Pay Debt vs Invest. I invested. Right Choice?

[JonSnow]

I want to thank everyone on this forum as I have learned so much reading all the posts. I've read The Bogleheads' Guide to Investing and wants to invest, but should I be investing or paying my debt?

Age: 30 in 2013
Income:
115k to 120k Gross
Federal Tax Rate 28%
State Tax Rate 7.95%
Filing status is Single
Job Security: Very safe.

Debt:
Student Loan 12,800 @ 6.550%
Student Loan 19,311 @ 6.550%
Student Loan 86,012 @ 5.375%
Mortgage 212,988 @ 4.250%
No credit card or other debt.

2012 Contributions:
401K = 17,000
Roth IRA = 2,500 (opened in December 2012)

Planned 2013 Contributions:
401k = 17,500
Roth IRA = 5,500.

401K Details:
Current Balance, approx. 35K, Company match up to 6%.

Emergency Fund: enough for 6-12 Months.
---

I feel very behind in terms of retirement savings. Started my full-time job late 2011 after graduation, 2012 was first full year of working full time and contributing to the 401K.

My question is, am I doing this right?
1. If I don't contribute to the 401K, I am paying a A LOT taxes @ my current tax rate. Even If I contribute just 6% to get the match, I feel like the tax-deferral benefit is too great to pass on. Regardless of my contribution to the 401K, It will not change my tax bracket. Since I feel behind in retirement savings, (started career too late), I feel that I need to contribute the maximum amount to catch up. Am I over-valuing this tax-deferral and should just contribute the 6% and pay off the loans as quickly as possible? In addition, the student loan interest is not tax-deductible for me, which gives me another incentive to get rid of them.

2. Should I even bother with the Roth IRA? Once I read about the power of compounding interest, there was no going back, I had to invest, but at what cost? those 6.550% loans are are too high for my taste.

3. If I focus all my effort into student loan repayment, it will delay my retirement savings for a few more year..eek!

Thank you all in advance.

[epilnk]

Am I over-valuing this tax-deferral and should just contribute the 6% and pay off the loans as quickly as possible?

Yes. Take the match - it's free money. But there's no reason to expect that your 401k and/or Roth will return over 6.55%, tax adjusted or otherwise. So go for the sure thing.

You'll never get these years back, but you're only 30. A lot of us started much later than that. It's harder to catch up but you need to get yourself to the starting line.

[interplanetjanet]

2. Should I even bother with the Roth IRA? Once I read about the power of compounding interest, there was no going back, I had to invest, but at what cost? those 6.550% loans are are too high for my taste.

The problem is that debt compounds, as well.

I would use your 401k in your tax bracket (though not necessarily to the maximum), but I would pay down debt in preference to contributing to a Roth IRA. You have a lot of debt at fairly high rates for these times, and knocking it out will help significantly.

3. If I focus all my effort into student loan repayment, it will delay my retirement savings for a few more year..eek!

You have to pay the loans off one way or another, and they count against your net worth regardless. Like I said, I don't think I'd throw everything at them (though I probably would if they were credit card debt at high rates) but I would attack them aggressively. You make enough such that you should be able to knock out the debt in a reasonable period of time, if you are frugal.

[rr2]

If your job is very safe, I would decrease the emergency fund to 3 months. In fact put the emergency fund in a Roth IRA in some safe investments. Contribute enough to get the 401k match and throw the rest at the debt.

[lindisfarne]

Always get the match on 401k.
Live frugally & knock the 2 smaller loans (with higher interest rates) off in a year or so. A guaranteed 6.5% return is quite good. (Which loan you attack might not only depend on interest rate. You might want to weigh the terms & whether any are private loans (gov't loans usually have better terms). This may not really matter for you given that you feel your job is very safe.)

