Paying student loans vs Losing compounding interest

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pennstater2005
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Paying student loans vs Losing compounding interest

Post by pennstater2005 »

Is it worth it to lose years of compounding interest from investment contributions to instead direct money to pay down higher interest rate student loans? I'm pretty sure I know the answer but was interested in possible different perspectives.
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Re: Paying student loans vs Losing compounding interest

Post by Longtimelurker »

pennstater2005 wrote:Is it worth it to lose years of compounding interest from investment contributions to instead direct money to pay down higher interest rate student loans? I'm pretty sure I know the answer but was interested in possible different perspectives.
Debt compounds same as investment returns. Math is math.
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Jay69
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Re: Paying student loans vs Losing compounding interest

Post by Jay69 »

I think a general rule is to take the free money (401k/403b matches, etc.) then pay down debt.

I'm a big fan in those years to build up your emergency fund in a Roth, if you don't have an emergency you save some space.
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Re: Paying student loans vs Losing compounding interest

Post by jimb_fromATL »

pennstater2005 wrote:Is it worth it to lose years of compounding interest from investment contributions to instead direct money to pay down higher interest rate student loans? I'm pretty sure I know the answer but was interested in possible different perspectives.
Not worth it if you are paying virtually any income taxes that can be deferred in a tax-deferred retirement plan; and can afford the payments; and if you want to put your money to its best use to build wealth and security for the future instead of just feeling good about getting rid of a debt faster.

You get to defer taxes in your highest bracket now by maxing a 401(k) or other plan and investing the money to earn compound interest for the rest of your life. Then even with the same income after retirement –adjusted for inflation— and with possible substantial increases in the tax rates in the graduated tax brackets, you'll most likely still pay a lower total percentage of tax on your withdrawals after retirement and thus have more money after-tax in the long run.

Plus, debts are compound interest in reverse, and in compounding Time is an exponential factor more important than Rate in determining the total interest earned in an investment or paid out on a debt. You earn compound interest on investment for the rest of your life, but even student loand and mortgages are relatively short term by comparison.

My post in THIS THREAD shows an example illustrating how losing even a short time for investing and compounding -- and paying taxes when you could have deferred them by postponing retirement contributions-- can cost an astounding amount of money out of your future retirement income in exchange for saving only a tiny fraction as much interest on the relatively short term debt. Here's another example

If you want to post some more details such as your age, tax brackets, income, whether you have any tax deferred plans available, and your debt balances, rates, and minimum payments, we can go into more detail about how much it might cost you to pay off your debts too fast.

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Re: Paying student loans vs Losing compounding interest

Post by pennstater2005 »

A couple differing opinions already. I am considering continuing to invest while directing extra money at least to the higher rate loans. Currently were only investing about 10% of income due to student loan debt. The high rate loans are all 6.8% and the rest are all 3.25% or less most at 2.35%. I was going to direct some some freed up money to increasing savings rate however may now at least pay extra towards high rate loans. Thanks for the responses so far as any insight is helpful.
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Re: Paying student loans vs Losing compounding interest

Post by JupiterJones »

As you'll see from the responses here, there isn't really one "correct" answer. There are lots of factors involved, and the correct answer for you depends on your situation, and on what you value and want to focus on.

If we assume you will always have a job and a steady source of predictable income, and we assume that there is a high degree of certainty you'll get a given % return on your investments (with matching figured in), and you don't mind one way or the other if you have debt or not, then it becomes a fairly simple mathematical problem: If you are losing more in loan interest that you'd gain in investment interest, prioritize the student loans. Otherwise prioritize the investing.

But those assumptions don't always hold. Jobs and income aren't always secure, student loans are often not bankruptable, feelings about debt vary, etc. There can be a real benefit, from a risk perspective, to quickly freeing up the cash flow that's now directed at your loans, and that benefit may be something you value more than the potential interest you'd otherwise get from investing the same money.

Personally, I think that any company match provides such a huge immediate return on investment that it's tough to beat in all but the most dire circumstances. Beyond the match is where things can get fuzzy. So I always recommend that people crunch the numbers both ways (or in numerous ways if you're considering several scenarios).

With a spreadsheet and some digital elbow grease there is no reason to simply "wonder" what choice is the best. You can actually put a dollar figure on all your options and then choose the one that is "worth it" for you, based on how you (not me or any other forum member--you) value things.
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Re: Paying student loans vs Losing compounding interest

Post by Ketawa »

jimb_fromATL wrote:Not worth it if you are paying virtually any income taxes that can be deferred in a tax-deferred retirement plan; and can afford the payments; and if you want to put your money to its best use to build wealth and security for the future instead of just feeling good about getting rid of a debt faster.

You get to defer taxes in your highest bracket now by maxing a 401(k) or other plan and investing the money to earn compound interest for the rest of your life. Then even with the same income after retirement –adjusted for inflation— and with possible substantial increases in the tax rates in the graduated tax brackets, you'll most likely still pay a lower total percentage of tax on your withdrawals after retirement and thus have more money after-tax in the long run.

jimb
You didn't mention it in your post, but this advice only applies if OP plans to max out all tax-advantaged savings for the rest of OP's life. For example, is OP going to have kids and still be able to max out the 401k if they're in college? If OP isn't in a position to do so, then paying off the high interest debt would beat any safe fixed income investment, and the missed contributions can be made up when the debt is gone. It's also probable that OP's income will be higher in the future, making the additional future contributions more valuable.

I would still invest enough to reach the maximum 401k match, of course.
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Re: Paying student loans vs Losing compounding interest

Post by pennstater2005 »

Age
Him 35
Her 27
Combined income 60,000
Tax bracket 15%
2 kids
Cars paid off
No credit card debt
Mortgage at 4.5% 80,000

Student loan debt total of 60,000 of which 15000 is at 6.8%. Wife has simple IRA and we do get match and then contribute into Tira. Not maxing tax advantaged accounts out as our savings rate is about 10% presently. Don't know if this info helps or not.
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Re: Paying student loans vs Losing compounding interest

Post by Ketawa »

I'm not familiar with SIMPLE IRAs, but some brief googling leads me to believe you have at least this much tax-advantaged space:

SIMPLE IRA: $12k
2x Traditional and/or Roth IRAs: $11k
Total: $23k

Possibly an additional $17.5k if you are covered by a 401k (you didn't mention it). I might have some of this wrong, but I should be in the right ballpark.

