Many workers on the verge of retirement have a litany of financial problems—savings shortfalls, rising health-care costs and inflation. Starting early and saving often is the message typically offered by the financial services industry to meet these challenges and secure a decent retirement.
So why isn't this same message applied when it comes to paying down student debt?
For the current generation—likely to be in the worst shape of all—student loan payments are a financial challenge that will stare them in the face for decades to come. But it doesn't get wrapped up with a bow into a similar investment solution packaged by the financial services industry.
It's no surprise, then, that some enterprising millennials are proactively turning to investing in order to pay off their loans.
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The traditional model of job, new home and retirement planning is being disrupted, said Dan Thibeault, president and CEO of GL Advisor, which offers financial advice to professional graduates on managing student loan debt. Thibeault has been seeing recent graduates, often MBAs, using their new skills to crunch the numbers to figure out if they will fare better by investing in the markets to attack their student loans versus investing in their retirement accounts.
A quick review of the numbers shows why recent grads need to think of student loans as a problem requiring an investment solution on par with saving for a home or retirement.
Student loan debt obligations in the U.S. stand at a little more than $1 trillion, according to the data company MeasureOne. The Institute for College Access and Success reported that the average student loan debt has risen to $29,400 per borrower. This makes student loans the fastest-growing form of consumer debt in the country.
Interest rates are lower today than they have been in the past—undergraduate federal rates are 3.86 percent and graduate averages just under 6 percent—and they are fixed. Private loans—which account for about 8 percent of that $1.1 trillion—have shrunk in recent years as big players like J.P. Morgan have exited. Nevertheless, those saddled with private loans are often subject to higher rates—some up to 12 percent—many of which are variable.
Wage trends, meanwhile, aren't offering much of a boost in paying down student debt. The average salary for the most recent college graduate is $45,633, according to government data analyzed by the National Association of Colleges and Employers. Out of that salary comes monthly loan payments than can run several hundred dollars, easily taking a significant chunk out of a millennial's first paycheck.
Student loan expert Heather Jarvis, who provides educational resources for students and parents, sees just how much monthly payments are "directly affecting a graduate's ability to purchase a home or save for retirement." She warns that due to accruing interest, loans often turn out to be larger than expected. Therefore, it's in a borrowers best interest to pay down loans as soon as possible. "The faster you pay, the less you pay over time," Jarvis advised.
A good way to start plotting out an investment plan to pay off student loan debt is to become familiar with ETFs, since the products often have among the lowest fees in the fund industry and offer exposure to broadly diversified indexes.
Of course, there are risks associated with any investment. Bobby White, chairman and CEO of Reliance Financial Group, along with the company's chief investment officer Wesley Fleming, pointed to the market crash of 2008 as an example of why investing always needs to be a long-term play for investors. Time is the best way to "stretch the risk out."
And investing to pay off your loans does depend on how much disposable income you have—if you can't even meet your monthly bills, then this strategy has no place for you. But then again, should you be maxing out a 401(k) plan contribution at 10 percent—which most financial services firms recommend—if you can't put even one dollar from a paycheck to an investment plan to pay down your student debt?
Some broad U.S. equity indexes easily beat the 3.86 percent current undergrad rate on federal loans: the SPDR S&P 500 ETF has a 10-year total return of more than 7 percent, and iShares Russell 2000 ETF has generated more than 8 percent.
"If you look at the average portfolio over the last 25 years, you are getting a return that is exceeding historical averages," Thibeault said. By doing the math, some might find that, based on anticipated returns and their after-tax earnings, an individual investment account could outpace their student loans, which continue to accrue interest.
A recent college graduate could take a look at the traditional approach to investing, such as a 60/40 portfolio—a 60 percent stock, 40 percent bond split—to take a little risk off the table, even at a younger age. According to a Vanguard study, from 1926 through 2013, a 60/40 portfolio has given an average annual return of 8.6 percent; in the last 13 years it has been 4.6 percent. Despite the lower returns, Vanguard stated that "a long-term, strategic approach with a balanced, diversified, low-cost portfolio can remain a high-value proposition in the decade ahead."
A decade ahead is exactly what a recent graduate needs, since the average federal student loan takes around 10 years to pay off after graduation, according to the Consumer Financial Protection Bureau.