I'd also look at whether you can get a better interest rate on mortgage - 4.25% seems high. I'm assuming it's 30 year? I wouldn't do 15 year because your loans are so high & you'd rather pay those off). You can run the calculations to see if refinancing makes sense - if you can get down to 3.625% or less on a 30 year, with reasonable closing costs (I think you can), I think that would save enough to make refinancing worthwhile. (If you'd have to have Private Mortgage insurance on the refinance, that's not as good - look hard at whether you can get down to 80% LTV).

Once you've gotten rid of at least 50% of total loan balance, start to think about contributing more to 401k. If you're committed to being frugal, you could be there in about 3 years (less if really frugal). Some people might say pay all the loans off first & that's also a reasonable position (you'd have to weigh the interest paid on the loans vs. what you feel you forgo by not being in the market; I wouldn't let the feeling that you're behind in retirement affect your decision too much because with your income, you can make that up quickly).

As mentioned above, at least part of your emergency fund could go in the Roth.

[leo383]

Yes, 401(k) up to the match for sure.

After that, I'd be very tempted to knock out those 5+% loans ASAP.

After that, I'd consider debt vs.investing to be pretty much a tossup.

[NYBoglehead]

If your job is very safe, I would decrease the emergency fund to 3 months. In fact put the emergency fund in a Roth IRA in some safe investments. Contribute enough to get the 401k match and throw the rest at the debt.

+1

I don't see how paying the loans off quicker will delay your retirement. There are two sides to the personal finance coin. Those interest rates are very high, much much higher than you can safely get elsewhere.

[letsgobobby]

This is not meant to be smart alecky, but can you do both by looking again at your overall expenses?

[Grt2bOutdoors]

Leave your emergency fund alone even if your job is secure. Sometimes you need cash and the vendor will not take a credit card or your word of repayment.

Great job on maxing out 401k and Roth - I'd continue along this path as time is your friend.

Any disposable income should be directed towards those 6%+ student loans. No taxable investing until you knock those two loans off.

[HonoluluGator]

Is it possible to do student loan consolidation? I did mine years ago, when interest rates were much higher than today, and got a much lower rate than you have, but not sure if these consolidations are still available.

I made the mistake years ago at figuring I can get a better return on investing than on paying off loans, and I was wrong. Now I am paying down loans much more aggressively, but only after taking care of my tax advantaged retirement options first. I just feel better getting out of debt, but I also want to work on a nest egg.

Here is my "happy medium" option.

1. See if you can consolidate student loans to a lower rate.
2. Spend as little as possible.
3. Max your 401k.
4. Max your IRA.
5. Use the extra to pay down loans.
6. Once the loans get under better control, then worry about investing extra money in non tax advantaged accounts.

There are much smarter people than me on here when it comes to financial advice, and you may do better by paying down some of the loans before maxing the IRA's, but I personally like the psychological advantage of of saving in the Roth at the same time as paying down the loans.

[ObliviousInvestor]

Take the match - it's free money. But there's no reason to expect that your 401k and/or Roth will return over 6.55%, tax adjusted or otherwise. So go for the sure thing.

This would be my approach.

Looking at it from the other perspective, I wouldn't even consider borrowing money at a 6.55% rate (or, frankly, even a 5% rate) in order to invest it -- even if I hadn't maxed my retirement accounts for the year.

[nimo956]

With the way your interest rates are setup up (higher rates on the smaller balances), you could use the debt snowball method. Pay the minimums on all loans and direct everything extra to the one with the smallest balance. You'll pay this loan off quickest, and when you do that frees up cash flow which you will then direct towards the loan with the second lowest balance, and so on.

I personally started out by investing rather than paying off my student loans, but I hated constantly monitoring my performance to make sure I was beating the interest rates on the loans. While I actually was beating the interest rates, after a few years I just decided to go with the sure thing and pay off the balance (and I haven't regretted it since). There's a lot of peace of mind when you're debt free. I would fund your 401k up to the match and forgo all other retirement contributions until your student loans are paid off. Also look into refinancing your mortgage (and getting rid of PMI if you are paying for it).

