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Student Loan Payoff vs. Invest Calculator: thoughts?

Home Student Loan Management Student Loan Payoff vs. Invest Calculator: thoughts?

  • Avatar Tim 
    Participant
    Status: Accountant
    Posts: 1789
    Joined: 09/18/2018

    Simple question:
    Borrow at 4%
    Invest at 3%.

    All things being equal, you are losing $1 per each $100 unit each year, negative on your books. Wonderful!
    Once you eliminate all things being equal you are not dealing with a calculator. What do you get for the $1?

    #180464 Reply
    Zaphod Zaphod 
    Participant
    Status: Physician, Small Business Owner
    Posts: 5510
    Joined: 01/12/2016

    Simple question:
    Borrow at 4%
    Invest at 3%.

    All things being equal, you are losing $1 per each $100 unit each year, negative on your books. Wonderful!
    Once you eliminate all things being equal you are not dealing with a calculator. What do you get for the $1?

    Click to expand…

    As an accountant I know you know that isnt true. You are comparing a single snapshot in time of simple interest vs. compound interest.

    You are also only able to avoid the interest, not the principal, thats really whats at stake, how much extra interest over an accelerated payoff are you saving vs. long term investing gains. That is usually quite the nominal difference.

    Compound interest will crush even egregious simple interest rates given a long enough time horizon (make sure you have one of course), and of course principal matters (another reason to get that thing started).

    #180476 Reply
    Avatar Tim 
    Participant
    Status: Accountant
    Posts: 1789
    Joined: 09/18/2018

    All things being equal. His rate of interest was APR, his return on investment was APR. Rinse and repeat, that is compound interest. Payments are assumed to be the same.
    The reason for choosing $100 was to show its impact is negative $4 per yr ($1 per 3 months or $0.333 per month). The sooner he pays it AND the invests, he will mathematically have more wealth.

    Realistically, 1% penalty for lack of capital, liquidity, or earnings uncertainty is not a bad premium. Locked in and guaranteed, he would be negative as long as he has the loan.

    #180482 Reply
    Zaphod Zaphod 
    Participant
    Status: Physician, Small Business Owner
    Posts: 5510
    Joined: 01/12/2016

    All things being equal. His rate of interest was APR, his return on investment was APR. Rinse and repeat, that is compound interest. Payments are assumed to be the same.
    The reason for choosing $100 was to show its impact is negative $4 per yr ($1 per 3 months or $0.333 per month). The sooner he pays it AND the invests, he will mathematically have more wealth.

    Realistically, 1% penalty for lack of capital, liquidity, or earnings uncertainty is not a bad premium. Locked in and guaranteed, he would be negative as long as he has the loan.

    Click to expand…

    That is not compound interest. Dont care how often you rinse and repeat the loan interest APR, its different and doesnt compound (outside of initial capitalization which is unavoidable) by definition.

    #180503 Reply
    Avatar Tim 
    Participant
    Status: Accountant
    Posts: 1789
    Joined: 09/18/2018

    Was the 3% return calculated as compounding the monthly investment contributions? We’re those deposits made on the first day of the month or the last.
    The actual details of the loan and the investment contract matter. If you wish to calculate, in detail that’s great. 20 years has zero to do with the calculation.
    On his loans, he says average. Putting cash to work at the best rate of return is the math problem. Minimizing the outflows that negatively impact net worth and positively impact net worth. It actually applies simply as leverage. Maybe a three yr payment term with a balloon? It’s all money,
    if you spend more than you earn, you are going backwards.

    #180520 Reply
    Avatar newdoc2016 
    Participant
    Status: Physician
    Posts: 10
    Joined: 08/26/2018

    why are your investments earning you 3 %

    They’re not, it’s an arbitrary number I selected.

    For starters, 4% interest rate on your loans is pretty good, and you are already on a solid path with a 5-year payoff. Based on your username, I assume you are a younger physician so the next two big tailwinds are time in the market and compounding interest. With just those notes alone, extra savings makes sense. The $2,000 extra per month is probably going to a taxable account I assume since the other $3,166 is maxing out the 403b & 457b (great job!). If the funds are in a taxable account and one day you decide you hate student loans, you can pay them off with a lump sum, if needed. Probably not a bad idea to max out a back door Roth IRA each year with a portion of the extra savings.

    Click to expand…

    Thanks Chad, my own student loan interest rate is actually 3.8% with a payoff period of about 6 years from the time of refinancing; however, i’ve been paying about 2000 on top of that, so my payoff time has been reduced to less than 4 years. I’m debating on whether that is the smartest thing to do right now based on this calculator lol. I max out my 403b, 457b, and backdoor roth every year. Thankfully, I found this website early on to know to live like a resident for a few more years!

     

    My student loans are 1.625% and less than half a months average pay.  I’m 15 years into a 30 year payoff and that $362 a month is the least of my concerns.  15 more years or so and they’ll be gone.

    Click to expand…

    I am so insanely jealous of that interest rate right now.

    Was the 3% return calculated as compounding the monthly investment contributions? We’re those deposits made on the first day of the month or the last.
    The actual details of the loan and the investment contract matter. If you wish to calculate, in detail that’s great. 20 years has zero to do with the calculation.
    On his loans, he says average. Putting cash to work at the best rate of return is the math problem. Minimizing the outflows that negatively impact net worth and positively impact net worth. It actually applies simply as leverage. Maybe a three yr payment term with a balloon? It’s all money,
    if you spend more than you earn, you are going backwards.

    Click to expand…

    Tim, all of those numbers I used were fairly arbitrary. My actual investment returns have been higher (although the recent downturn has dug into my returns quite a bit).

    #181521 Reply
    Liked by ChadCFP
    Avatar Tim 
    Participant
    Status: Accountant
    Posts: 1789
    Joined: 09/18/2018
    Earnest refinancing bonus

    Really? Feel free to change it. That’s the miracle of spreadsheets. If you don’t like the answer, just change the assumptions! Based on the last three weeks, you might want to consider boosting that rate of return!

    #181530 Reply

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