It seems unlikely that you'd be able to increase your tax-advantaged retirement savings from 10% to at least 38%, so there's no reason to worry about maxing your tax-advantaged space for the rest of your life. I would invest in tax-advantaged accounts up to the maximum match, then pay off the 6.8% debt as quickly as possible. In addition to the guaranteed 6.8% return, you would benefit from improved monthly cash flow once the debt is paid off.
Last edited by Ketawa on Tue Apr 01, 2014 10:31 am, edited 3 times in total.
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Re: Paying student loans vs Losing compounding interest

Post by jimb_fromATL »

pennstater2005 wrote:A couple differing opinions already. I am considering continuing to invest while directing extra money at least to the higher rate loans. Currently were only investing about 10% of income due to student loan debt. The high rate loans are all 6.8% and the rest are all 3.25% or less most at 2.35%. I was going to direct some some freed up money to increasing savings rate however may now at least pay extra towards high rate loans. Thanks for the responses so far as any insight is helpful.
So ... are you saying that you want to feel good about eliminating the debt faster regardless of the fact that it may easily cost you anywhere from tens to hundreds of thousands of dollars more out of your probable lifetime future retirement income than you'll save in interest on your debt?

If you'll take the time to read my explanations and examples in the threads I linked, it may help you avoid making a very, very expensive mistake that cannot be undone. You simply cannot make up for lost time in earning compound interest. So if you delay contributing the most you can possibly afford to retirement now, even for a few months to a year or two, it can cost you a mind-boggling amount of money in the long run. Plus, the money you pay in your highest tax bracket now will never pay bills, buy necessities, pay down debt, or earn compound interest for the rest of your life either.

Here are some other considerations:

While student loans are usually not dischargeable even in bankruptcy, you stand a pretty good chance of getting income-based-repayments if you fall on economic hard times, and if they're federally-backed loans.

Plus, 401(k)s and other retirement plans are protected from most lawsuits and judgments in case (shudder] you are sued for any reason -- and lose.

Finally, if times are really tough and you can't make the payments, creditors including the tax folks might be able to take some of your assets, and a mortgage lender might foreclose on your home; but no matter how hard they try, they can't repossess your education.

Combine those thoughts with the probability of paying more taxes in your lifetime and losing large sums of probable future retirement income if you reduce your retirement contibutions now ... in exchange for saving only a tiny fraction as much interest on the debt ... and it just doesn't make a lot of financial sense to pay off your debts faster than necessary before you pay yourself as much as possible first.

Here's an example to illustrate the problem. The stock market has historically averaged around 10% or more over long periods of time. I'll use a much more conservative 8% to illustrate that the rate is not really as important as the Time lost. And we'll look at your highest student loan rate.
  • For someone making perhaps $80,000 per year, the $17,500 max for a 401(k) would be 21.88% of gross income. If they only contribute 10% ($8,000), that's a difference of $9,500, $791.67 per month, that could be contributed to the 401(k).

    If you stopped contributing $9,500 per year ($791.67 per month) to a 401(K) and if your top tax brackets were 25% federal and 6% state for a total of 31% then you would pay $245.42 per month more in taxes, leaving $546.25 to pay on the debt.

    That $245.42 is money that won't pay bills, buy necessities, earn compound interest for the rest of your life, or pay down debt either if you don't contribute to the tax-deferred retirement plan.

    A debt of $10,000 at 6.8% can be paid off in 72 months with a payment of $169.53 per month. The total interest will be $2,206.

    Reducing the contributions to the retirement fund and adding the $546 per month remaining after tax to the debt payments will pay off the debt in only 14.6 months with $448 in interest. So you save $1,759 in interest and 57.4 months time on the debt.

    This sounds good at first, but notice that during that 14.6 months you've paid an extra $3,582 in taxes that you could have invested for yourself in order to save that $1,759 in interest.

    If you did not delay your maximum contributions for perhaps 38 years until retirement, earning a conservative average of 8.% will grow to $2,338,829. If you delay it then resume contributions after15 months while paying of the debt faster, you would have a total of $2,111,677 at the end of 38 years.

    That is a loss of about $227,152. At retirement time, but that’s not all. At a conservative 4% earnings during retirement the $227,152 could have paid you another $757 per month in interest earnings. If you lived another 30 years it would result in a lifetime loss of $499,735 in retirement income in exchange for saving $1759 on the short-term debt.

Most people do NOT continue to sacrifice their living standard after they pay off a big debt; and you would not get to defer taxes because of the limits to 401(k) contributions However, if you did have the self-discipline to reinvest the freed-up $170 per month payments with no delay, it could work like this:
  • For the remaining 57.4 months of the original loan, the extra investments earning the same 8% woud grow to an extra $151,463 by retirement.

    Added to the $2,111,677 in the reduced 401(k), you'd then have a total of $2,263,140 in retirement funds. So you're still short by $75,689 at retirement time in exchange for saving the $1,759 interest on the debt.

    And that's still only part of your long-term loss.

    At 4% earnings after retirement that could pay you $252 per month in interest if you never touched the principal. So if you lived 30 more years you would still lose the $75,689 you won't have plus the $90,827 interest it won't earn in the next 30 years for a potential total loss of $166,516 of income during your life in exchange for saving the $1,759 interest on the debt.
The example is for a high rate student loan and relatively low earnings rate in your investment account. If you earned more nearly the long-term stock market averages, and delayed contributions to pay off lower rate loans, the long term loss of retirement income would be much worse.

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Re: Paying student loans vs Losing compounding interest

Post by pennstater2005 »

Ketawa

No 401k. And you are right. I won't be maxing tax advantaged accounts anytime soon. So you're saying get match from simple and then all extra money that would be going to high rate loans and once those are paid off then continue to put money into Tira/Roth?
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Re: Paying student loans vs Losing compounding interest

Post by Ketawa »

jimb_fromATL wrote:Here's an example to illustrate the problem. The stock market has historically averaged around 10% or more over long periods of time. I'll use a much more conservative 8% to illustrate that the rate is not really as important as the Time lost. And we'll look at your highest student loan rate.
8% is not a conservative estimate. For one thing, you should be using guaranteed returns on fixed income for the comparison, since the debt repayment is a guaranteed return. In addition, most investors here are not 100% equities. Even if you (incorrectly) use the expected return for the overall portfolio including equities, it is more likely to be 7% or 8%, since the portfolio probably includes bonds.

The rest of your post isn't really applicable to the OP since his and his wife's combined income is $60k in the 15% tax bracket with two children. It isn't feasible for them to max tax-advantaged accounts for the rest of their lives.
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Re: Paying student loans vs Losing compounding interest

Post by Longtimelurker »

pennstater2005 wrote:A couple differing opinions already. I am considering continuing to invest while directing extra money at least to the higher rate loans. Currently were only investing about 10% of income due to student loan debt. The high rate loans are all 6.8% and the rest are all 3.25% or less most at 2.35%. I was going to direct some some freed up money to increasing savings rate however may now at least pay extra towards high rate loans. Thanks for the responses so far as any insight is helpful.
My post wasn't an opinion. It was a fact. Calculate the rate net of taxes for both options. Understand that paying down debt is 0 risk, while investing has risks. Understand if you get a match or not for investing.

