pay off student loans or build savings?

[muddy]

I stumbled across this site and found a lot of good stuff here. My question is: should I use extra income to build up savings or pay down my significant student loans..

So far I've mostly been trying fund my ROTH and then save for a rainy day, with the thought that my interest rates are low on my student loans and I need to have some cash on hand in case of a job loss or unforeseen expense. Now that I have a couple of months of savings built up, I'm wondering if I shouldn't be more aggressive putting extra money to student loans. I'm curious what you guys think. Here's some additional information:

I'm 24, single, relatively low living expenses (lots of roommates and low COL city) and above average income for my age. On a typical month I have $1,000 to $1,250 after expenses to save, invest or put towards debts

Assets:

Cash Savings = $9,000
Roth IRA = $12,000
Taxable Brokerage Account = $1,500 (handful of indiv stocks)
Defined contribution pension = approx $5,000 vested

Liabilities:

Student loans = approx $45,000 (interest rates vary, but the majority are in the 2.5-3% range)
Car loan= $13,000 (2% interest rate)
Credit Card debt = $0

Shorter term financial goals: possibly go back to grad school full-time, although much of that cost would probably be financed

Long term goals: same as most everyone else, own a home, retire comfortably, live the dream, yada yada you know

 

[clifp]

You are doing very well for your age and especially in this economy.

Given the very low interest rates for you student loans I would definitely be in no hurry to pay them off. Except if you have some that are above 5%, they are decent candidate for paying off early. At the 2-3% interest rate I'd focus on savings.

Your car loan is a different story. The interest rate is also very low (although unlike student loan it isn't deductible) so no hurry to pay it off. However, IMO a good intermediate goal is make this car the last car you ever borrow money to pay. You can generally get a better paying for a car in cash than taking advantage of the low interest rate loans dealers offers. So I recommend directing about 1/3-1/2 of your saving in to a car fund which pays off your existing loan and than saves up to buy the new car in the next 5-7 years.

All in all you look to be on track to have net worth before you are 26. That is no easy feat now days congratulations and welcome to the boards.

 

[jimnjana]

I would be paying extra on the car loan, and then when that is paid off put the car loan payment against the student loans. I would build up the cash account a bit more as well.

 

[Celany]

I would focus on getting that car loan paid off first. That's the one that isn't getting you anything at all, & is actively just sucking money away. The car fund idea that clifp suggested is great if you think you're going to continue to live in an area where a car is a necessity.

Beyond that, I think it depends on both interests rates & your temperment. I couldn't stand having student loans hanging over my head, so I paid them off first (although I still funded my ROTH IRAs while doing it). The student loans bugged me enough that I made more sacrifices, in the name of getting those paid off, than I would have made for investing.

But if you've found investments that you'd get a better return on vs. the interest that you're paying on student loans, & neither choice really calls to you mentally, I'd go with doing more investing first. Especially since you do get a *little* back in the way of deducting that student loan interest from your taxes.

 

[slazenger]

You're paying too much to your broker, even if it's discount. It's not a good idea to have a "handful of stocks" amounting to $1500. IMO, that's not enough to justify the purchase of even one (individual) stock.

For your taxable account, try a money market fund until you meet the fund minimums of a balanced mutual fund, preferably tilted more towards bonds, or even a short-term bond fund. Given the amounts you listed total, I can't think of a good reason to have a 100% stock, taxable account since it is likely that money will be for short or mid-range goals. Combine that money with the "cash savings".

I have some individual stocks, but I don't even purchase ONE until I have at least $2000. Using Scottrade, that'd amount to a 0.7% expense if i held the stock for a year (0.35% to buy, 0.35% to sell). Comparing that to Vanguard, that's pretty high.

 

[aaronc879]

I don't see you mention a 401k or equivlant. If you have one you should put in enough to get the full match then max your ROTH. After that, I would add to your cash savings since your rates are low on your debt. If your cash starts to exceed a full years worth of expenses and you already maxed your ROTH then you could start to make extra payments on the car loan.

 

[seabourne]

Because student loans are tax deductible, you are pretty much owing $58k at 2% interest overall. You don't say what your monthly expenses are - this matters a bit because I don't know if you have 2 or 9 months expenses saved in cash. If it's 3 (likely) then I would suggest saving in your cash account until you hit 6 or 7 months expenses in cash, then invest 3 or 4 months worth at once, reducing your cash to 3 months and keeping your trading expenses minimal. I would also pay attention to what stocks you own in a taxable account: Berkshire won't pay any dividends, so your taxes will be deferred until you sell, GE would pay quarterly, and you'll have to pay taxes on the payout, so be aware.

Someone mentioned a 401k - of you have one with matching, use it up to matching. If not, look at opening something similar, such as an individual 401k or other account as fits your employment. Given the very low interest rates on your loans, I would put prepayments into investments and keep your cash account heavy, but it's a matter of risk versus reward. You are 24, and I would suggest that you can take the risk for the reward, but what lets you sleep soundly at night will matter more than the couple of points difference.

 

[muddy]

Thanks for the comments everyone! Couple of things -

My company does not offer a 401K.

Student loan interest is deductible, but that deduction phases out aggressively once you get over 55K of income. I make more than that. The tax man cometh!!!

The point is well taken that when I buy a stock for $7 on scottrade, I could have paid 0.2% on a Vanguard fund. In the long run, the vanguard fund will probably have a better return. However, I don't think this is a tragedy. I know that I've spent 20 bucks on many things that will have less long term value than small slivers of companies like boeing. I'm learning about investing and all of the stocks I've bought have performed well. Obviously it helps when you buy stocks in a raging bull market, but all 3 stocks I've bought have outperformed the dow and 2 out of the 3 have beaten the S&P. I'm not claiming to be Warren Buffet and I've read A Random Walk Down Wallstreet. The benefits of diversification and low costs are undeniable. I'm comfortable with what I've done so far, but it's definitely worth thinking about, particularly as I have more assets in the future.

 

[RAE]

IMO a good intermediate goal is make this car the last car you ever borrow money to pay. You can generally get a better paying for a car in cash than taking advantage of the low interest rate loans dealers offers. So I recommend directing about 1/3-1/2 of your saving in to a car fund which pays off your existing loan and than saves up to buy the new car in the next 5-7 years.

I agree 100% with this advice. The car loan is the biggest thing that is dragging you down right now. I understand that you need a reliable car for work, but direct some savings to a car fund over the next several years so you can avoid getting into this position again. Avoid financing cars at all cost.......that is where dealers make their money.