Ben needs your help

Ramit Sethi

Here’s an email I just got. It’s a good one. Instead of just trying to answer it myself, I thought I would put it on IWillTeachYouToBeRich and see what other people think. Let’s try to get a few good responses up here.

Ben Clark writes…

My question is simple. You write so positively about people our age investing (and investing aggressively), and I’ve seen the calculations and it makes a truckload of sense. However, it has been my experience that most of us have student loans and credit card debt — in other words, we’re in the red, despite what little cash on hand we may have.

If I am paying interest on student loans (only about half of my total debt is the interest federally subsidized), and I’m paying interest on credit cards each month (despite your advice to pay it off, that’s harder than it looks), shouldn’t I take the money I would invest and instead try to pay down the debt?

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If that’s the case, what advice would you give to someone who will likely be in debt for $30k-$40k in a few years? Am I just S.O.L. when it comes to any sort of financial security in the future, or can I still try to get a leg up?

Thanks for all your help, and thanks in advance for any advice you can offer regarding this. I’m sure I’m not the only one wondering this!

What do you think?

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  1. Michael

    My thoughts:

    1) If your employer offers a decent match for participating in a retirement program, invest just enough to get the maximum match.

    2) Build up a small (~$1k) cash Emergency Fund. Fast.

    3) Once that’s done, pay off the debts as fast as you can. Focus on credit cards, auto loans, and other non-tax-advantaged and high-rate debts. Student loans and mortgages tend to be tax-advantaged in some way; make minimum payments on these until the other debts are gone.

    4) Compound your payments (use payment money from previously-dispatched debts) and attack those student loans.

    5) Finish the Emergency Fund. (3 to 6 months’ worth of expenses.)

    6) Start investing for REAL. Pile on the wealth.

    Remember: Paying off debt IS an investment. Its return is not strictly monetary, either.

  2. Chris

    I say pay off the debt. It’s unlikely that any investments would earn more than the credit card interest.

  3. james

    This sort of decision making can be a very hard one. However, There are at least two points your reader might want to consider.

    1) First, what his goals are. The first step to financial planning is goal setting. Having a measureable and achieveable goal is a prerequisite for debt reduction. I am certain your reader will find that when he knows where he wants to go, a lot of the psychological barriers in getting there will be removed.

    2) Second, paying credit card debt has immediate and substantial returns. Credit card debt has two major disadvantages. First, it often carries very high interest rates, often in the 11 to 20 percent range. Second, interest on credit card debt is non-tax deductable. The combination of these two factors is makes paying down credit card debt the absolute best way of effectively improving ones financial health.

    I would say your reader should consider these two points and come up with a written plan for his personal finances over the next year or so.

  4. Jose

    My Advice:
    1) Take control of your finances. Learn to live below your means so that the balances don’t increase any more. (you may have done so already). DO NOT SPEND A CENT THAT YOU DO NOT HAVE. Get out of the debt-addiction.
    2) Develop a “pay myself first mentality”. You invest first. You pay debt. And then with whatever is left, you pay housing, food, transportation, and all other expenses. Of course, you have to figure out the correct and comfortable levels before you start.
    3) Improve your credit score if you have not done so. How? Make sure you pay your cards and bills on time. (you may have done so already, but if you haven’t it will probably take time)
    4) Once you have a good credit score, you can apply for low interest credit cards. I have a capital one fixed rate at 7.9% — that is below my expected rate of return on the S&P 500, and slightly above long term bonds and CDs. Make sure the card offers balance transfers with no fees.
    5) Transfer high rate balances to that card. Leave the student loans alone, those usually carry a low interest rate anyway.
    6) Now the answer to your question: Keep investing AND paying debt at the same time. (Some people differ on this one and I invite you to follow the link below for my explanation.)
    My suggested priorities:
    a) Pay double the minimum payment on your credit cards and student loans.
    b) Max your 401k or IRA.
    Put this into SP500 or similar. Will probably give you more than the 7.9% interest the card will charge.
    c) Invest 10% outside of retirement accounts. Will probably give you more than the 7.9% interest the card will charge.
    Put this into SP500 or similar.
    d) Anything else goes back into debt payments.
    e) Then comes all of your regular expenses.
    f) DO NOT SPEND A CENT THAT YOU DO NOT HAVE. Get out of the debt-addiction.
    7) RECOGNIZE THIS WILL TAKE TIME. Maybe Years. It is a long process but it will:
    a) Build wealth. – If you only reduce debt, at the end of 5 years you do not have a cent. If you do both: reduce debt AND invest, you will have no debt and some balance. Time is on your side: but only if you have CAPITAL.
    b) Create discipline. After a couple of years you will have learned (with some manageable pain and suffering) how to live a life below your means and make money.

    Debt Management Link:

    Savings are Sacred Article:

  5. Will

    “a) Pay double the minimum payment on your credit cards and student loans.”

