Thanks for coming back to the Planning for Your Purpose blog! The purpose of the blog is to introduce financial planning concepts that I come across in my day to day work. I want to start discussions about that will educate, benefit, and improve your financial life. Ultimately, to help you focus on your telos!
So, should I be saving if I still have student loans?
This is one of the most common questions I get from Millennial clients and non-clients alike. But the logic here applies to all ages and other loans than student loans. In a previous post, I discussed some different strategies for saving and investing with different levels of aggressiveness. Today, I wanted to revisit one of those scenarios and talk more in depth about saving and paying down loans.
Why do I need to start saving early?
The reason to start early is the magic of compounding interest – no it’s NOT really magic. The longer you have money invested, the more it grows, the more growth you get on the growth, and it’s an amazing thing when it’s working for you. As an example, at 7% interest, if you saved $5,000 per year for 10 years starting at age 22, when you turn 65 years old, you would have a total of $737,562 from your original $50,000 you invested. If you wait until age 30 to start saving and save every year to age 65, you would only end up with $686,184 from $170,000 of savings. The numbers speak for themselves and are staggering. . .
That is the reason to start early. That is the reason I recommend saving (as long as the interest rate on the loans is reasonable) even if you have loans.
It is a riskier strategy to be saving for retirement when you have interest accruing, the interest on your loans is guaranteed and the market returns are not. There are some investment products that offer guarantees by banks or insurance companies, but they will tend to pay a slightly lower rate than what the market historically has yielded.
Is 7% a reasonable rate to expect?
I’ll bring it back to risk. It depends on how much risk you are willing to take. If you decide to save, as recommended earlier in lieu of paying down loans and you just save to cash, you’re losing and I would not expect that to earn 7% per year. If you look at the broad market indices over long periods of time, they have done very well.
Depending on the period you look at, the return statistic vary, but as a reference, during the 90 years from 1937 to 2017, the S&P 500 Index has averaged 10.4% return. It was positive 77% of the calendar years, so was negative 23% of those years.
Going back to my comments about risk, you need to understand when you are investing in the markets, you have the possibility of losing money; especially in the short term. One of the critical decisions you make when deciding how to invest is how much risk you are willing to accept and that will influence the return you end up with. It’s also important to remember that when you are investing in equities like the S&P 500, they typically reference long periods because in the short term, it will bounce up and down.
Remember, if it’s negative 23%, about one out of every four years, you would have experienced a negative return. It also means about three out of every four years you would have had positive returns. It’s been shown that we feel the effects of negative events more strongly than positive ones – so you have to determine what your threshold is for risk.
Are there any other reasons to start saving early?
What a great question – why yes there are. Another is budgeting or behavioral practice. If you get used to saving early, you will be in practice of saving and you are more likely to continue long term. If you pay off your loans with the attitude that when they’re paid off you can finally by the *whatever*it is you wanted, you’ll have a hard time saving with that mindset. It really helps to start the process early so you continue.
Another reason related to budgeting is it helps keep spending in check. There’s a phenomenon called lifestyle creep. This is where as you earn more money, you tend to buy more things, essentially, your lifestyle creeps up slowly to eat up your extra earnings. If you work with a financial planner, they may recommend increasing savings to use those extra earnings.
What if I don’t like risk?
If you don’t like risk, it still can make sense to invest early in a more conservative fashion. Ultimately, paying off debt most quickly is going be the most conservative option and will save you in interest paid. But if you’re young, you have time and that is one of the biggest factors in performance of investments.
Save early and save often.
Financial decisions have long term ramifications and can make a big difference in your financial success over your lifetime. If you are willing to take some risk, you have the potential for great returns. Always consult a professional or make sure you know what you’re doing before making investment decisions.
Call Telos Financial at 734-468-3050 now to schedule a meeting to review your financial situation. Telos offers free consultations and would love the opportunity to meet with you and discuss this in more depth. Make sure to check my website and blog for more information and my youtube channel for videos as well.
Telos Financial is a Michigan’s financial advisor for Xennials, Millennials, Generation Xers, young professionals & their families. Dennis LaVoy, CFP®, CLU® founded Telos Financial and uses his experience, knowledge, and expertise to build lifelong relationships with his clients as the financial advisor for Ann Arbor, Detroit, and across the country to achieve their goals.
The views expressed are my own opinions and do not apply to every situation. Your situation may vary so make sure to consult a professional for advice prior to making any decisions.