Wednesday, February 12, 2014

401K vs College Loans

Over at Reddit we came across the following discussion:  401K vs College Loans (self.personalfinance)submitted  ago by CrazyMonkeyPoopPretty simple question that probably has been asked already. Right now i am putting a small amount (3%) into my 401K and paying off a large College Loan that has interests varying from 4-7 percent. Should i increase the 401K but decrease the loan payments? Basically is it more beneficial to concentrate on the loans than switch to 401K increase? I am paying monthly extra payments towards my loan for the loan with the highest interest.
  • all 9 comments
    [–]United Statesblackbirdblue 5 points  ago
    Does your employer offer any matching? If so you should be contributing at least enough to take advantage of the match.
    After that direct anything you can to loans that are higher interest and once you've paid off loans that are above 5% re-evaluate.
    [–]capn_untsahts 1 point  ago
    Same situation as OP, my company does no matching. I'm only contributing 4% currently. Think I should drop that lower to put more into loans?
    [–]United Statesblackbirdblue 1 point  ago
    That's a tough call.
    When you get a company match of say 50% on the first 7% it's a no brainer because that is an automatic 50% return on investment.
    After that the question becomes can you consistently make more by investing than you are paying to service your debt (interest rate). When you pay down the principal on your loans you are getting an automatic, guaranteed return on investment equal to the interest rate of the loan.
    Most people with quote that number somewhere between 3-6% but it will vary depending on the funds available in your 401k and how you have made your investments. Also if it's close you have to consider that you aren't paying taxes on what you contribute to your 401k but to a certain extent when you are still paying off debt I wouldn't think about that too much, consider it later when your loans are paid off and you're trying to maximize your tax advantaged savings.
    I'd say that with no company match if the interest rate on my loans was 5% or higher I'd consider reducing contributions in order to pay off the debt but if the interest rate was lower I'd expect to do better in the long run by investing in my 401k. Also consider making a post and ask /r/pf to evaluate your budget, they can help put things into perspective if there are areas that you can save money.
    [–]capn_untsahts 1 point  ago
    Thanks. I'll have to check what my loan's interest rate is but I suspect its around 6-7%. You mentioned "how you have made your [401k] investments". I've never really looked at what funds my 401k is going into, do I need to actually look into that and consider trying to manage where the money goes myself? I've logged in to my 401k online but was a little confused with what I was seeing, besides the basics "you've put this much in, you've made this much interest."
    I already know where I'm spending too much (eating out for lunch mostly... I hate grocery shopping so my kitchen is often bare) I just need to work on actually changing that.
    [–]United Statesblackbirdblue 2 points  ago
    You should at least be aware of what types of investments you have. The bogleheads site has a lot of good information. If you don't want anything too difficult a Target Retirement Date fund is usually a pretty good choice. If your 401k provider offers multiple funds for your target date, look for the one with the lowest expense ratio. You can start by looking at your current numbers and see your returns over the past few years, don't just look at the last quarter, overall returns last quarter were abnormally high. Look over an extended period of time.
    Maybe for lunches try making something that you can make easily or cook once eat throughout the week. I like to make things like a pan of lasagna or enchiladas that will provide lunches all week. You could even consider frozen entrees, they aren't all just junk and it's still cheaper than eating out or search /r/eatcheapandhealthy for lunches. But we say you spend $8 a day on eating out and you switch to bringing a lunch that costs $3 or less on 2 days a week thats and extra $40-45 per month or 500/year that you can use to pay down your loans.
    [–]capn_untsahts 1 point  ago
    Thanks I'll try to look into that stuff tonight! I've only had a 401k for 1.5 years but I'll try to compare what I have.
    Yeah I need to try to start making stuff in bulk so I can have it ready for the whole week. That sub is definitely very useful, I haven't used it enough. I also like /r/slowcooking but everything I make from there is so delicious I usually eat it all in 1-2 sittings!
    [–]United StatesaBoglehead 1 point  ago
    Have you read the FAQ? Basic advice is to build your emergency fund, contribute to your 401k up to your employer's match, then pay down your high interest debt. If your employer doesn't match go straight into paying your debts.
    [–]CrazyMonkeyPoop[S] 1 point  ago
    I got the emergency fund covered but have only couple of percent on my 401K. I am not putting the max for company match. I was just confused about how much to put in 401K. So say my company matches 50% up to 10 percent, then your recommendation is put in 10 percent. Is that correct?
    [–]notyourbroguy 1 point  ago
    Yes, absolutely. Contribute up to your match and use whatever you have left after your monthly expenses to pay down that debt.