Paying Off Student Loans Vs Investing for Retirement

You read a lot about people with a ton of credit card debt, and how paying that off is more important than saving for retirement.  But what about those of us that have no credit card debt, but student loans instead?  Do you wonder if you should be aggressive with those loans, and cut out all retirement investments?

We’ve been saving for retirement while still paying off my wife’s (Megan) student loans.  She graduated just under a year ago, and we’ve had these student loans hanging over our head for as long as we’ve combined our finances.  While she was in school, we paid the interest on her loans with just my income, while paying her current college expenses (so she wouldn’t rack up any more student loan debt).  It was all we could afford to pay.  Once she graduated and got a job, we have gotten aggressive with paying them down.  We’ve made a good dent in them, but still have the largest loans still out there.

Now that we are having a baby, our priorities have shifted.  We won’t have as much income if Megan decides to cut back a day or two on work to stay home with our daughter, plus all the added expenses of raising a child.  This debt that’s been hanging over us has gotten me thinking even more about how we should handle the student loans.

I figured that if we cut down our retirement saving to be the bare minimum, we can pay off all our debt other than our house in 2-3 years.  Since this is just a short term commitment, it won’t have too much of an impact on our retirement savings.  I wish I would have realized this right when she graduated, as we would have been even further on our way of paying down the debt.

If you have student loans, and wonder if you should pay down that debt or save for retirement, my recommendation is to cut all retirement saving and get rid of all your non-house debt.  It’s a short-term commitment that will help you out in the long run.  Some people might argue that you lose more in the long run because of compounding interest, but getting out of debt is just as much mental as it is mathematical.  Once you are out of debt, you can contribute more to your retirement fund to catch up.  Since you only take a couple years off, it’s not that difficult to catch back up to where you were.  Get rid of all non-house debt, then save for retirement.  It’s a much better feeling being debt free than the little bit of difference you’ll possibly make in those 2-3 years investing.

Budgeting Basics – Spend Less Than You Earn

Ok, I’m going to talk about the dreaded “B” word – budgeting.  If you want a better connotation for the same thing, use something like “cash flow.”  It’s all the same.  Budgeting is a necessity in life that most people just don’t grasp (or don’t want to even try).  It’s really simple though: simply spend less than you make.  That’s what it all comes down to.  I’ll help you get started though.

First, start tracking every dollar you spend.  This includes everything from mortage, rent, car payments, and insurance to buying groceries and eating out to morning coffees, sodas, vending machines, etc.  Everything you spend needs to be tracked.  You can use a program like Quicken or YNAB to do this, or you can simply use a spreadsheet like Microsoft Excel or Google Docs.

Once you track your spending for one month, take a look at where your money has gone.  Add up all your expenses, and add up all your income.  Did you spend more money than you brought in for the month?  If so, you aren’t alone.  This is the reason why most people have so much money on their credit cards.

Start looking in detail at where you spent your money.  Where can you cut back, even if it’s just a little next month?  Did you eat out a lot this month?  Maybe you could cut it back, even if it’s just $10 or $20.  Do you eat out every day for lunch?  Maybe you could pack your lunch a couple days a week.  Do you spend money on things you don’t actually use, like a gym membership, Internet usage or text messaging on your cell phone?  Those premium channels, like HBO, Showtime, etc?  Do you get coffee at the local Starbucks, or buy a soda every day at work?  If you find things you are paying for that you don’t use, try removing one of them next month and see how it goes.  You may find out that you really can live without it.  If you find yourself wishing you had it back, add it back.  Try cutting one big item out of your spending for the next month, and try to cut back 10% on one additional item (such as eating out). Doing this starts you down the path of living on less than you earn.  Once you start thinking about things in this manner, you’ll be able to find lots of little ways to cut back that can end up saving you a lot of money.

Okay, so now that you see where you’re spending your money, how does it compare to what it should be?  Group everything into a high level category of fixed costs (such as mortgage, rent, utilities, car payments, credit cards, groceries, gas, etc.), fun money (eating out, drinking, clothing, etc.), retirement (401k, Roth IRA, other investments), savings (emergency fund, vacations, house down payment, etc.), and giving (Christmas presents, birthday presents, religious giving, etc.).  This gives you an idea of how much you should be spending in each category:

Fixed costs: 50 – 60%
Fun money: 15 – 30%
Retirement: 10 – 15%
Savings: 5%
Giving: 10%

After only one month of tracking, you may not fit directly into these categories.  After tracking for a while though, you should fit pretty close.

If all that seems way too complicated, simply live off of 80% of what you make, and put the rest toward giving and saving for retirement.  It all comes down to one simple thing: spend less than you earn.  If you can get to that point, things will be much easier.  You will be able to pay down your debts, start to save money, and you will not be stressed about money as much.