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College Student - Is investing right for me?

Posted: Fri Mar 04, 2011 10:42 pm
by Jag6313
Hi all,

First, I want to say thank you so much for all creating/contributing to such a friendly and wise forum.

I have been lurking and reading for a few days now trying to amass as much knowledge as possible and feel I have finally found a few questions that have not (or maybe cannot) be answered through others situations.

Let me give you all my information and then I will get to the situation/questions.

Age: 23

Occupation: Student

Funds: 16,000 (Currently all liquid - 14,000 in High Yield Savings and 2,000 in checking)

Fund to invest: $3-5,000

Debt: $21,833 in student loans

Federal Tax Rate: 15% for past two years, this year may be 10%

NC State Tax: 6%

Portfolio: I imagine it would be 80/20 or 90/10 stocks and bonds

Part 1:
Ok, with all that in your mind here is my situation. I just finished reading Bogleheads': Guide to Investing. Great book, but I am still a little lost in my financial situation!

I am currently finishing classes in May of this year. After that time I am to do a cooperative education employment. This is where I go to work (it is paid) with an employer in my field of study for 3 months. At the end of that 3 months (in August) I will officially graduate and my student loans will begin counting down.

At this time no permanent job is on the horizon, though it is somewhat likely (have not figured out where to live, where my significant other is going, etc). I have also recently begun my application to teach English abroad next year through a Fulbright Fellowship, which if granted, I would be able to defer my loans for another year (though I would momentarily need to pay them between February and June). Again, this award, if perused, means no permanent job in the near future.

I am extremely interested in investing and would like to start sooner rather than later. I am unsure though of whether or not my student loans should take precedence or my investment for my future?

Part 2:
If the general consensus is that I should invest, what is the best first course of action?

I currently have two options in my head (though please suggest others if you like!):

1)Vanguards Target Retirement Fund - My only question with this is if it is better than me attempting to create my own portfolio or not?

2)IRA - After reading Bob's not my name's post (Cannot include the link yet, but it is titled "TIRA as Emergency Fund / Insurance") I am confused as to whether a tIRA or Roth is appropriate. Any explanation would be most helpful (I did read the wiki as well, but that only confused me too).

I may be missing the point on this, but I know you can put things inside your tax-deferred account (though I do not quite understand this). Would putting a target retirement fund inside of an IRA be the best of both worlds?

Part 3:
I realize this is a lot at once so I'll try to sum it up succinctly.

I am 23 year old student who is graduating in august and has no permanent job on the horizon. I have approximately $22,000 in student loans that will need to start being paid within the next year. I am extremely interested in investing and would really like to start sooner rather than later. Should I focus on paying off my student loan debt or invest? If investing seems like a great way to go, which is my better option; Target Retirement Fund, an IRA (Roth or Traditional) or something I have not thought of?

I look forward to all of your responses and will try to answer any questions quickly and effectively as possible!

Thank you!

I'll be updating with responses below as to try and consolidate all my information into this one post!

grberry - I have already begun practicing my saving skills, which I feel is one of my strongest assets. The only expenses I really have are gas, food, books and clothing as well as the occasional drinks with friends. I moved to Kentucky for a co-op this fall and in three months managed to save 7,500 of the 12,500 I made in that time.

I agree with your thoughts and while I made a outline of my future plans I neglected the immediate ones like moving costs after graduation for work, possibly a new car (for my girlfriend as I have a great econbox that gets in the mid 40s around town [you'll be happy to know I purchased it for $1300 and am ASE certified so repair labor is a non issue)), and the like. I'll go back and update what I have.

grberry, retcaveman - I currently have the following six loans:

$4,500 @ 6.8%
$4262 @ 6.8%
$821 @ 6%
$5,500 @ 5.6%
$4.000 @ 5
$2,750 @ 4.5%

Since they are all federal I have the option to consolidate. If I did I would have an overall of 5.875%. Paying about $4000 per year I can manage to decrease the amount of interest owed to approximately $5,000. If I can find a way to pay it off faster though, I will.