    How can you justify paying a cent more than the mininum for student loans? You will not be getting lower cheaper debt than your student loans ever. I think a good rule of thumb is to never pay above the minimum for student loans (provided they are very low). Bearing debt isn’t a bad thing, it’s isn’t a crime and the stigma attached to it is from days when people were much less resource savvy than they are today.

    Paying $100 today towards your student loan saves you $4 (or $X depending on the interest rate) over a year. Is that $4 lower or greater than what you’d expect to earn if you put that money in the market? That’s the question you should ask yourself.

    Or ask yourself, are you better off paying $100 today towards you student loans to save $4 over a year or applying that money to your credit card debt and saving $10 or whatever your interest rate would imply.

    The general rule for me is that credit card debt is debt you should always pay off immediately before anything else because it’s the most expensive debt. Student loans you should almost never pay off more than the minimum.

  6. Jenny

    Pay off the credit card first. It’s unlikely that any investment will earn a higher return than your credit card interest rate.

    After that, invest if the interest on your student loans is lower than what you think you can earn if you invest over the lifetime of the loan (this is probably the case).

    Last, pay off the student loans. Yeah, they’re massive, but they’re probably “cheap” compared to your credit card interest + fees and the opportunity cost of not investing.

  7. Jonathan

    A major lesson of this and other financial advice columns is to get in the proper mind set – the mindset of moving your money wisely. Even though you have little money, you can still make out a budget each month and see how much you’re spending on consumable goods, and if you can spend more on reducing the debt. As a student, being frugal can pay off later. Get rid of the credit card debt any way you can…. consolidate it into a cheaper rate from a bank if you can.

  8. ~Dawn

    ***Setup an emergency fund
    ***Max out your employer’s matching part of the retirement fund.
    ***Start paying down the debt with what you can and snowball the payment to the next debt once one is paid off.
    Just my 2¢

  9. Marc James

    I am a 19-year-old college student and am frankly disgusted at how so many of my peers get into debt. I realize student debt is often unavoidable to those whose parents don’t pay for college (mine luckily do), but what there is no excuse for is credit card debt. I only have a debit card and therefore I only spend what I have. The best way to get out of debt is to avoid it in the first place, and that involves common sense, something I fear a lot of young people lack. 🙁

  10. Rahul

    1) Just pay off as much as you can of your credit card debt first.
    2) Then pay off the next loan which has the highest interest rate even if they are student loans. Work out on a excel sheet or whatever how much you end up paying in interest and how much tax benefit you really get. When I did mine – I was getting only $300 in tax saving but still paying $1000 per year. Not worth it.
    3) As Ramit mentioned in a previous post – do some gigs to make some extra cash. Every little bit helps.
    4) Live frugally. Even though I have a job and all that now, my tough days taught me that I really dont need that sexy new gizmo.
    5) Many may disagree, but what I did while I was in debt, I saved ~100-150 a month so while I get out of debt, that 150 is my investment money. I put it in a savings account so it makes at least 3% (as opposed to nothing). When I got out of major debt, it got invested.

  11. Nikki

    When in a whole stop digging.

    Start by living below your means.

    Stop charging your expenses OR only charge what you can pay off at the end of the month.

    Save 10% of your income. 10% because it’s big enough to make a difference in the saving ie. you only have to save 10 times to see your paycheck in the bank AND it’s small enough to not hurt. This is your “car can’t start and needs a new transmission” money, not the “I have to go to the doctor for a checkup but failed to budget it” money.

    Put 10% away for investing. This is the money you will put to work for you. It is the money you can afford to lose. Use to build capital for a business idea OR to buy investment property OR grow it in stocks. What you do with this money will require significant research. Don’t throw it at the latest get rich quick scheme, property, or stock.

    Continue paying your bills on time. If you have extra money left after saving 10% and putting away 10% for investing. Use that to pay down the credit card debt. You will need to have some debt in order to establish good credit. It is easier to get credit for good things like real estate investing or business loans when you have an established good credit history.

  12. Ben

    Everyone: thanks for the great advice! I do have some responses to a few specific issues.

    ** Just a reminder, I am still a grad student, and I’m about to start a PhD program (which means another 4+ years of being a full-time student). While I hope that I’ll get a nice-sized paycheck as a professor, this means that I am forced to live beyond my means at the time being simply because I don’t have the time to work 40 hours a week. (Last year, I only earned about $15k as a part time worker — barely enough to live on.)

    ** Nevertheless, I like the idea of starting a “emergency fund.” I don’t really have one of those right now. Also, I will get more aggressive about my credit card debt, as it is killing me every month. I think those two things will help me get a little more financial stability.

    ** I especially like the advice of not paying a cent more than the minimum on my student loans. It makes perfect sense to invest what I would pay. I will definitely do this once I start paying off the loans (after graduation).

    ** So, thanks again everyone!