You'd think that student loan repayments were the sisyphean rock for American millennials - doomed to a life of never-ending debt repayments as we delay buying homes and starting families. Certainly, a monthly payment to retroactively fund an expensive education can be and is crippling for many. But new data shows a different story for many young Americans.
Personal Capital helps people track their net worth. (Full disclosure, the company also pays my salary). Of the company's more than one million users, 43,000 people are monitoring their student loan accounts, along with the rest of their financial accounts. Out of this group, 17,000 of them have more than $100,000 in investable assets. They're well-off - not millionaires, but they've got a lot of money at their disposal. We looked at this well-off group and found that they carry an $87,000 average student loan balance, while holding onto $197,000 in investment savings. They have more than enough money to pay off their loans, but they aren't. Why is that?
I'm also one of the 43 million graduates with student loans, and I've got more than the average of $37,172, according to Student Loan Hero. Thanks, Stanford. And I'm in no rush to pay those loans off, even though I could afford far more than my minimum monthly payment. Here are the three reasons why I think it pays not to pay off my loans with my investable assets.
Cash is King. Having liquidity can be more important than lowering your debt burden, particularly if you're just starting out in your career. At this stage, I want to build a solid emergency fund with 3-6 months of living expenses and enough for a down payment on a first home (which in San Francisco is no easy feat). Paying off my student loans early doesn't rank as high.
Retirement Savings. Like many of the well-off Personal Capital users with student loans, I'd rather save for my retirement than pay off the debt quickly. I have assets in 401ks and IRAs, and a wise financial advisor would recommend I keep those retirement funds where they are. There are powerful compounding effects of time on money and severe penalties and taxes I'd incur if I prematurely liquidated my nest egg. In addition to federal and state income tax, investors younger than 59½ who cash out have to pay a 10% early withdrawal penalty. The potential result: Cashing out $50,000 in 401k savings may leave just $35,000 in cash after 20% withholding and a 10% early withdrawal penalty.
Market Return. A careful look at the math shows that if you're willing to take the risk, you can make more over time in the stock market. Interest rates on federal student loans are less than 5 percent, but the average annual return on the stock market is 7 percent. It makes sense to try to capture that 2% spread. In the three years since I graduated from business school, my total return (on a globally diversified portfolio) has been over 20 percent. That roughly 7 percent annual return I've received, compared to my low interest rates around 3 percent, shows I've made a solid investment - at least for now, while markets have done well.
Roughly 40 percent of America's total $1.3 trillion student loan sum was used to fund professional and graduate degrees. A graduate or professional degree can result in a significant bump in your annual income. The expected median starting salary for recent MBA graduates in the United States is around $100,000. And many of those professionals, like me, could pay off their debt, but are choosing not to.
Despite the popular rhetoric that student loan debt is crippling an entire generation's financial future, instead consider that some millennials are simply being thoughtful with their money. For many, student loans are smart debt that boosts their earning and investing potential.