Posted: Fri Mar 04, 2011 11:23 pm
by grberry
What is most important at this time is that you develop financial discipline. The basic is that you should be keeping your income above your expenses (or your expenses below your income) and becoming a disciplined saver. Try to pay cash for everything possible - taking on added debt when you are starting out can be very expensive in the long run.

I suggest you set out your goals and make plans. Over here EmergDoc discusses goals and planning in the context of goals in the one to twenty year time frame. In the next few months you are going to graduate. After that come some significant life changes, several of which carry financial implications.

Here are four examples:
1) You'll be moving to new housing. If you move to a major city and get an apartment, the landlord will probably be looking for two to four months rent before you move in (first/last/security deposit/agent's fee). In some places, that is only a few hundred dollars. Hereabouts, that is a couple thousand dollars.
2) You may need transportation. A quality used car costs a few thousand. A beaten up used car costs less, but will probably cost more to operate.
3) You and your girlfriend might want to get married, which has costs. (Don't buy too much rock - I cut the diamond industry's recommendation roughly in half and my wife and I have both been happy. Others here might argue for going even more thrifty than I did.)
4) You might want to buy a house some day, and to start saving towards a down payment.

You need to think through all these upcoming changes, and come up with a plan to handle it all while keeping a funded emergency account.

After you have that plan, you may have some money left over. I certainly hope that you do. So then you should develop the habit of putting your money to use, or saving it. There are two natural ways of saving - paying off existing debt faster and investing. Both are forms of savings. Paying the interest on debt isn't saving, that is paying your expenses. But putting extra towards the debt is an savings that lowers the future interest expense.

You didn't say the interest rate on your loans, but unless it is amazingly low, you can get a better rate of return by paying it down than from any risk free investment. Traditionally, one year U.S. government bonds have been thought of as risk free. Right now a 1 year treasury obligation is paying just under one-quarter of one percent. Even five years was only at 2.3% today. You won't get a better risk free rate of return on your existing money by investing than you will by paying down the loans - I recommend picking whichever one has the highest interest rate.

From your income, I recommend that you plan on investing for retirement. Starting that now will make the entire process less painful and require less of you later in life. But I recommend using what you can of cash on hand to eliminate debt.

Posted: Fri Mar 04, 2011 11:28 pm
by retcaveman
What is the interest rate on the loan(s)?

Posted: Fri Mar 04, 2011 11:38 pm
by hsv_climber
Open Roth IRA @ Vanguard and invest $5K into 2050 Target Retirement Fund.
Use the rest of the money to build emergency fund and repay student loans.

Posted: Sat Mar 05, 2011 1:38 am
by campy2010
Currently, there is no benefit to consolidation of federal student loans and I would advise against it. Consolidation only offers a weighted average of the student loans you already have so there are no interest savings. Plus, you loose the ability to pre-pay principal on the higher interest loans and loose some options for in-school deferment and hardship forbearance. Consolidation is falsely advertised as a beneficial thing to do when that is simply not true.

If you do indeed decide to teach abroad for a year then I would try to avoid putting my loans in deferment during that period, unless absolutely necessary. If you are on a 10 year repayment plan then one year adds up to about $2400 in payments. Manageable on your savings. Every time you defer a loan, interest is capitalized and you become even further behind. Keep the econo box and pay down your student loans instead.

Posted: Sat Mar 05, 2011 3:52 am
by MrMiyagi
Contribute to a 403b/401k up to the match.

Then pay off the loans. 6.8% is very high and you can't get a guaranteed return like that with index funds.

Re: College Student - Is investing right for me?

Posted: Sat Mar 05, 2011 6:37 am
by Bob's not my name
Jag6313 wrote:$4,500 @ 6.8%
$4262 @ 6.8%
$821 @ 6%
$5,500 @ 5.6%
$4.000 @ 5
$2,750 @ 4.5%
Are any of these subsidized (no interest accrues while you're in school)? Are any of the interest rates variable?

At these rates you should prioritize paying off debt over investing, as others have already advised. You should pay off unsubsidized debt first, because it's currently accruing interest, and obviously you should pay off the highest rate first. If you have mixed subsidized/unsubsidized you can selectively pay off the unsubsidized first, but do follow up to make sure the debt servicer didn't screw up -- this happened to me when I paid off my kid's unsubsidized loan.

