calculations would be as accurate as possible.  With that being said, let’s get this party started!


The Experiment

Study Subjects

We’ll take two physicians, Dr. Investor (Dr. I) and Dr. Payoff (Dr. P).  They graduate from residency at the age of 35 and have $180,000 in federal student loans.  They plan to work for 30 years and retire at the age of 65.

The Constants

They both enter the same medical specialty making the same annual salary.  We’ll also assume that they each max out their tax-advantaged retirement accounts ever year in the amount of $23,500 (401k at $18,000 and backdoor Roth at $5,500).  They both start out with $0 in retirement savings but with no other types of debts or obligations.  Also, they were both able to refinance their student loans at 4% over a 20-year repayment plan with a minimum monthly payment of $1,090.76.

The Variables

Dr. P wants to be debt free ASAP and decides to pay off his loan in five years by paying $3,314.97 per month.  He will then invest that amount every month for the remaining 25 years until retirement.  Dr. I decides to take advantage of the lower interest rate by paying the monthly minimum while investing the extra $2,224.21 instead.  He will do this for 20 years until the loan is paid off, then he will invest the full $3,314.97 a month for the remaining 10 years and retire at 65.  I’ll also look at scenarios where Dr. I pays off his loans over 15-year and 10-year terms.

The Assumptions

We’ll assume that Dr. I and Dr. P make no other additional investments and that they each completely stick with their plans.  We will also assume investment returns of 7% real and that they both re-invest all dividends and capital gains.

Here’s a summary of what we have so far:

Dr. Investor

  • 20-year payoff plan: investing $2,224.21 monthly for 20 years, then $3,314.97 for the remaining 10 years
  • 15-year payoff plan: investing $1,983.53 monthly for 15 years, then $3,314.97 for the remaining 15 years
  • 10-year payoff plan: investing $1,492.56 monthly for 10 years, then $3,314.97 for the remaining 20 years

Dr. Payoff

  • Paying off loan aggressively in 5 years, then investing $3,314.97 monthly for the remaining 25 years


The Results

Here are the results of the calculations given the scenarios noted above:


Dr. Investor comes out ahead in all scenarios with the maximum difference resulting from a 20-year loan payoff plan.  The gap narrows as you decrease the length of the loan payoff.  These results illustrate the real benefit of time and compound interest.  Having a head start on investing by just five years gives Dr. I over $193k more at retirement.  Depending on your annual withdrawal rate, this amount could provide another two to three more years of retirement income.  The question then becomes whether or not that extra money is worth carrying student loan debt for 15 additional years instead of just paying it off in five.  For some people, the answer will be yes… for others, no.  But to really answer this question, we need to look at the big picture.


The Other Half of the Equation

Let’s now take a step back and factor in all of their retirement savings.  As mentioned before, Drs. I and P each contribute the maximum to their 401k’s and Roth IRA’s to the tune of $23,500 annually.  Assuming an investment return of 7% real and a 30-year time horizon, they each will have $2,303,123.09 at retirement.  Combining this amount with their other investments would give us the following:

Dr. Investor

  • $2,803,446.53 + $2,303,123.09 = $5,106,569.62 at retirement using the 20-year payoff plan

Dr. Payoff

  • $2,610,437.15 + $2,303,123.09 = $4,913,560.24 at retirement, again with a difference of -$193,009.38

Sure you end up with more money if you invest rather than pay off your loan aggressively, but the difference between the two is not that significant.  For instance, using a 4% withdrawal rate, Dr. P’s nest egg of $4.9 million would equate to $196,000 per year of retirement income versus $204,000 with Dr. I’s $5.1 million retirement account.  That’s a difference of just $8k per year, which is a premium I’m willing to pay in order to be student loan debt free after five years.  These amounts don’t factor in taxes, mainly because I’m too lazy to do those calculations as well.  But if we were to assume a 25% effective tax rate for Dr. I and Dr. P, they would be left with $153k versus $147k of annual retirement income, respectively.