[Toons]

Get the 401k match,beyond that keep chipping away at the debt with laser like focus until it is paid off.
Live frugal and Budget

[Random Musings]

I'd keep the emergency fund where it's at.

With your job being very safe, 401K to match and continue Roth.

Pay off the 6.55% student loans first (if you are motivated, you may be able to do that in one year if you watch your budget), then 5.375% next. See if you can refi the mortgage if the payback is reasonable.

RM

[BL]

If your job is very safe, I would decrease the emergency fund to 3 months. In fact put the emergency fund in a Roth IRA in some safe investments. Contribute enough to get the 401k match and throw the rest at the debt.

+1

You have received many good suggestions here even though some may be conflicting. If you can spend a little less and put any raises into debt payoff, you will get out of debt and have retirement funding in good shape just a little sooner. Also check out refinancing your home.

Are any of your loans variable rate?

[tyrion]

"You know nothing, Jon Snow!"

Sorry, couldn't resist

I agree the advice given above is good. You should invest in the 401k to the match at a minimum. You should pay down your debt (highest interest rates first). The rest (401k past the match vs Roth vs debt repayment) is a function of which gives you the best feeling of accomplishment and how you view potential investment gains going forward.

Some people are debt averse, and will want to pay off the student loans first. Others want to start building for the future, they will want to invest in the 401k and Roth. Probably a mix will work best for you.

[JonSnow]

"You know nothing, Jon Snow!"

I want to thank everyone for their advice to start, I appreciate all the input and it seems that paying off some of the debt is the general consensus here. I had suspected to be the better choice, it was good to get some opinion from more experienced folks.

Here is my plan:
1. Contribute to 401K @ 14% of Gross income, contributing 6% for the match vs 14% will only change my net income alittle over $100, which I can live without.
2. Send 40.63% of my net income to student loans. The big loan @ 5.375% is a consolidated loan. I didn't consolidate the 6.550% one cause they were higher rate and i wanted to pay them off quickly.
3. Mortgage is 26.87% of net income. I've only purchased the place in Oct'11 and the balance is still quite high vs. the loan amount. I plan to move in a few years possibly. Not sure if its worth it to refinance? Any opinion on this?
4. Another 15% of Net in come will go to other bills that I can't escape from.
5. Now I have 17.5% of my Net income remaining, for food, gas, other necessary expenses of daily living + leisure. Whatever I don't spend I will throw it toward the student loan. I am already living frugally, but there is still room for improvement I am sure.

Goodbye Roth IRA for a few years.

Does that sound like a workable plan?

[Grt2bOutdoors]

No need to be a monk, either. Are you sure you can enjoy your life taking a vow of "poverty"? Balance is key. Your proposal sounds unhealthy.

[Khanmots]

3. Mortgage is 26.87% of net income. I've only purchased the place in Oct'11 and the balance is still quite high vs. the loan amount. I plan to move in a few years possibly. Not sure if its worth it to refinance? Any opinion on this?

How sure are you that you'll be moving? If reasonably sure that you'll move before 5 and quite sure of before 10 years are out, and will have (or can get) 80% LTV, it may be worthwhile to refinance into penfeds 5/5 ARM. It's currently at 2.625% for the first 5 years, with a max of 4.625% for the 5 after (and a lifetime max of 7.625%). As they pay all closing costs, even if you move in a year or two you'll be ahead. That said, if you think there's a reasonable chance of you still being in this house 10 years from now, the 5/5 ARM is not as good of a choice (unless you pay it off by then of course!)

Does that sound like a workable plan?

Sounds quite workable to me. Just make sure that you don't go *too* frugal! It is ok to live and have fun today, just keep it in moderation

Of course if you enjoy a life of austerity (I kinda do... ) that's one thing. But if you want various things and stuff or nifty trips or whatever, don't completely deny yourself. That's not healthy and it's a good way to be unhappy. Don't go hog wild either. Moderation!

[Savvy]

You can still contribute to your 2012 Roth Ira until mid-April. Fill that up before contributing to the 2013 Roth IRA.