Posted: Sat Mar 05, 2011 7:54 am
by beyou
Top financial priorities :

1) Pay down debt
2) Build some cash reserves for emergencies (and think about what
is really an emergency -inability to eat or have a roof over you head).
3) Put small amounts in a Target Date fund just to force some early discipline at saving, and dealing mentally with the ups/downs of the markets. Think of this as your retirement "bucket".
4) Think about when you want to settle down, start a fund towards
downpayment on your first home. If you don't think that's for 10 years,
you could consider funding a different Target Date closer to that timeframe (more conservative for a short term goal than retirement).

No need to have multiple funds to get started investing, it's only a distraction now, but I think it will be a motivator to watch the balance grow (and a good lesson when the markets cause the opposite). Open with min balance and then add a small amount on autopilot untl you have met 1st 2 goals (at which point start to increase the additions. You can always move to a multi-fund asset location strategy once you have more significant savings and a higher tax bracket.

Re: College Student - Is investing right for me?

Posted: Sat Mar 05, 2011 9:17 am
by JupiterJones
Bob's not my name wrote: and obviously you should pay off the highest rate first.
In my book, it's not so cut-and-dried. There are several schools of thought about which debt to attack first in a multi-debt situation.

IMHO, a good case can be made for paying off the lowest balance first. Especially if most of the rates aren't horribly different and the overall time horizon for paying off all the debts isn't too many years.

The main advantage is that it frees up cash flow. If an emergency strikes, the fewer mandatory minimum payments on loans you have to make, the better. Paying off the smallest debts first knocks out mandatory "have to" payments the quickest.

Then there's the often-undervalued psychological aspect. There's a lot to be said for the motivation a few quick wins will give a person.

In the end, I'd recommend calculating it both ways--highest interest first and lowest balance first. The total interest paid and time taken will always be the smallest with the highest-interest-first method. But the difference could wind up being less that you'd think, and might be worth it for the cash-flow and momentum advantages you gain.


P.S. All that said, I'll agree with the posters who are prioritizing debt repayment and emergency-fund-building over investing. Investing a great idea, particularly while young, but it's nonetheless "dessert". You've got to eat your peas and drink your milk first. :P

Posted: Sat Mar 05, 2011 11:30 am
by Jag6313
Campy2010 - Thanks for the insight I had no idea deferment allowed for continual compounding! I will probably not do that now if I can help it!

Bob - The only unsubsidized loan is the 4,262 @ 6.8% loan. The rest are subsidized and the $4,000 @ 5% is a Perkins Loan (no interest accrues while in school and payments begin 9 months after my graduation date). I'll be sure to contact them and double check that these figures are all legitimate!

JJ - I understand what you are saying. I have entered all of my loan data into excel and am currently playing with what the best plan of action is for repaying my loans and keeping interest to a minimum.

I really appreciate everyone's response! It is very helpful for me to clear that up so I can fully focus on chipping away at my loans (especially my unsubsidized) while building up a larger emergency fund. This will give me ample time to keep reading and searching the forums as well!

Thanks again!

Posted: Sat Mar 05, 2011 4:09 pm
by Bob's not my name
Jag6313 wrote:The only unsubsidized loan is the 4,262 @ 6.8% loan. The rest are subsidized and the $4,000 @ 5% is a Perkins Loan (no interest accrues while in school and payments begin 9 months after my graduation date). I'll be sure to contact them and double check that these figures are all legitimate!
I'm not a federal loan expert but I see that wrote:Interest does not accrue on the loan while you are in school at least half time, or during any future deferment periods. The federal government "subsidizes" (or pays) the interest during these times.