I would get my full match then pay down any debt over 3% net. <- this is opinion.
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Re: Paying student loans vs Losing compounding interest

Post by Ketawa »

pennstater2005 wrote:Ketawa

No 401k. And you are right. I won't be maxing tax advantaged accounts anytime soon. So you're saying get match from simple and then all extra money that would be going to high rate loans and once those are paid off then continue to put money into Tira/Roth?
Yup! Once your high-rate loans are paid off, redirect those payments in your budget to your tax-advantaged savings, or to other loans. I would definitely do this for the 6.8% debt. You will have to weigh the pros/cons for lower interest rate debt. It's a balancing act/personal decision.

You should also have a suitable emergency fund before prepaying the debt. A good place to keep this is a Roth IRA since you can withdraw contributions at any time.
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Re: Paying student loans vs Losing compounding interest

Post by mnvalue »

Ketawa wrote:For one thing, you should be using guaranteed returns on fixed income for the comparison, since the debt repayment is a guaranteed return.
While I think you're right in theory, I don't think that matches how people make this choice in real life. People are always going to invest at some AA regardless of whether they have debt or not.
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Re: Paying student loans vs Losing compounding interest

Post by jimb_fromATL »

pennstater2005 wrote:Ketawa

No 401k. And you are right. I won't be maxing tax advantaged accounts anytime soon. So you're saying get match from simple and then all extra money that would be going to high rate loans and once those are paid off then continue to put money into Tira/Roth?
I see that while I was posting my previous example, you posted more information. I'll revise it later for something closer to your specific situation.

Even if you can't afford to max the SIMPLE for her, it is still to your advantage to contribute more to tax-deferred and tax-advantaged retirement plans instead of paying off the student loan debts faster. Even with only 15% taxes, there's nothing to gain by paying that to the government now instead of investing it to earn compound interest for the rest of your life for yourself.

Since you mention 6.8%, I'm guessing that they are federal loans. So if you're having a hard time making the payments, you can apply for income-based-repayments. It would be better to stretch out the loans if that's what's necessary to enable you to invest more for retirement now.

Do you pay a state income tax? and you live in what state? The tax-deferred accounts are even better if you can defer state income tax now, and live in Georgia or might move to some other state where you'd not pay state income tax on your retirement withdrawals later.

Another consideration, if you don't already have at least 6 months or more of money saved for emergencies. You can withdraw your contributions from a Roth IRA at any time without tax or penalty. Both traditional and Roth IRAs are a once-per-year use-it-or-lose it chance to invest some of your after-tax money where it will earn compound interest for the rest of your life tax-free. So once you have a few thousand on hand for short-term emergencies, it would be better to put more of your "emergency" funds into a Roth or Roths now instead of losing the chance forever. You could move some of your spare cash to a Roth for 2013 between now and April 15th, too.

Just be sure to put any money earmarked for possible emergencies within your Roth(s) in stable value funds like CDs or money market accounts, not stock mutual funds, so you can be sure that the money will be there if you do need it in a dire emergency. At some point in the future when you're sure you have plenty on hand for any emergency, you can move the Roth money into more agressive stock mutual funds. This way, if you need the money for emergencies, you haven't lost anything, but if you don't need it you're way ahead because you didn't miss the chance to put it in a Roth for any given year.

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Re: Paying student loans vs Losing compounding interest

Post by pennstater2005 »

Jimb

That's going to take some time for me to digest. Thank you for the response. It makes sense on paper however why does the general consensus here always seem to be to pay down high interest debt first?
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Re: Paying student loans vs Losing compounding interest

Post by jimb_fromATL »

pennstater2005 wrote:Jimb

That's going to take some time for me to digest. Thank you for the response. It makes sense on paper however why does the general consensus here always seem to be to pay down high interest debt first?
When you're paying extra, you'll save the most interest and time in debt by paying off the higher rate debts first. However, when you take away the taxes that you're paying instead of investing that money for yourself, and lose the time for earning compound interest for the rest of your life on the taxes and the remaining money you didn't invest as soon as possible (assuming anywhere near the long-term market earnings averages) you'll lose far more compound interest earnings in your life than the extra after-tax money will save on the debt.

There's also some merit in paying off a lower-rate, smaller and shorter-term loan first, even though it may not save the most interest. The main reason is that it will give you more room in your budget by having a lower required minimum total of payments ... in case you do fall on harder times.

Plus, there's no denying that it feels good to eliminate a debt, even if it really might cost you a lot more money in the long run. Provided you do plan to "snowball" the debts by reinvesting the freed-up payment, chances are the total difference in interest won't be a lot ... in exchange for having more elbow room in your budget.

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Re: Paying student loans vs Losing compounding interest

Post by Ketawa »

mnvalue wrote:
Ketawa wrote:For one thing, you should be using guaranteed returns on fixed income for the comparison, since the debt repayment is a guaranteed return.
While I think you're right in theory, I don't think that matches how people make this choice in real life. People are always going to invest at some AA regardless of whether they have debt or not.
I agree, which is why I added the part about 7% or 8% not being conservative even if we use the AA of the entire portfolio.

But some people do change their AA based on debt, at least to some extent. I did! I used to not bother with a separate emergency fund. I am in the military with stable employment and when I didn't have a mortgage, I had enough in taxable accounts to cover any unforeseen circumstances. Now I have a mortgage and I keep a sizable emergency fund/underwater mortgage payoff fund. I don't want to risk becoming an untentional landlord if I'm forced to move, my home value falls, and there's a stock market crash.
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Re: Paying student loans vs Losing compounding interest

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Work down that loan. Fast.
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Re: Paying student loans vs Losing compounding interest

Post by Ketawa »

jimb_fromATL wrote:When you're paying extra, you'll save the most interest and time in debt by paying off the higher rate debts first. However, when you take away the taxes that you're paying instead of investing that money for yourself, and lose the time for earning compound interest for the rest of your life on the taxes and the remaining money you didn't invest as soon as possible (assuming anywhere near the long-term market earnings averages) you'll lose far more compound interest earnings in your life than the extra after-tax money will save on the debt.
We can quibble over to what extent people actually invest the extra cash flow once a debt is paid off. However, holding things equal, prepaying the debt does not cause an added tax cost since it allows an investor to defer more income later, possibly in a higher tax bracket.
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Re: Paying student loans vs Losing compounding interest

Post by jmg229 »

pennstater2005 wrote:Jimb

That's going to take some time for me to digest. Thank you for the response. It makes sense on paper however why does the general consensus here always seem to be to pay down high interest debt first?
There are two things I see missing from Jimb's calculations (as best as I can follow them): Future taxes and a reasonable rate of return. You will need to pay taxes eventually on the money you defer into retirement savings, whether that rate will be higher or lower than your current tax rate is impossible to predict, though at the 15% tax bracket currently, I might err on the side of your taxes being lower now than in the future. A fair guess would be that your taxes in the future will be the same as now, so you need to deduct that off of the ending retirement balances, which will wipe out most of the the gains seen in Jimb's calculation (the tax liability compounds as well; Case A: apply a 15% tax now on 100 dollars, let the remaining 85 grow at 8% a year Case B: Let 100 dollars grow at 8% a year, then apply a 15% tax. Your outcome is the same). The second piece, as pointed out, is that 8% is hardly a guarantee for an entire portfolio.

