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Nov 03

Investment vs. Loan Payoff

A few weeks back, I was contemplating various ways Jess and I could possibly payoff school debt sooner rather than later.  I had a spreadsheet detailing my current Loan Payment Plan, but I was more than willing to knock months off the bottom of that plan, if at all possible.  So I mulled over several schemes for paying them off sooner: embezzlement, bank robbery, pirated movie sales.  The usual.  But none of these options gave me complete confidence that they were bullet proof.

And then another, slightly more ethical thought crept into my mind: what if I pulled money from my own investments and used that to pay off school loans?  After all, my investments were earning less interest on a monthly basis than the loans were accruing interest.  Surely it made sense then to use the money from investments to payoff the loans.

Additionally, though I would be lowering the balance of the investments for the short term, I would more quickly be able to put larger monthly contributions toward them, as I would no longer be putting those monthly payments to my student loans.  This seemed intuitive.  And, after Googling the idea, I found that this isn’t all that uncommon of a practice, and many of the articles encouraged this practice.  The other half of the articles suggested that it’s not possible to take money from a mutual fund (like a 401k or an IRA) before you’re 59 and 1/2, but this isn’t true.  I know.  I called several brokerages.

 

The Realization

However.

Upon further research, and with an Excel spreadsheet that was the brain child of my brother, I have found these assumptions to be untrue.  It seems common sense—and it seems reason would suggest that pulling low interest investments out and putting the money toward high interest loans would save you money in the long run, but the long-term ramifications of this were actually quite startling.

The attached spreadsheet, I believe, will speak for itself.  But the understand you at least need to have going into it is knowing why the these posts suggesting pulling from a mutual fund is a good idea; they’re missing the concept of exponential growth.

In the short-term, you believe that pulling a few thousand out of mutual funds now won’t matter, because you’ll quickly pay that few thousand back, with interest.  But you’re missing how fast mutual funds start to grow exponentially each subsequent year, and the more you pull out, the more difficult (or even impossible) it will be for you to catch up with payments over the long-term.

 

The Big Idea

Download the spreadsheet, plug your numbers in, and see if pulling from your investments is a good idea for you (there are a few circumstances where, if you’re disciplined, you can pay yourself back soon enough).  But I would suggest against this.

But here’s the Big Idea, and the real heart of the issue.  Withdrawing money from your investments, whether you can ultimately pay the amount back in full, or whether you’ll save money by paying off your loans sooner, gives you a dangerous mindset toward long-term investing.  It puts the thought into the back of your mind that, if absolutely necessary, your mutual funds may be liquid cash.  And they’re not.  They shouldn’t be.  You will need those funds for you in thirty years when inflation is catching up with your finances, when your kids start looking at college, and when you’re thinking about retirement.