The Race to FIRE

Next, we’ll take a look at the situation where Drs. I and P would want to get FIRE’d up.  In this exercise, we’ll include their retirement savings of $23,500 annually (or $1,958.33 monthly) from the get-go and assume that each have a target retirement amount of $2 million.

Dr. Investor

  • Invests $4,182.54 a month ($1,958.33 + $2,224.21) at 7% annual return
  • Reach FIRE in 232 months (19.33 years)

Dr. Payoff

  • Pays off loans for five years while investing $1,958.33 a month, then invests $5,273.30 thereafter
  • Would reach FIRE in 238 months (19.83 years)

In the end, Dr. P would work six months longer to reach financial independence but enjoy almost 15 years of being debt free.


What About You, SRGO?

For our final experiment, let us take a look at my situation and see how the numbers work out. Again, we’ll compare investing with a 20-year payment plan versus a quick payoff strategy.  This time around, however, I’ll use my actual loan amount ($300k) and the fact that I will be able to pay off my loans in three years rather than five when performing the calculations.  The retirement time-frame will be 30 years using an annual return of 7%.  After running the numbers, investing  will come out ahead by just $97,931.14.  Since there is no way in heck I want to work for 30 years, I figured out how long it would take to reach the goal of $2M.  In this scenario, investing will get me there in 9.75 years versus 10.5 years using the aggressive payoff plan.  One issue with this, at least for Investing SRGO, is that he would still have another 10 years of student loan payments to make and budget for.  On the other hand, Payoff SRGO will be completely debt free.


Some Things to Consider

Going through this experiment was quite revealing.  While investing does come out ahead in terms of the final numbers, the difference is not that significant, particularly if you factor in other retirement savings.  The following are some important take-away points to keep in mind.

For low-interest debt, investing comes out ahead in terms of terminal wealth

You will end up with more money if you invest any extra money instead of using it to pay off debt quicker.  That’s just how powerful time and compounding is.  The actual amount you end up with will depend on the loan interest rate, the investment time-frame, and your returns.  One thing to keep in mind is that these calculations only work out if you stick with your plan and actually invest that extra money every month for the entire investment time-frame.  If you’re disciplined financially and are certain you won’t spend that extra money at some point in time, then go ahead and invest away.  If not, you might be better off putting that money toward your debt instead.  And while it may seem like using extra money to either invest or pay down debt are your only choices, there might be a third option available that suits you better.

You should still pay off high-interest debt ASAP

This goes without saying, but you should pay off high-interest debt as quickly as you can.  An example is credit card debt with interest rates in the mid to high teens.  I personally consider anything 6% or above to be high-interest.  Another debt that I would pay off quickly would be a new car loan.  Although these technically aren’t high interest, with current rates in the 4-5% range, the fact that new cars depreciate at such a rapid rate makes car loans in general a bad idea.

Pay yourself first

One thing you can do to make the difference between paying off loans and investing less significant would be to simultaneously save for retirement.  I’m a big fan of paying yourself first, even if you’re trying to get out of debt.  Any little amount you can put away every month adds up over time.  And if you’re able to set aside funds from your paycheck before you see it, you will be less likely to miss that money.  Over time you’re lifestyle will adjust to the smaller paycheck.

If you’re paying off debt, saving money, and investing, you’re doing it right

You can’t really go wrong with either investing or paying off low-interest debt quickly.  Like the featured image above, either choice can be the right one.  Both strategies result in an increase in your net worth.  I prefer to be free of student loans, regardless of interest rate, as quickly as possible.  But at the end of the day, the decision is a personal one.

26 thoughts on “Invest or Pay Off Student Loans: A Closer Look at the Numbers

  • January 25, 2017 at 4:21 pm

    Whenever I think about the invest vs. pay off debt debate, I just imagine if I would ever borrow that money to invest. Even at a really low-interest rate, I think the answer for me is no. It seems to make it so much simpler to just pay off debt right away, when it’s easiest to do so, then just play catch-up with your investing later. Seriously, if you’ve been a student for a long time, it’s really not that hard to keep living like a student for just a few more years!