What it really comes down to is a prediction of future vs. current tax rates (if lower now, pay off the loan, if higher now, defer) and expected returns vs. after-tax interest rate (don't forget to deduct your student loan interest, so if your rate is 6.8%, your effective at a 15% marginal is 6.8*(1-.15) = 5.78%). If you think your returns will beat your after-tax rate, invest; if not, pay down the loans.

In addition, there are cashflow issues and peace of mind issues pointed out already. Note that I am also assuming, in making this calculation, that the loan repayment money will go into retirement savings when the loan is paid off in order to make this a fair comparison.
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Re: Paying student loans vs Losing compounding interest

Post by Twins Fan »

I'm going to stay out of the debate that started here. :D

But, I will piggy back on this opinion...
Longtimelurker wrote:I would get my full match then pay down any debt over 3% net. <- this is opinion.
That would be my opinion in the OPs situation also. The amount in student loans being equal to the the combined yearly salary and most of that being what I think of as mid to high interest rates would be off putting to me (peace of mind). I would get any match and attack the debt.
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Re: Paying student loans vs Losing compounding interest

Post by pennstater2005 »

The loan repayment money would go into retirement savings once the loan was paid off. I'll definitely get the match from the simple IRA. Then I'm leaning toward putting some of the extra money to pay off the higher interest student loans as well as some towards one of the other IRAs. So, a little bit of both maybe.
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Re: Paying student loans vs Losing compounding interest

Post by jeremyi »

Our situations are very similar, so thank you for posting this!
We have 3 children (most recent born in December), about $50k in student loan debt. 2 paid off cars. Similar income, although my wife is a SAHM. Mortgage total is around $130k ($118k 1st, $12k HELOC balance)

I can share what my current plan is at least:
* Student loans are in IBR. My current required payment is $0. The benefit of this is that I can direct payment to the highest interest un-subsidized loans on my own. My loans are about $21k unsub and $29k subsidized. For the first 3 years in IBR, subsidized loans continue to be subsidized. Most of my loans are at 6.8%, but I have a few that are lower, down to 4.5% (combo of undergrad and graduate/MBA loans).
* My employer has a small company match for 401k. This is a no-brainer.
* Up to $60k AGI, we are eligible for 10% retirement saver's credit which applies to the first $2k put into retirement accounts for myself and a spousal IRA for the wife. I have put mine in the 401k, my wife's in a Roth IRA. 401k contributions will increase Earned Income Credit if you are eligible for that. With EIC and Retirement Saver's credit, every dollar into my 401k nets about 40% tax savings/credits, even though I am only in the 15% tax bracket.
* Beyond that $2k into retirement accounts, my focus is to pay down the high interest student loan debt. We bought a house a year ago and with 3 kids (and now a mini-van), we really don't have a ton of extra income to spare.
* The other thing to consider (situations, preferences, numbers may vary) if you wish to pay down some of that high interest debt - with 2 cars paid off, is to look at PenFed's auto loan rates. 60 months, 2.49%. I'd debated this for a while and recently pulled the trigger on cashing out the value of our 2008 Honda Odyssey (other car is too old, high mileage) for $18k which I will put mostly towards the 6.8% student loan debt.

Happy to clarify or share more details on this.
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Re: Paying student loans vs Losing compounding interest

Post by pennstater2005 »

jeremyi wrote:Our situations are very similar, so thank you for posting this!
We have 3 children (most recent born in December), about $50k in student loan debt. 2 paid off cars. Similar income, although my wife is a SAHM. Mortgage total is around $130k ($118k 1st, $12k HELOC balance)

I can share what my current plan is at least:
* Student loans are in IBR. My current required payment is $0. The benefit of this is that I can direct payment to the highest interest un-subsidized loans on my own. My loans are about $21k unsub and $29k subsidized. For the first 3 years in IBR, subsidized loans continue to be subsidized. Most of my loans are at 6.8%, but I have a few that are lower, down to 4.5% (combo of undergrad and graduate/MBA loans).
* My employer has a small company match for 401k. This is a no-brainer.
* Up to $60k AGI, we are eligible for 10% retirement saver's credit which applies to the first $2k put into retirement accounts for myself and a spousal IRA for the wife. I have put mine in the 401k, my wife's in a Roth IRA. 401k contributions will increase Earned Income Credit if you are eligible for that. With EIC and Retirement Saver's credit, every dollar into my 401k nets about 40% tax savings/credits, even though I am only in the 15% tax bracket.
* Beyond that $2k into retirement accounts, my focus is to pay down the high interest student loan debt. We bought a house a year ago and with 3 kids (and now a mini-van), we really don't have a ton of extra income to spare.
* The other thing to consider (situations, preferences, numbers may vary) if you wish to pay down some of that high interest debt - with 2 cars paid off, is to look at PenFed's auto loan rates. 60 months, 2.49%. I'd debated this for a while and recently pulled the trigger on cashing out the value of our 2008 Honda Odyssey (other car is too old, high mileage) for $18k which I will put mostly towards the 6.8% student loan debt. How do you cash out the value of a vehicle?

Happy to clarify or share more details on this.
Jeremy
It seems as though you do a little bit of both as you are able. I'm not familiar with the savers credit. I'll have to research this.
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Re: Paying student loans vs Losing compounding interest

Post by jeremyi »

Precisely. A little bit of both to the extent to where it is most favorable. At this point, I haven't had a ton of excess money to really make the decision... the tax credits, employer 401k match, and life circumstances (home, 3rd child->minivan) have made my decision for me.

