Hello and welcome to Financial Face-off, a MarketWatch column where we help you weigh financial decisions. Our columnist will give her verdict. Tell us whether you think she’s right in the comments. And please share your suggestions for future Financial Face-off columns.
The Biden administration’s much-debated student-loan cancellation plan is expected to launch soon, with online applications expected to roll out in early October. Individual borrowers who make less than $125,000 a year (or $250,000 in household income) will have up to $10,000 in federal student-loan debt canceled; eligible Pell Grant recipients will get another $10,000 forgiven.
With borrowers receiving some financial breathing room, what should they do with the “extra” money that will be in their monthly budgets: Pay off other debts or invest in the stock market?
Why it matters
Student-loan debt is a heavy burden for many Americans. Some 45 million people collectively owe $1.6 trillion in federal loans, the White House says. The average monthly payment is $460, according to the Education Data Initiative.
This debt has changed the course of some borrowers’ lives, forcing them to put off goals such as buying a house, getting married or having children.
Student-loan debt has staying power: It takes the average borrower 20 years to pay off their loans.
If you’re a student-loan borrower, you may feel like you’re just scraping by. You may have been taking advantage of the student-loan payment pause to pay basic expenses. But now that some student-loan relief will be permanent, you have the opportunity to be intentional about what you’re doing with this extra money, said Kelley Long, a certified financial planner, CPA and founder of Financial Bliss in Oro Valley, Ariz.
Borrowers who’ve been shut out of major financial milestones because of their debt can finally take action on the maxim “Pay yourself first” by setting up an investment account.
This may be especially important for people who thought they couldn’t afford to invest because their budget was eaten up by their student-loan payments. Some people assume that investing is for wealthier people with well-established financial lives. Now is a good time to revisit that assumption, Long said.
“There’s so much psychology in your identity as a money person,” Long said. “When are you going to start to think of yourself as someone who is worthy of investing? What situation has to exist? The answer, is — what I’m hoping you’ll say is — ‘Oh gosh, I probably need to start thinking of myself as an investor yesterday, or tomorrow or today, right now.’”
One way to ease into investing is to start with your own personal “don’t think twice” amount of money, Long says. For example, you might have no problem with spending $11.99 on a shirt at a discount store and only wearing it once or twice. “You’re investing in this throw-away retail clothing knowing that you’re not getting anything back,” Long said. “Whatever that amount is, you can afford to put that amount into an investment account on a monthly basis.”
Using a low-cost investment provider that doesn’t have minimum account balances or charge fees, you could set up an account where that amount of money goes into an index fund monthly.
“Before you know it, you’ll have a comma in your account and then you’ll have five digits and it happens faster and faster,” Long said.
Of course, investing right now, with markets entering bear-market territory this week, may feel scary.
But Jack Hills, chief investment office of Icono Capital in Rochester, N.Y. said there’s no time like the present.
“Imagine seeing something you need, already buy every month, and normally pay full price for marked down 15%-25% off,” Hills told MarketWatch. “That’s the stock market right now.”
He added: “How many of us are cursing ourselves for not buying more in the first quarter of 2020 or not even buying anything at all? Granted it’s terrifying seeing the markets lose so much so quickly, and always impossible to know where the bottom ever really is, but we’re also realistically in a similar opportunity now. Plus this is money that’s going to be used on a monthly basis, meaning it’s dollar cost averaged, and offsetting the downs as much as the ups.”
Is my verdict best for you?
On the other hand, if you have debts with interest rates of 7% or higher, it generally makes better sense to pay down that debt first, Long said. That’s because carrying that debt costs more than you could make on average with long-term stock-market investments.
It’s also true that paying off debts can feel mentally freeing, no matter what the interest rate is.
“Some people might be able to sleep better if they know they’ve paid off their car,” Long said. “Maybe they’ve got private loans or a 401(k) loan or something else that isn’t quote unquote bad debt, but they would feel more comfortable not having that obligation.”
Paying off other debts can also have real-world consequences you may not have thought of, such as improving your credit score and helping you qualify for a lower-rate mortgage down the road, said Chris Haigh, a certified financial planner and chief executive of Icono Capital.
He gave two scenarios: In Scenario 1 you pay off other high-interest debts, which increases your FICO score, and you qualify for a 5.875% mortgage with a $300,000 balance, which would make your total loan cost $638,000. In Scenario 2, you invest in the stock market, your FICO remains the same, and you receive a 6.5% mortgage on a $300,000 balance. That puts your total loan cost at $682,000. That’s a hefty difference that you may not have considered.
Can’t decide between investing and paying off other debts? You could try dividing the money into thirds, Long suggested. One-third goes to “past you” by paying down additional debts; one-third takes care of “future you” by putting it toward retirement (or emergency cash savings if you don’t have sufficient cash savings); and one-third goes toward “present you,” by spending the money on something that will enhance your current life, such as a cleaning service, joining a club or getting a monthly massage.
“No matter what you do, the most important thing is to be intentional with the ‘extra’ money, especially if you’ve gotten used to not having the payment already due to the payment pause — it’s easy to absorb extra money into our spending without noticing any difference, even if the payment itself seemed painful when it was happening,” Long said.
Tell us in the comments which option should win in this Financial Face-off. If you have ideas for future Financial Face-off columns, send me an email.