Vanilla and Chocolate live in the fantasy world Banana Bread Land (BBL). They have a daughter Swirl. Swirl has recently graduated university, the University of Banana-Hammock. She has student loans of 50,000 muffins, will pay 5% annual interest, and a period of 20 years. This gives her a payment of 330.25 muffins a month. Her parents are willing to give her 500 muffins a month to help cover her loans. Swirl wants to know, is it better to pay off the loans faster and invest at a guaranteed 7% every year, or start investing the money her parents give her right away? Let’s take a look.
This is Swirl’s starting position at the beginning of 2021.
| 2021 | No extra payments |
| Assets | Liabilities |
| Student Loans: 50,000 muffins |
Swirl is fortunate to get a good paying job after university. She tells her parents the extra payment is not needed. If she only made minimum payments on her student loan, this is her position after 5 years. She says, I am young, let me enjoy my life. I can save later.
| 2026 | No extra payments |
| Assets | Liabilities |
| Student Loans: 41,864. 53 muffins |
Finally, after 20 years, she makes her last payment. At last! Freedom is at hand.
| 2041 | No extra payments |
| Assets | Liabilities |
| Student Loans: 0 muffins |
You will easily notice that Swirl has never accumulated any assets over 20 years. She didn’t follow her parents footsteps, who prudently saved for retirement. Luckily, Swirl has one of those fancy time travel machines (no Time Variance Authority here), and travels back 20 years. She goes back to her parents, humbly says, I’ll take the extra 500 muffins a month, and I’m going to pay down my loans faster.
| 2026 | 500 muffins extra a month for debt |
| Assets | Liabilities |
| Student Loans: 8,500.51 muffins |
Swirl pays down her loans in month 70. She invests 830.25 muffins a month at a guaranteed 7% interest rate for the remaining 170 months. This is how her situation changes after 20 years.
| 2041 | 500 muffins extra a month for debt |
| Assets | Liabilities |
| Investments: 241,395.05 muffins |
Not bad! Swirl wonders, I wonder what the situation would be like if I used my time machine, and invested the money, all from the start! Capital idea, Swirl. Swirl invests the 500 muffins her parents give her from the first month. After 5 years, she takes a peek.
| 2026 | 500 muffins extra a month for investments |
| Assets | Liabilities |
| Investments: 35,796.45 muffins | Student Loans: 41,864.53 |
Oh! This is slightly better, says Swirl. I have assets, and how much I am worth, while negative, is better than before. Let’s continue for 20 years.
| 2041 | 500 muffins extra a month for investments |
| Assets | Liabilities |
| Investments: 260,463.30 muffins | Student Loans: 216.22 muffins |
This is the best of all worlds, claims Swirl. I have the most assets and very little in student loan debt. She lives happily ever after. The End.
In reality, things are not so simple. It’s hard to earn a high, consistent, guaranteed rate of return for 20 years without taking more risk of loss. Returns are variable, and can go negative. How much debt should you pay off in full before you invest? Paying off debt generates a guaranteed return. In my experience, you should start investing right away, even if it is 1 unit of currency per week. Fintech companies like Robinhood, Acorns and Sofi make it simple to invest in passive, sustainable investments or actively invest with small amounts. This blog has emphasized paying off debt consistently. There does come a time when you need to start investing while paying off debt. That point for us was when debt was no longer choking our ability to live.
Swirl didn’t have any unexpected expenses in her fairy tale life. That’s not true for most of us. The pandemic has shown us the value of emergency savings and built up, liquid assets. Be prudent, pay off your debt as much as you can, start investing as soon as you can, and while that happens, live in the present and enjoy your life. Slowly increase your savings and investments as you progress in your career and have more side gigs to earn income. Your net worth will go from negative to neutral to positive over time. Investing is a long game. Do it right, and it will reward you handsomely.
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Warmest regards,
smilingdad
smilingdad 