Cashing out the vehicle is pretty easy. Application can be filled out online. I used PenFed although Alliant Credit Union might actually have a better current deal. They use a NADA value and I had to fax front and back of my vehicle title. I just got the check in the mail and will now have to mail the title in for the lien to be placed.
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Re: Paying student loans vs Losing compounding interest

Post by pennstater2005 »

and life circumstances (home, 3rd child->minivan) have made my decision for me.
That is where I'm at now. Life circumstances! All my own choices though.

Edit to add: I obviously don't know how to snip quotes.
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Re: Paying student loans vs Losing compounding interest

Post by jimb_fromATL »

Ketawa wrote: You didn't mention it in your post, but this advice only applies if OP plans to max out all tax-advantaged savings for the rest of OP's life. For example, is OP going to have kids and still be able to max out the 401k if they're in college? If OP isn't in a position to do so, then paying off the high interest debt would beat any safe fixed income investment, and the missed contributions can be made up when the debt is gone. It's also probable that OP's income will be higher in the future, making the additional future contributions more valuable.
The example I posted in this thread shows how a 15 month delay in contributing an extra $791.67 per month earning 8% in a tax deferred retirement plan while paying off the debt faster can result in a loss of about $227,152 at retirement.

It also shows that even reinvesting the freed-up payments in an after-tax account earning the same rate will still come up short by $75,689 at retirement time.

Those differences are completely separate from any additional amounts you might contribute to retirement at any time after the orginal loan period.

We're realy talking about two choices:
  • (1) Investing an extra $791.67 per month for 72 months in the retirement account and paying $169.53 per month on the loan for 72 months.

    Or (2) Stopping the $791.67 per month retirement contributions, paying an extra $245.42 per month in taxes, and using the remaining $546.25 per month to pay off the loan faster. This way it will be paid off in just 14.6 months. At that point resuming the $791.67 per month pre-tax contributions for the remaining 57.4 months of the original loan period.

    If the $791.67 per month were invested at 8% for the original 72 monnths of the loan it would grow to $72,853.

    If it were delayed for the 14.6 months it takes to pay off the loan faster, the remaining 57.4 contributions would only grow to $55,144 by the end of the original loan period. With no more contributions at all, the $17,710 difference earning 8% would grown to the $227,152 difference shown in the remaining 384 months until retirement.

    While virtually nobody actually does it, we can also choose to invest the freed-up $169.53 per month payments for the remaining 57.4 months until the end of the original loan period. If we really do it, the 57.4 freed-up payments in an after-tax account earning the same rate would grow to $11,809 by the end of the original 72 month loan period.

    Along with the $55,144 in the delayed retirement fund, that would give us a total of $66,952 after the original 72 months. That's short by $5,901 at that point in time. Then earning the same rate with no more contributions for the remaining 384 months that $5901 could have grown to the $75,689 difference shown in the example.

    So ... because of the loss of Time for compounding and the loss of taxes that we pay prematurely and which earn nothing for the rest of our life, the best casd for exactly the same total of pre-tax and post-tax payments during that 72 months will still come up short by $75,689 by retirement time.
As the example shows, because of compounding that deficit at retirement time will result in a much bigger loss after retirement.

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Re: Paying student loans vs Losing compounding interest

Post by jimb_fromATL »

Ketawa wrote:
jimb_fromATL wrote:Here's an example to illustrate the problem. The stock market has historically averaged around 10% or more over long periods of time. I'll use a much more conservative 8% to illustrate that the rate is not really as important as the Time lost. And we'll look at your highest student loan rate.
8% is not a conservative estimate.
The OP asked about compound interest for investing. Not about getting guaranteed savings. That implies taking some risk -- and most likely earning more. An index fund using the S&P 500 is about the best that most investors are likely to ever do ... and better than probably 95% or more of all professional financial advisors and funds managers do in the long run. So it's not unreasonable to use it as a benchmark.

Here’s more supporting evidence:
  • They have well over 30 years until retirement.

    Since the crash of '29 the worst 30 year rolling average for the S&P 500 index fund VFINX was 8.46% for the period ending in 1958. (The total market has done even better in modern times.)

    The average of 30 year rolling averages has been 11.13%;
    The Compound Annual Growth Rate (CAGR) was 11.38%;
    ...and the median has been 10.86%

    Even including the crashes of 2001/2 and 2008, the 20 year average is over 9%, and didn't drop much below 8% for any significant length of time even including the crash of 2008.

    The 30 year average has still been over 10% since the 90's even including the crash of 2008.
In my opinion, the prospects for doing 8% are pretty good in a much more conservative balanced fund, too.
  • Since the crash of '29 the worst 30 year rolling average for Vanguard’s balanced fund VWELX-with a lot of bonds-- was 5.54% for the period ending in 1950.

    The average of 30 year rolling averages has been 9.05%; the cagr 9.52%; and the median has been 8.74%.
Since folks are actually doing dollar-cost-averaging with periodic retirement contributions to their retirement plans, which would minimize their losses during bad times in the market, chances are they'll do even better.

Incidentally, probably the most prominent proponent of eliminating all debt as fast as possible without regard to the lost opportunity costs is Dave Ramsey. But he also promises his followers that they can count on earning an average of 12% both before and after retirement as though it were a constant.

So... IMO it's not at all unreasonable to plan for an average of 8% annual earnings... and to hope for more.
The rest of your post isn't really applicable to the OP since his and his wife's combined income is $60k in the 15% tax bracket with two children. It isn't feasible for them to max tax-advantaged accounts for the rest of their lives.

We don't really know that it isn't feasible for them to max at least the equivalent of one 401(k) – possibly some in her SIMPLE and some in IRAs.

Whether than can do the equivalent of maxing a 401(k) or not, they’ll still save 15% federal tax for every dollar they contribute to a tax-deferred plan.

IF they make enough contributions to tax deferred plans, it appears that with the child tax credit, not only will they pay very little federal income tax at all, they may be able to pay none and get an income subsidy in the form of a refund of money they never had wittheld. That's even more likely for the poster who has similar income and three children.

Even if they can't afford the max, and if their earnings are anywhere near the conservative estimate I used, they'll lose more compound interest for the rest of their life on the taxes they pay prematurely and for the rest of the money they delay contributing than the after-tax money will save in interest on the much shorter term debt. If their earnings are anywhere near the higher historical averages, they’ll lose a lot more.

In this case, if their screen name means they live in Pennsylvania, there is apparently no tax savings for contributions to a 401(k) or IRA. If that’s so, chances are pretty they’ll do well to contribute up to any match available, then put the rest in Roths, which will also give them more more funds on hand for emergencies. On the other hand, the child tax credit seems to change things, since Roth contributions don’t appear to reduce their taxable income. So it would take some more research.