    • January 25, 2017 at 10:38 pm

      That’s a good way to think about it, FP. Some people would take on low interest debt and use that leverage to invest. I would pass and be debt-free.

  • January 25, 2017 at 4:24 pm

    Oooh, this makes a fantastic point! Mr. Picky Pincher and I chose to pay off our student loans. Our interest rates are from 3% – 6%. Considering a historical 4% return on investments, we come out slightly ahead by getting rid of the student loans first. That also means less monthly payments in the long run, which will enable us to throw more moolah towards investments. But the numbers work differently for everyone.

    • January 25, 2017 at 10:45 pm

      Yeah those interest rates are in a gray area. Seems like you made a good decision based on your financial picture. Like you said, once those loans are gone you’ll have one less fixed monthly payment and increased cash flow. Thanks for visiting!

  • January 25, 2017 at 4:41 pm

    This is a really interesting comparison! Thanks for crunching the numbers. I’m generally a pay-off-debt fan myself, but I think the main key is to be purposeful and aggressive with either investing or paying off debt! Either way, you end up far ahead of others who aren’t planning for the future. Best of luck to you!

    • January 25, 2017 at 10:50 pm

      Thanks for stopping by, Mrs. COD! I’m also a pay off debt person and would prefer to be free of that burden. Like you said, the important thing is to be purposeful and stick with your plan, whether that’s paying off debt quickly or investing. It’s really a win-win situation when it comes to your net worth and financial well-being.

  • January 25, 2017 at 4:48 pm

    Just as I’ve never been a fan of Dr. Pepper, I’m not a fan of Dr. P :). Time is the biggest asset we have when it comes to investing. As you mentioned, the impact of starting your investing timeline just 5 years earlier can have a big impact.

    But as you’ve done here, it’s always important to actually look at the numbers and know that everyone’s situation is different. If your nut at retirement is $1 million, then $190k is a big deal. If it’s $5 million, then not so much.

    Another factor is the estimated return. A more risk adverse person who only expects a 6-7% return will have far different results than an investor who takes on more risk to earn 9-10% returns.

    I like your considerations at the end. First of all, know yourself. I’m incredibly disciplined when it comes to investing and know I can stick to a schedule I have laid out. Others might decide to spend of the gains or decide they’re a market genius and try to time the market. In those cases they would be better served to pay down their debt.

    Great post and analysis. We’re a bit different when it comes to debt, but I can’t argue with your analysis!

    • January 25, 2017 at 11:09 pm

      I’m also not a fan of Dr. Pepper, but I am partial to Dr. P. Haha! I agree, time is one of our greatest assets when it comes to investing and compound interest. That’s why I think it’s so important to pay yourself first, even just a little bit, while paying off debt. Thanks for the comment!

  • January 25, 2017 at 5:35 pm

    I’m down for paying off low interest loans last, but I still like having them paid off as soon as possible. For me it’s knowing that I am completely free and no longer an indentured servant. Corporations aren’t loyal to their employees and at a minutes notice you could be out of a job or be fed up and want to quit you job. I like to count my savings in number of years I can travel. For every $10,000 I can travel in South East Asia for a year and live like a king drinking and partying every day.

    • January 25, 2017 at 11:14 pm

      I feel the same way about knowing that you’re completely free from owing anybody anything. Also, like you said, things change and life happens. You might be jobless for an extended period of time, become ill, or suffer a loss in earning power. Having to pay back loans on top of these circumstances could make things even more difficult.

    • January 25, 2017 at 11:20 pm

      Thanks for stopping by, EJ! Agreed, in the end if your saving, investing, and paying off debt, you’re going to be okay. Like you said, the problem is when someone forgoes saving anything at the expense of demolishing their loans. While it might work out if you’re able to get rid of your debt in 1-2 years, even I wouldn’t pay off my student loans that aggressively.

