Should I pay off debt or invest?

Today’s question comes from Colleen. She asks:

“I am 22 and I recently started my first job out of college as a nurse. The place I work at is a non profit and they offer a 403b, not a 401k, so I decided not to put money in that account (since after a year they will put in 7% automatically) and instead to open a roth IRA at Vanguard.

I have decided to invest in an S&P 500 index fund and I’d ideally like to put the max in every year, but I have not opened the account yet and I am worried about having to put a large sum of money in right away, as my savings doesn’t really look like much right now. I am wondering if you know whether I can put small amounts in at regular intervals, or if they require me to put in more money all at once. I’d like to avoid putting off starting my retirement fund because I basically don’t want to have to deal with it and it would be easier for me if it felt like I didn’t have the money in my account in the first place.

Also, I have about $9,000 remaining in student loans. Another idea I had was paying this off first with money equal to the amount I would be putting into my roth IRA, until it is paid off, at which point I would open the IRA.

Let me know what you think.

I am really not very good with this kind of stuff and most of the time don’t know what I’m doing. Your site has been helpful so far and I’m hoping to gain some financial stability at a young age so I can thank myself later.”

If you’re 22 and setting up your retirement account you’re already doing better with money than 99% of people.

How do I know this? I get at least a dozen emails a week from people in their 50s asking me if it’s too late for them to start saving for retirement.

These are the most honest, frustrating, and heartbreaking emails, all at the same time.

The most heartbreaking part is these people spent their life working insanely hard, yet they’re realizing the idea of retiring on time is just a dream.

And they all tell me the same thing, “I wish I would have started in my 20s.”

It’s an important lesson because you’re in your 20s and have a unique opportunity to do better.

Most people your age think about getting started but retirement is decades away so it’s easy to put off. You tell yourself you’ll get around to it someday.

Plus, you have student loans to pay off, and then in your 30s you’re buying a house and raising kids, and then in your 40s you’re putting those kids through college.

And then you find yourself in your 50s sending me an email asking if it’s too late to get started and wishing you had a time machine.

The data coming out backs this up. The average family has about $104,000 saved for retirement. At a 4.5% withdrawal rate that provides $4,680 a year.

Okay, but what about Social Security?

The average Social Security check is $1,360, and when you’re living on $16,000 a year that’s pretty close to the $12,000 poverty line.

That might be okay if you live a simple life, but if you want to spend your retirement doing all the things you want to do that’s not enough.

Anyways, there’s the question about whether it’s better to pay off your student loans or invest, and here’s the answer: It’s always the better financial decision to do the one with the higher number.

You have $9,000 in student loans and you don’t say but let’s pretend the interest rate is 4%.

If you’re investing in the stock market the stock market historically returns about 7%. Some years it’s more, some less, and some negative, but over the decades that’s what it smooths out to.

Now that you know these numbers you’re deciding between paying off your debt at 4% or investing at 7% and it’s easy to see the better financial decision is to invest.

But not every decision in life is a financial decision. Think about how you’d feel not having debt, and if you’d feel better not having debt then pay it off.

Here’s an example from my own life: The interest rate on my mortgage is 3.125% and while I could write a check to pay it off I’d rather have the money invested. But I sleep okay not having a paid off house.

Make sense?

My recommendation for you is putting money in savings though. You’re telling me you’re worried about having money invested when you don’t have much in savings.

You should never feel worried about money you invest, and when someone tells me they’re worried about their investments I know right away they have too much invested.

To be successful at investing you have to invest within your comfort zone because when you’re investing within your comfort zone you’re less likely to make bad decisions — like pulling your money out at the worst possible time.

You weren’t investing in 2008 when the market went down 37%. If you were a new investor worried about losing money you’d probably pull your money out and never invest again.

And that would be really unfortunate.

If you focus on building up your savings you’re going to feel more secure and when you feel more secure you can start diverting money to investing, and the easiest way to do that is with your 403(b).

Your 403(b) probably has low-cost index funds like what you’re looking for, and then the money is coming directly out of your paycheck so you never “have it”.

And if you never have it you won’t worry about it, and decades from now you’ll look back and thank your younger self for starting in your 20s.