Paying any income taxes to the feds prematurely, even if there is no state tax on retirement withdrawal, and even with no federal tax savings in the present for Roths; and unless you have a crystal ball that can accurately predict that the market is going to be in free-fall for several years; it’s still much more likely to build more wealth in the long run by investing as much as possible as soon as possible in a federally tax-deferred plan or Roths instead of using the money to pay down short-term debts.

It is true that they can get a guaranteed savings roughly equivalent to the rate of the debt. In fact the equivalent rate is a little better because there’s tax on earnings in investments, but no tax on money you keep for yourself by NOT paying it out as interest on a debt.

But -- assuming the conservative average of 8%-- saving even 6.8% on the highest loan for a few years will not make up for the loss of paying even their low bracket of 15% tax instead of investing it, along with the loss of time and compound interest for the rest of their life on the taxes they paid and the other money that they delayed investing.

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Re: Paying student loans vs Losing compounding interest

Post by Ketawa »

The example you posted is true for someone who maxes tax-advantaged savings. Relatively few people are in a position to do this, and the OP is not.

Since we're talking about scenarios where investors aren't maxing their 401k, the freed-up payment in your example would be $245.70 pre-tax, which grows to about $17,113 over 57.4 contributions. The total tax-advantaged account is then worth $72,257, which is only $596 off the alternative of $72,853 in your example. The difference is attributable to your 8% assumption of expected return from equities, vs a guaranteed return of 6.8% from prepaying the loan.

Is it worth the extra riskiness of equities for $596 over six years, at the cost of higher required monthly payments in a budget for almost five years, and the need for a larger emergency fund? I don't think so.
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Re: Paying student loans vs Losing compounding interest

Post by Ketawa »

jimb_fromATL wrote:We don't really know that it isn't feasible for them to max at least the equivalent of one 401(k) – possibly some in her SIMPLE and some in IRAs.
We do know that it isn't feasible, since the OP said so. Freeing up the after-tax loan payment makes pre-tax money available for investing. Your example assumes that the investor doesn't have any additional tax-advantaged space.
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Re: Paying student loans vs Losing compounding interest

Post by pennstater2005 »

I'll be honest here. Most of the math here goes way over my head. Not exactly my strong point. I do appreciate all the thoughtful responses and am trying to decipher each as best I can. As I said before I will put extra money towards the high rate debt and continue to fund the investments as much as possible. The responses the thus far are somewhat split anyway so I'll do the same.
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Re: Paying student loans vs Losing compounding interest

Post by jimb_fromATL »

pennstater2005 wrote:I'll be honest here. Most of the math here goes way over my head. Not exactly my strong point. I do appreciate all the thoughtful responses and am trying to decipher each as best I can. As I said before I will put extra money towards the high rate debt and continue to fund the investments as much as possible. The responses the thus far are somewhat split anyway so I'll do the same.
You're really doing better than a lot of people already, so it's just a matter of deciding which way will make you the happiest.

The controversy is not really just about which is best, but also which will make you feel better, and whether you want to gamble that you can earn more in the stock market and balanced funds with interest compounding on the investments for the rest of your life compared to the 6.8% you can avoid paying on the short-term debt. The entire history of the stock market strongly suggests that you can do better by investing more.

Unless you're in dire straits such as facing foreclosure or having your wages garnisheed because you cannot make the payments, it's better to build your future wealth for retirement and have more savings for emergencies (which your retirement plans are too) than to pay off the debts faster.

With your 15% top federal tax bracket, and if you can earn anywhere near the normal long-term stock market and balanced fund averages, the math usually shows that you will come out with more money in the long run if you pay the minimum on the student loans and contribute as much as possible to the tax-deferred and tax-advantaged retirement plans.

On the other hand, some folks think it's more important to pay off debt faster no matter how much it might cost you out of your future retirement.

Absolutely do contribute enough to get all available company matching payments in your wife's Simple IRA plan. That's essentially more free money for doing nothing but saving some of your own money... while avoiding paying taxes on your money too.

Then, depending on which state you live in, it may be better to put more in Roth IRAs instead of the simple IRA.

Another important point is that it is a good rule of thumb to contribute at least 15% of your gross income to retirement plans. Since you're not quite doing that, all the more reason not to reduce your retirement contributions just to feel good about paying down the debt faster.

It also makes even less sense to pay down the very-low-rate loans faster instead of investing more for retirement, since there's no real question that you can earn a lot more in the investments than you'll save on those debts.

What state do you live in?
How much debt do you have, and what are the rates and minimum payments?
How much do you have to spare at the end of the month to either invest for retirement or pay extra on the debts?

Given more details, I can give you a better example of how much it might cost you to reduce your retirement contributions any further in order to pay off your debts too fast. Having a better idea of how much it could cost out of your future retirement compared to how much it might save in interest can help you decide how much it's worth to lose in the long run just to feel better about eliminating the debt faster in the short run.

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Re: Paying student loans vs Losing compounding interest

Post by jimb_fromATL »

Ketawa wrote:The example you posted is true for someone who maxes tax-advantaged savings. Relatively few people are in a position to do this, and the OP is not.
Most of the folks who write in to the bogleheads forum (and other forums where I hang out) are able to max a 401(k) and are in higher tax brackets, and at the time I didn't know the OP's income; which is why I said:
For someone making perhaps $80,000 per year, the $17,500 max for a 401(k) would be 21.88% of gross income. If they only contribute 10% ($8,000), that's a difference of $9,500, $791.67 per month, that could be contributed to the 401(k).
So in that scenario, when they resumed the contributions after paying off the debt, they wouldn't have any more tax-deferred space.
Since we're talking about scenarios where investors aren't maxing their 401k, the freed-up payment in your example would be $245.70 pre-tax, which grows to about $17,113 over 57.4 contributions. The total tax-advantaged account is then worth $72,257, which is only $596 off the alternative of $72,853 in your example. The difference is attributable to your 8% assumption of expected return from equities, vs a guaranteed return of 6.8% from prepaying the loan.
That's correct as far as it goes. However, I think you’re still missing the important point that the loan is a relatively short term compared to the investment for retirement, so the $596 difference at the end of the loan period is not the whole story.

Once the loan is paid off and even if the payments were reinvested tax-deferred (though it's not possible in that example) then earning the same rate with no more contributions that $595.67 deficit could have grown to $7,640 by retirement time. Then at a much more conservative 4% earnings after retirement that could pay you $25 per month in interest if you never touched the principal. So if you lived 30 more years you would lose the $7,640 you won't have at retirement time plus the $9,168 interest it won't earn in the next 30 years for a potential total loss of $16,809 of income during your life in exchange for saving the $1,759 interest on the debt.