  • January 26, 2017 at 6:48 am

    Great work. I loved all the different scenarios with Dr. Investor 🙂

    I do agree that if you can earn a higher return investing than paying a low interest rate student loan, logic dictates that you should invest the excess cash. At the same time, I understand how people (including myself) lean towards the opposite…it just sucks knowing you owe someone something. Given that the difference is not too big in your example, I think it really comes down to personal preference.

    • January 27, 2017 at 12:44 am

      Agree it all comes down to personal preference and situations. Some don’t mind having low-interest rate debt hanging around. I do, mainly because I’ve been in debt the majority of my adult life. Thanks for the comment!

  • January 26, 2017 at 8:55 am

    Great analysis! It explains why some PF bloggers choose to have a mortgage, even if they can pay for a home in cash.

    Although lower interest debt allows you to invest your extra cash flow and come out ahead, sometimes you just need to do what calms the mind and pay off your debt faster. It’s more mentality than the numbers in my opinion.

    • January 27, 2017 at 12:47 am

      Yeah it’s really all about what makes you sleep well at night. It’s really gonna be hard for me to not want to pay off our mortgage quickly, but I’m ok with keeping that around a little longer mainly for the tax deductions.

  • January 26, 2017 at 2:01 pm

    Solid analysis, SRGO! It’s a psychological vs. financial conundrum. You are correct (right?) whether you take the student loan (psychologically better) or the investing route (financially better).

    • January 27, 2017 at 12:51 am

      Thanks for stopping by! For me, I physically feel the burden of my student debt. So getting rid of it ASAP will lift a heavy weight off my shoulders. To me that’s worth more.

  • January 26, 2017 at 5:42 pm

    Awesome analysis SRGO!!! I know for me when it came to having debt vs. investing having the debt kept me up at night way more than worrying about potential gains in the stock market. So for me I was super happy paying off my mortgage 🙂

    • January 27, 2017 at 12:54 am

      Yes whatever allows you to sleep well at night. One of these days I’m going to join you in your debt freedomness!

  • January 28, 2017 at 3:38 pm

    Excellent analysis, but I’m with Dr. Payoff, I like sleeping at night knowing that there is no chains attached to me at all times, the risk of losing job, situations changing, you want to move to another country, economy could take a dive is too great to get the “guaranteed return” of a debt paid off.

    • January 28, 2017 at 8:35 pm

      Thanks for visiting! I’m with you and Dr. P. I prefer to be free of any obligations. Like you said, you never really know if you’re job is stable or if some other life event will happen and impact your ability to make payments.

  • January 29, 2017 at 10:34 am

    Great post. I think it really comes down to mindset. Neither doctor has the wrong strategy, they’ve both employed a strategy that works best for them. I know for me personally, I like to be debt free. When I’m not debt free, it’s hard for me to stay in a producer mindset. My investing suffers when I’m in debt, because I go into fear mode. I’m definitely Dr. P in this scenario. Which is good, because Dr. Pepper is my favorite soda.

    • January 29, 2017 at 1:46 pm

      Thanks for stopping by! I agree, both strategies can be right depending on each individual. I personally prefer being debt free, but I can see how others would lean towards following the math.

  • January 29, 2017 at 9:58 pm

    Great analysis SRGO! I definitely find myself leaning more towards the Dr. I side of things. But then again I’m counting on most of my debt disappearing into thin air in a few years…

    Love the new site btw. I found it a little later than the others judging from all the comments. Will be checking back for more great posts!

    • January 29, 2017 at 11:21 pm

      Thanks for stopping by, FPMD! I’m assuming that you’re going for PSLF. In that case it makes sense to invest rather than pay off quickly. Thanks for checking out the site. I’ve actually visited yours several times… just haven’t left a comment yet.

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