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Home>UPDATE: Save for retirement, or pay student loans? It depends on the math

UPDATE: Save for retirement, or pay student loans? It depends on the math

UPDATE: Save for retirement, or pay student loans? It depends on the math

09/26/2017

By Kent Smetters

The common mistake many people make

Recent college graduates, hopefully you've obtained your first job that offers a 401(k), and have a little cash set aside for emergencies. But you also likely are facing starting to pay back some student debt. So, should you focus on saving for retirement or paying off student loans faster?

This is the most common question that millennials ask me. Even some experts seem to disagree on the answer, potentially due to conflicts of interest.

Online search results on this subject typically bring up loan consolidators who demonstrate that paying off student loans faster can lead to significant interest savings. That simple argument, however, misses the fact that larger initial payments have an "opportunity cost" in terms of investment returns that could be made elsewhere.

In contrast, many financial advisers--who often make more money managing your assets than by helping you pay down debts--embellish the importance of these opportunity costs. Their standard argument is that stocks typically produce a higher return over time than the interest you owe on your loans. Moreover, since young people have a long investing horizon, making minimal payments on student loans and investing the difference must be the winning solution.

However, this argument is also wrong. Indeed, stock-market risk does not decline (http://faculty.chicagobooth.edu/lubos.pastor/research/investment_news_052409.pdf) with longer investing horizons, and it cannot be compared against "safe" debt.

Also read: Money Milestones: This is how your finances should look in your 30s (http://www.marketwatch.com/story/money-milestones-this-is-how-your-finances-should-look-in-your-30s-2017-05-18)

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