Another point to consider is that if they cannot afford to max a 401(k) or similar plan, then they aren't able to afford to pay as much extra on the debt as I showed in that example either. So the reduced amount they might pay extra on the debt would take a lot longer to pay it off. That means they will lose more time for compounding their earnings in the pre-tax plan even if they do try to catch-up. That also means that any deficit caused by delaying their retirement contributions will most likely be a bigger percentage of their total retirement nest egg.

To re-emphasize, I've been helping people with the math to weigh the pros and cons of investing for retirement versus paying down debt for several decades, and developing software for it since long before hand-held financial calculators, PCs, spreadsheets, and the internet came along. (I still marvel at how easy it is in these new-fangled spreadsheets compared to progamming it in assembly language or FORTRAN or C or BASIC in the days of the coal-fired computers.)

But in hundreds of real-life scenarios, I have yet to ever talk with anybody who actually sacrificed a long time to reduce their onerous debts, then continued to sacrifice so they could reinvest all of the freed-up payments. It's human nature to breath a sigh of relief and celebrate, and live a little higher on the hog. So IMO it's of academic interest to think about re-investing the payments, but in reality it ain't gonna happen.
Is it worth the extra riskiness of equities for $596 over six years, at the cost of higher required monthly payments in a budget for almost five years, and the need for a larger emergency fund? I don't think so.
In addition to the much larger long-term loss of compounding over a lifetime by investing the max (or any extra money) from the start you’ll have more money in the 401(k) or other tax-deferred plan that can be tapped in a dire emergency… such as an extended period of unemployment.

For example, people in higher tax brackets who might have an extended financial setback such as a job loss at some later time and have to withdraw it some of it to avoid financial disaster such as foreclosure would most likely be in a lower tax bracket then. Typically their tax on the withdrawal it might drop from 28% or 25% to 15% or even 10% during the really bad year. So there's a pretty good chance that the extra money deferred and invested in a high bracket during the good years could earn enough to pay the 10% penalty and the regular income tax and still come out no worse –and possibly better-- after taxes in the bad year.

By the way, for people who do have large emergency funds and normally are in higher tax brackets, a bad year with a very low marginal tax bracket can be a good time to convert a 401(k) or TIRA to a Roth, since it's more likely that the tax will be lower than it would be after retirement.

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Re: Paying student loans vs Losing compounding interest

Post by Ketawa »

You are vastly overstating the case for investing in equities expected to return 8% when the option is available to earn 6.8% guaranteed. If there was a 1 year CD paying 6.8%, Bogleheads would be backing up the truck! All my fixed income would be in that CD.

Do you also recommend investors be 100% equities? After all, 8% is almost 6% more than the yield on Total Bond Market. All the Bogleheads investing in Total Bond Market are giving up all that compounding by having anything in bonds!

$596 over 6 years is basically noise. Invest an extra $8/month. Taking $596 and applying 30 years of compounding to it obfuscates the issue.

This will be my last post in this thread. I've made my case.
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Re: Paying student loans vs Losing compounding interest

Post by deikel »

pennstater2005 wrote:I'll be honest here. Most of the math here goes way over my head. Not exactly my strong point. I do appreciate all the thoughtful responses and am trying to decipher each as best I can. As I said before I will put extra money towards the high rate debt and continue to fund the investments as much as possible. The responses the thus far are somewhat split anyway so I'll do the same.

It kind of amazes me that people would really talk you into or actually staying within debt....even very basic math would let me think that the 6.5 % loan is a no brainer to pay down asap - where do you get that kind of (garuanteed!!!!!) return nowerdays ?

The 2.5 and 3.5 % ones are the arguable ones and it becomes a choice of living free of debt or starting investing earlier (and basically borrowing money to play the market IMO). Imagine the market will drop 20 % over the next 3 years, would you still debate if you should pay off debt or invest in market (turn the argument around and think about an inflation rate hike to say 4 %)

Even if the calculations were true (8% return/average - when was that the last time ?), that we would end up with a 200k difference come retirement, than a) that is future money right, not todays dollars ? and b) it would have to be taxed in the future - so the number looks large, but really is not IMO.

No one has the facts, only opinions running around here

+1 on maxing out any possible match than paying back the debt - gives you much more life flexibility in the near to medium future

Or to put it another way, retirment lives from lower expenses rather than higher income and paying off debt lowers your expenses. period.
Everything you read in this post is my personal opinion. If you disagree with this disclaimer, please un-read the text immediately and destroy any copy or remembrance of it.
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Re: Paying student loans vs Losing compounding interest

Post by jimb_fromATL »

deikel wrote: It kind of amazes me that people would really talk you into or actually staying within debt
It’s not about staying in debt. It’s about putting your money to its best use to strike a balance between avoiding paying more taxes than necessary earlier than necessary and earning more compound interest in the long term -- versus paying taxes in your highest bracket(s) now and eliminating debts faster in the short-term while ignoring the consequences of lost opportunity costs.
....even very basic math would let me think that the 6.5 % loan is a no brainer to pay down asap
It is a no-brainer for after tax money in a taxable account. But it's not that simple for tax-deferred and tax-advantaged retirement investments.

The problem is that compound interest is not simple math. It's hard to visualize because in compounding Time is an exponential factor that is more important than Rate in determining the total interest earned in an investment or paid on a debt. You have two non linear curves -- one going up and the other going down exponentially with differing curves depending on the time involved.

By the way, the borrower’s debt IS the lender’s investment in an annuity with interest compounding monthly on the unpaid balance. The math formulas for calculations are exactly the same. The only difference is whether you’re paying the interest as a borrower or earning it as the lender/investor.

Since your investments earn compound interest for your entire life, even a little extra money invested now --as much as possible as soon as possible-- can earn a lot more compound interest than the same amount of money will save in interest on a short-term debt, especially when you have to pay taxes on the money.

Plus, if you pay taxes instead now instead of deferring it and investing the money for yourself now, that money doesn't pay bills, buy necessities, earn compound interest for the rest of your life, or pay down debts either.

Assuming you are able to max your tax-deferred retirement accounts -- which you should if you can afford it-- then if you reduce the contributions to retirement for a while to pay down your debt faster, you won’t get to defer the taxes on the extra money that you’ll have to invest to catch up for the loss of time and compound interest on the money you didn’t invest, because of the yearly contribution limits.

Depending on your level of income, reducing your AGI by maxing your tax-deferred investment opportunities first may help keep some of your income out of higher brackets and may help with other tax breaks or credits ... and in some cases maybe even with reduced or subsidized health care costs.
Ketawa wrote:You are vastly overstating the case for investing in equities expected to return 8% when the option is available to earn 6.8% guaranteed. If there was a 1 year CD paying 6.8%, Bogleheads would be backing up the truck! All my fixed income would be in that CD.
deikel wrote: - where do you get that kind of guaranteed!!!!!) return nowerdays ?
ANY investment where the percentage yield is not guaranteed (and consequently returns a lower rate) you're gambling that you can earn more in equities, bonds, etc than you can earn in a stable value vehicle like CDs, treasury notes, money market accounts, OR paying off debt.

