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By Teresa Stewart - May 23, 2017
You crossed the stage, shook hands and received that diploma. Sixteen years of education paid off with a new job secured and… $30,000 in student loans. Wait. What? Earning a degree is often the first step toward beginning your future. However, it's also when a new reality sets in: paying your student loans. Before you settle for ramen noodles for the foreseeable future, consider your options.
Students are graduating college with increasingly more debt. In 2016 , the average was $37,000, a six percent increase from the year before. Many people may not like debt, but student debt is still considered "good debt." The loans typically have low interest rates, and having a college degree may lead to brighter income horizons. Four million jobs have gone to college grads with a bachelor's degree, compared to only 80,000 for those with a high school degree, or less. But you shouldn't have to trade off saving for your future to pay off your debt. It's possible to repay student loans, invest and build up savings—simultaneously.
If you're an undergrad, your student loans could have an interest rate of four percent or lower . And many federal student loans come with affordable repayment plans and options to refinance or consolidate. Paying off your student loan quickly may feel good, but it may not be the best option. Long-term investments, like an employer's retirement plan, have historically averaged 5 to 8 percent returns . Saving for retirement is something you should consider, especially when you weigh any potential returns against what you're paying in interest on your student loan. Instead, you may want to pay a smaller amount on your loan so that you can start saving for retirement. Here's why.
Thinking about retirement after you just graduated may seem a bit much. But… you've got two big things on your side: youth and time. These two factors are key to compounding , which lets you start with a small amount and, over time, helps the money build. Let's look at two hypotheticals, comparing the outcomes of starting to save for retirement at 25 years-old vs. 35 years-old.
The hypothetical calculation above assumes an initial investment of $250 and additional monthly contributions of $150 earning a rate of 6% annually over 30 and 40 years respectively. It additionally assumes reinvestment of all realized gains, dividends, and interest receipts and does not account for the effects of any added fees, expenses, or taxes that might be incurred. If all taxes, fees, and expenses were reflected in the calculation, reported portfolio values would be lower.
If your employer offers a 401(k) or another type of retirement plan, consider signing up. At a minimum, we recommend investing at least as much as your company matches. If your job doesn't offer a plan, set up automatic investment in an individual retirement account (IRA).
So, you are paying off student loans and saving for retirement. But, what happens if your car breaks down? If all your extra cash is spoken for, you may be begging for rides or burning through cash on Uber. Think about setting aside some money for unexpected expenses. The good news is, that after saving enough to cover three to six months of living expenses, you'll have a nice cushion. Seem impossible? Keep reading.
Remember when you developed an outline for term papers? You probably thought you'd never use that skill again. Creating an investment plan works the same way. Lisa, a recent graduate, put together a plan to pay down her loans, sock away emergency cash and start a retirement savings plan with her employer. Here's how she did it.
Lisa prioritized her loans by interest rate. Getting paid twice a month, she paid the minimum on all of them with her first paycheck, and then used her second to make an extra payment to the highest-interest loan.
Making two payments a month towards the higher interest rate loan kept the interest from building up too fast. And it meant more of my payments were going towards principal.
Lisa wanted to save $1,000 for unplanned expenses. After her student loans and other bills, she figured out how much she could put into emergency savings. She socked away this amount until she reached her goal (even making her own latte at home to save).
I pretended my emergency account didn't exist. When I needed to use the money for an unplanned expense, I re-routed my extra loan payments to my emergency fund until it was whole again.
After college, Lisa started in part-time gigs that didn't offer 401(k) plans. Instead, she started a Roth IRA account and treated it like a bill to pay each month. When she landed a job with a company that offered a 401(k), she started investing immediately.
To receive my company's 401(k) matching payment, I had to invest a required amount. For example, if I put in the required three percent, my company would also put in three percent. My portion was taken out of my paycheck automatically, so it didn’t feel like I was sacrificing anything.
It may seem daunting, but you and your future deserve a smart plan. Learn more about how to start one for your long-term goals.
Learn more about how to start one for your long-term goals.
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The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.