Where Should You Put Your Extra Cash: Stocks or Student Loans?

by Alyssa Oursler | August 19, 2013 9:00 am

Where Should You Put Your Extra Cash: Stocks or Student Loans?

One of the best parts about post-college life? Actually having money.

youngInvestorsB.png Where Should You Put Your Extra Cash: Stocks or Student Loans?[1]One of the toughest? Deciding what to do with it.

Imagine you’re a recent graduate — like myself — and have sliced and diced your pay for the month to cover rent, food, gas and other bills, including the minimum amount on your student loan payments.

You already have a rainy-day fund built up in case something unexpected hits and — even after splurging on a few happy hours, concerts and other diversions — manage to have some cash left over at the end of the month. Sure, you’d love to buy a new outfit or go on a trip, but you decide to do something responsible with it.

Two obvious options: invest, or plow it into knocking down that tall stack of student loans a little quicker. So which is the better choice?

At first blush — and as I’ve pointed out in the past[2] — the decision should be decided by interest rates. From a late 2012 article:

“Even if you have loans to pay back[3], investing may still be a better move than paying down that debt early. Think of it this way: If you have a loan with a 3% interest rate, for example, paying it back early is the equivalent of getting a 3% return on your investment.”

A 3% return isn’t too difficult to beat, so you’re better off plowing that money into the market. Heck, so far in 2013, the S&P 500 has climbed 15%.

A quick instructive video from USA TODAY[4] follows the same logic. If you have a loan with a higher rate — say 6% or more — the video says, you should opt for paying it off that early since it’s less likely you’ll beat it investing.

It’s a sound theory.

However, I’ve experienced this a few times myself and can tell your firsthand that the decision is far from simple. It’s easy to set up an equation that will tell you the best place to put your money, but that’s part of the problem with economics: It doesn’t consider the fact that emotion, sentiment and psychology play a role.

See, while in terms of returns, investing might make sense for me right now, there’s a part of me that just wants to have my loans done. Gone. Goodbye. Such peace of mind might not be quantifiable in terms of money I’m making or saving, but it sure would be nice to have.

Plus, knowing I’m not thousands of dollars in debt could also allow me to invest more aggressively when I do have the funds available — something that I should be doing because of my age, but have trouble pulling the trigger on. In that sense, it could indeed boost my returns, just not right off the bat.

So, what’s the right answer? I like what Charles Sizemore — editor of the Sizemore Investment Letter[5] — recently wrote (albeit about a different topic[6]):

“When my mind tells me to invest but emotions tell me not to, I split the difference. Rather than go all in, I start small and average my way in over the course of a few weeks or a few months.

Is this a scientific approach? No, but it helps me to manage my emotions, which is the single hardest aspect of the investing process.”

With Sizemore’s advice in mind, if you’re a recent grad trying to decide what to do with some extra cash, put some of it in the market and some of it toward your loans.

Still, it’s far from cut-and-dry. At one point this summer, for example, I was planning to take my extra cash and throw it at my student loans, since I hadn’t sliced a little extra off the pile lately. But when the markets sold off heavily, I decided it was a better time to snatch up an ETF that I had been eyeballing instead.

The bottom line: There’s no equation that factors in timing or emotions. And while it’s easy to understand the logic behind what experts say you should do, it’s also impossible to ignore the reality that other factors will inevitably sneak into your financial decisions.

So when in doubt, don’t be afraid of treading the middle ground.

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Endnotes:
  1. [Image]: http://investorplace.com/hot-topics/young-investors-series/
  2. I’ve pointed out in the past: http://investorplace.com/2012/12/10-reasons-20-somethings-should-invest/
  3. if you have loans to pay back: http://investorplace.com/2012/12/4-rules-for-grads-swimming-in-student-debt/
  4. quick instructive video from USA TODAY: http://usatoday30.usatoday.com/video/ask-usa-today-student-loans-or-invest/1762272871001
  5. Sizemore Investment Letter: http://sizemoreletter.com/
  6. albeit about a different topic: http://investorplace.com/2013/04/its-not-too-late-to-chase-stocks/
  7. Sign up for our Young Investors e-letter: https://order.investorplace.com/index.jsp?sid=QL8104

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