But when you're talking at least a 20 or 30 year or more horizon, and if the entire history of the stock market is any indicator at all, your chances of earning an average of well over 6.8% or 8% are pretty darned good. For example:
  • The S&P 500 has had an average APY of 9.22% for the last 20 years 10.3% for the last 25 years, and 11.1% for the last 30 years.

    Since the crash of '29 the worst 30 year rolling average for the S&P 500 was 8.46% for the period ending in 1958.

    Since the great depression of the 30's the average APY of rolling 30 year periods for the S&P 500 has been 11.13%; the CAGR (Compound Annual Growth Rate) has been 11.38%; and the median of 30 year rolling averages has been 10.86%.
History strongly suggests that you can do a lot better than 8% even with a lot of bonds in the allocation.
  • Vanguard's Wellington balanced fund (VWELX) has in the range of 30-40% bonds and stable value funds, but it has earned an average APY of around 9.59% for the last 20 years, 10.14% for the last 25 years, and 10.91% for the last 30 years.

    The average of its rolling 30 year yields has been 9.36% for last 50 years.
I personally don't think we're going to see the 11-12% earnings that we've seen in the market in the good times in the last few decades again any time soo. But I suspect you'd probably have to work hard at churning your funds and making bad choices to do much worse than 8% in the long run.

Bear in mind that the above averages include the bad market crash of 2001/2002 and the second-worst crash in history in 2008. If you think the market is going to do a lot worse than that in the future, you probably shouldn't invest in anything risky at all --and might even want to keep it all in cash in your bunker.
that we would end up with a 200k difference come retirement, than a) that is future money right, not todays dollars ?
Nope. The numbers in my examples are in terms of today's dollars.

As inflation goes up, the contribution limits for tax-advantaged retirement plans go up too. With any luck at all, so will your salary. So you need to increase your contributions to keep up with inflation (as well as increase your salary.) If you do increase the contributions and your salary with inflation, that $200K will still be in the same proportion in terms of today’s dollars.

No matter what the dollar might be worth in the future, the more of them you have, the more stuff you will be able to buy and the more bills you will be able to pay. So the investment plan that has the best prospects to give you the most dollars for retirement is still the best plan.
  • 1. In 40 years with an average of 3% inflation, today's $2 loaf of bread will cost $6.52. But you're not going to be able to go down to MalWart's and get them to let you have it for $2 even though that is its value in terms of 2014 dollars.

    2. Suppose a person is making $60,000 per year ($5,000 per month) now and contributing 10% ($500 per month) to retirement. Let's further assume that their pay increases with inflation/cost of living at a yearly rate of 3% and that they keep the same percentage of contributions.

    After 40 years, they will be making $190,022 ($15,835 per month) if all their pay did was keep up with inflation. At that time their contribution of 10.% of their income would be $1584 per month.

    If they were able to average 8.% earnings on their investments during their working years they'd have $2,467,851 in their retirement account. That's 41 times their salary today, but that's only 13 years of their salary at the time they retire.

    Using the probable new rule of thumb that suggests withdrawing no more than 3% of your nest egg per year after retirement, they'd only be able to withdraw $74,036 per year ($6170 per month) to be reasonable sure of not running out of money in their retirement years.

    While that's 123% of their salary today, it is only 39% of the salary they'd have at the time of retirement. Adjusting for inflation at an average annual rate of 3% it's the equivalent of having $1,891 income per month today instead of $5,000.

    If their retirement account earns a fairly constant average of 4% per year, and they increase their withdrawals to keep up with the cost of living at 3% per year, it will all be gone in 40 years.
By the way, the prospect of being able to withdraw only 39% of their future yearly salary if they only contribute 10% to retirement from now on seems to me like a pretty good argument why the OP needs to contribute more to retirement now -- and definitely not reduce contributions to pay off any reasonably manageable debts any faster now.
and b) it would have to be taxed in the future - so the number looks large, but really is not IMO.
To put it in perspective, if you have an extra $200,000 in your retirement funds, in 40 years at an average of 3% inflation it's equivalent to having an extra $61,311 in savings now.

That $200,000 earning a conservative APY of 4% could pay you an extra $954.83 per month for 30 years before it was all gone.

In terms of today's dollars, that's equivalent to having an extra $292.71 per month income for the next 30 years starting today.

If you don't think that's signficant, here's an exercise you might want to try out:
  • Go to the bank and withdraw $292.71.
    Then throw it out the window as you drive down the freeway.
    (If you want to diversify, throw it out a little at a time on different freeways.)
    Do that for a few months.

It it continues to feel like good use of your money, then maybe it really isn't much money to you. In that case you probably should go ahead and pay down debt as fast as you can without regard to any lost opportunity costs.

jimb
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Ketawa
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Re: Paying student loans vs Losing compounding interest

Post by Ketawa »

jimb_fromATL wrote:No matter what the dollar might be worth in the future, the more of them you have, the more stuff you will be able to buy and the more bills you will be able to pay. So the investment plan that has the best prospects to give you the most dollars for retirement is still the best plan.
Ketawa wrote:Do you also recommend investors be 100% equities? After all, 8% is almost 6% more than the yield on Total Bond Market. All the Bogleheads investing in Total Bond Market are giving up all that compounding by having anything in bonds!
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JupiterJones
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Re: Paying student loans vs Losing compounding interest

Post by JupiterJones »

jimb_fromATL wrote: (If you want to diversify, throw it out a little at a time on different freeways.)
LOL! :)
Stay on target...
WL2034
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Re: Paying student loans vs Losing compounding interest

Post by WL2034 »

I would pay off the 6.8% interest loan first, without a doubt. Another point that I'm not sure anyone has made is that a constant 6.8% without any volatility (i.e. your loan) actually will possibly compound to a greater amount than an investment with an average rate of return of 8%, depending on volatility. Volatility is bad for compounding, loans have no volatility.
mnvalue
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Re: Paying student loans vs Losing compounding interest

Post by mnvalue »

will34 wrote:Another point that I'm not sure anyone has made is that a constant 6.8% without any volatility (i.e. your loan) actually will possibly compound to a greater amount than an investment with an average rate of return of 8%, depending on volatility.
You have to assume the numbers quoted are CAGR, so this has already been accounted for. Doing a simple arithematic average of yearly returns is insane, and something that simply never comes up, except when looking at how Dave Ramsey quotes investment returns.
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