Should you invest in the stock market or pay off debt? It depends on several factors, but one 25-year-old didn’t want to guess. This individual turned to Reddit and asked if it makes more sense to pay off a student loan at 6% APR or start investing in their 401(k).
Several Redditors offered their suggestions, but most of the comments had a few key details in common. Knowing how to tackle investments and loans is an important part of building wealth, and Redditors didn’t disappoint in the comments.
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Take Advantage Of The 401(k) Match
Most Redditors suggested that the 25-year-old capitalize on their employer’s 401(k) match program. The employer match program can help you grow your portfolio at a faster rate, and it produces a much higher return than the 6% APR the 25-year-old saves with early student loan payments.
“Take at least the match. 50% return guaranteed!” the top commenter said.
Another commenter went deeper into the numbers to demonstrate how much the 25-year-old would gain from the employer match.
“If you put in 6% of your salary, get the bonus 3%, you are turning $3,900 into $5,850.”
The 25-year-old won’t save 50% of their money by paying student loans early. The interest rate is much lower than this guaranteed rate of return, and that doesn’t even include tax benefits and potential stock gains.
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Risk Tolerance Plays A Key Role
While the employer match seems like the best route to maximize returns while paying off debt, some Redditors suggested maxing out the 401(k) and paying off the student loan with the remaining money. This approach leaves the 25-year-old in debt longer, but it may be the right choice if the original poster has a high risk tolerance.
“It ultimately just comes down to an individual’s risk tolerance,” one Redditor said in the comments. “Do you want a safe 6% or a risky 10% average return? If you’re single without dependents and you have the ability to take some risks, then put extra cash into retirement. If you want to be debt-free sooner, then pay off extra towards loans. Neither answer is correct.”
Some ETFs like the Invesco Nasdaq 100 ETF QQQM have consistently outperformed a 6% APR. This ETF has an annualized 22.1% return over the past three years. This level of outperformance shows how much the 25-year-old can grow their portfolio by maxing out their 401(k) now. Maxing out also results in more tax savings.
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Projected Income Growth Also Plays A Role
The original poster’s financial situation will change over time. Income, expenses, and obligations are some of the many variables that can change over time. While you can’t control what the Federal Reserve does with interest rates or how policies affect the stock market, you have more control over your income.
“Is there any chance of making more money in the future?” one commenter asked the original poster while hypothesizing some of the factors that can influence whether 401(k) contributions or student loan payments make more sense.
If the 25-year-old anticipates better career opportunities in the future or picks up a side hustle soon, it significantly impacts the decision. Anticipating extra money makes 401(k) contributions more plausible than extra student loan payments. That’s because the 401(k) limit resets each year, offering limited opportunities to grow your nest egg while enjoying tax benefits.
A 6% APR gives the 25-year-old flexibility to invest in their 401(k) without having their debt snowball out of control. It’s also possible for the portfolio to outperform the interest rate, and the options really start to expand if the original poster gradually grows their income.
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