Stafford and Perkins loans:
Principal and interest payments may be deferred while the borrower is:

Attending school at least halftime.
Unemployed (up to three years).
Studying in an approved graduate fellowship or rehabilitation program for the disabled.
Experiencing economic hardship (up to three years).
I'll guess that the $4,500 6.8% loan is a subsidized graduate student Stafford loan and the $2,750 4.5% loan is a subsidized undergraduate student Stafford loan. Not sure what type the 5.6% and 6% loans are. In any case, you should research deferment (and forgiveness) carefully so you have a clear understanding of how likely you are to be able to avoid interest accrual during your coming years. Since no interest is currently accruing on the subsidized loans, they are free cash flow and you are earning interest on the money in your checking account, so you should not repay the loans (but never forget that you have them!). You should also read up on the student loan interest deduction in Pub. 970 and think about interest you will pay in calendar years and whether you are likely to exceed the income limits in coming years -- calculate the effective interest rates given the deduction, e.g., 15% federal tax rate + 6% state tax rate (IF your state uses your federal income after the tuition deduction and does not add that back) = 21%, so 6.8% interest is really 6.8 * .79 = 5.4%.

Pay off the unsubsidized loan immediately if you feel you can spare the money and still have an adequate cash cushion and will not qualify for forgiveness.

Posted: Sat Mar 05, 2011 5:06 pm
by Jag6313
I did not realize all the subtleties of the Perkins loan. I am not sure I would qualify for any forgiveness, but the more I know about these loans the better!

All of the loans are undergrad. I obtained an associates in Automotive Technology before moving on to get my bachelors (in a 5 year program) in Mechanical Engineering. Total I have spent 6 years in school which is why my age is what is most considered to be a graduate level.

The loans with various rates are Direct Subsidized. Depending on the disbursement dates the rates vary. Below is the chart on the Direct Loan service site:

Date of First Disbursement Interest Rate for Subsidized Undergraduate Loan
7/1/08–6/30/09 6.00%
7/1/09–6/30/10 5.60%
7/1/10–6/30/11 4.50%

The Direct Unsubsidized is the 4,262 @ 6.8% (all unsubsidized loans are at 6.8%)

The Perkins is the only other exception with a rate of 5% and much more flexibility in deferment.

My Unsubsidized loans have already accrued 368 dollars in interest and I can pay them off now and still have over a 10,000 dollar cushion.

Currently 90% of my funds are in a High Yield Savings account making about 1% a year.

Would it be advisable to open a Money Market account or something similar until my grace period ends next February? This way I can make the money I have work the hardest for me until I have to return it?

Re: College Student - Is investing right for me?

Posted: Sat Mar 05, 2011 5:19 pm
by market timer
JupiterJones wrote:Then there's the often-undervalued psychological aspect. There's a lot to be said for the motivation a few quick wins will give a person.
If that's the case, why not just create a spreadsheet, then divide and rename all loans into small increments? Someone saving $2K/month could turn a $50K loan into 25 $2K loans, and have the satisfaction of eliminating Loan March 2011 this month. I see no reason ever to pay off a lower interest rate on a smaller loan balance, all else equal.

This framing principle goes beyond loan repayment. Sometimes I think I put more effort into accumulating frequent flyer miles than others because I track their value in my net worth spreadsheet.

Posted: Sat Mar 05, 2011 6:50 pm
by jmbkb4
"no permanent job on the horizon"

you should not be investing. you should be saving for rainy days that are obviously coming.

pay down debt.

Posted: Sat Mar 05, 2011 7:41 pm
by Bob's not my name
Jag6313 wrote:Currently 90% of my funds are in a High Yield Savings account making about 1% a year.

Would it be advisable to open a Money Market account or something similar until my grace period ends next February? This way I can make the money I have work the hardest for me until I have to return it?
You won't do much better than 1% for a one-year term anyway. 1% of $10,000 is only $100, but it's a free $100. More importantly, you need the $10,000 of liquidity.

Make sure you deduct the $368 interest on the first page of your 2011 tax return.

Posted: Sat Mar 05, 2011 7:54 pm
by Bob's not my name
Looks like the Perkins is your best deal.
DOE wrote:A borrower may defer repayment if he or she is enrolled and in
attendance as a regular student in a course of study that is part of a
graduate fellowship program approved by the Department, including
graduate or postgraduate fellowship-supported study (such as a
Fulbright grant) outside the United States.

A borrower may defer repayment on a Perkins Loan for up to
three years, regardless of disbursement date and contrary provisions
on the promissory note, if the borrower is seeking and unable to find
full-time employment.