Ask MAX: Payoff Debt or Takeoff in Funds?

July 6, 2006

Dear MAX,

We are a 26-year-old couple getting married and want to invest our wedding money in the best way possible. (We estimate receiving 25k.) My fiancé is still in grad school, and I am paying off student loans. Should we put the money toward paying off our educations? Or should we invest it in a mutual fund?

Ray and Margaret
Salem, PA

Dear Ray and Margaret,

As an investment advisor, I should tell you to pay off all debts before investing because it's unlikely you'll earn more investing than the rate on your debts — especially after taxes, commissions, and the like. Plus, it's a lower risk strategy — imagine your investments go sour, you lose your job (the two can be correlated with the economy) AND you still have your debts.

That said, I'd only pay off high interest rate debt like credit cards (and then only if you WON'T rack the debt right back up). Student loan interest is acceptable debt to carry. For one, unless you earn a lot of money ($65,000 per year single filers or $130,000 for joint filers) the interest is deductible on your taxes (thank you Bill Clinton). Credit card interest is not deductible (thank you Ronald Reagan).

Thanks to government backing, student loan interest rates are ultra low given they are secured by nothing but your social security number. The key is to consolidate the loans at as low a rate as possible, which you can do by calling the government (1-800-848-0979) who probably has your current loan. Also set up automatic deduction of payment from your checking account because the government will give you a discount on the rate if you do. Unfortunately, student loan interest rates reset at a higher level on July 1st, 2006.

Home mortgage interest is largely deductible (Reagan kept that one alive). While it’s a good idea to pay off your mortgage at an advanced rate, you will want to invest along the way as you pay off the house debt.

Its important to start investing early and get in the habit of adding to your portfolio (as well as making timely debt payments). If you don't plan on using this newfound wealth to buy a home in the next few years (which would require playing it safer, with more savings, bonds, and less stocks, so you don’t lose big right before you need the dough), buy a stock mutual fund, as you are young enough to take on some risk. Consider Bridgeway Blue Chip 35 (BRLIX) with about $20,000 (don't panic if your account drops by $5,000 in a rough market) and put $5,000 in a high yield savings account for a rainy day (so you can keep paying your debt if you lose you job…).

For no risk savings, go with a low fee money market fund like Vanguard.

Thanks for the question.


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