Is This Stock Market Begging Me to Pay Down My Student Loans?

Each day I watch the stock market in awe.  At 4 PM EST, I read a headline like “Stock Market Sets New Record” and when I log online in the morning I am reading an article about how the market is up in the pre-market once again.   By the end of the day, it is like de ja vu and I start the process all over again.  This market makes finding stocks the meet our stock screener difficult, how could it not?  Well, I have been thinking a lot about where I want to allocate my capital recently and what I want my next move to be.   After doing some research on various blogs, including some articles written by my fellow Diplomat, I find myself considering the option that the title of the article outlines.  Is now the time to accelerate the payments on my student loans?

The Dilemna

Last night at the hotel, I spent some time running various stock screeners to try to find some undervalued stocks to add to a watch list.  Lanny just published his December stock watch list over the weekend and it inspired me to compile a listing of stocks of my own.    What I found didn’t excite me or surprise me one bit and I doubt it will shock any of you either.  P/E Ratios are sky-high.  The S&P 500 has a 24.87x P/E Ratio per the WSJ, an increase from 22.73X at the same time last year, while the DJIA’s is showing a PE ratio of 21.72X compared to 16.83X a year ago.  The kicker came when I read My Dividend Pipeline’s recent article about selling General Mills after a massive run-up.   He recognized a 63% gain after owning the stock for just a few months Think about that…a 63% gain after just a few months for a consumer staple dividend stock. Insane.

Are there deals to be had? Of course.  Dividend stocks would not have made it on Lanny’s stock watch list if they were too expensive and didn’t meet aspects of our screener.   Leaving my experience running screeners uninspired, I spent the rest of the night debating where I should go from here.  Should I hoard capital and wait for the stock market to decrease?  Should I stash some more money away for a down payment our future first house?  I looked over a few old articles on our website, specifically, Lanny’s Pay Down the Mortgage vs. Invest Series (Part I – The Original and Part II – The Rising Interest Rate Environment) to find some inspiration in this situation.  Obviously I don’t own a house or else you all would know about it here.  But if you all recall, I recently wrote about how I am going to aggressively try to pay down my wife’s student loans in less than two years to wipe this high yielding interest rate off of our personal financial statements.  AH HA!  The light bulb flashed on.  Similar to Lanny over the years, I to found myself debating about whether I should pay down my debt or should invest in the market.

My situation is different from Lanny’s though.  In his case, his debt is longer in nature and each additional payment directly reduces principal, builds equity in his house, and reduces the future interest to be paid on his mortgage.    Also, his interest rate is 4.375%, which is now in line with the current interest rate environment versus the last several years where that rate exceeded the current market rate.  In my case, clearly a student loan is a different type of note compared to a mortgage and I feel ridiculous for typing such an absurd statement.  But I am not building equity with each payment and the interest rate (north of 6%) is way higher than most dividend stocks.    Currently, the S&P 500 is yielding just north of 2% and the DJIA is yielding nearly 2.4%.  Meanwhile, my portfolio’s yield has decreased from over 4% a few years ago to 3.3%, another example of how much the stock market has appreciated over the last two months.  Despite the fact I keep referencing Lanny’s situation from his articles, we are dealing with apples and oranges here.

My Thoughts on Investing or Paying Down Student Loans

Based on my situation above, I am going to continue to carefully weigh the pros and cons over the next few months.  Here are some of the thoughts that have been going through my head and I would love to have your insight/perspective on my thoughts and add some of your own to the comment section.

-Why Invest for the sake of investing?  Our investing strategy is to find undervalued dividend growth stocks.  We have a stock screener that helps us find investments that meet our “strict” criteria.  If a stock is too expensive and does not meet our P/E Ratio threshold, then don’t force yourself to buy a stock for the sake of buying a stock.  Stick to your methodology and wait for the right opportunity to present itself.

-The disparity between the current market’s yield, my portfolio’s dividend yield, and the interest rate on the student loan is large.  The interest rate on our student loan debt is triple the yield of the S&P 500 and double the yield of my portfolio.  Where am I going to find quality investments with a dividend yield greater than my student loan interest rate?  I feel like I would need to sacrifice quality and reach for dividend yield in order to find a company with a yield greater than the student loan interest rate.  I’ve been bit reaching for yield before and I learned my lesson the hard way.  Reaching for yield is NEVER THE ANSWER.

-Accelerating our student loan payoff plan and paying off the darn debt would free up capital in the future.  Without strict monthly payments on student loans, we could easily implement an aggressive plan to pay down our future mortgage (Similar to Lanny) or we could use the extra free cash flow to invest heavily in the market.  Hopefully by this time, the valuations will cool down and we will return to more reasonable multiples and valuations.  So basically, I can summarize this though as passing on investing now while the market is high, use the cash to pay down the debt, and free up capital for future investments.

-Do I really want to slow down the growth rate I have seen over the last few years?  A few months ago, I crushed my 2016 goal of $3,250 in forward dividend income.  What was crazy is that I considered that a stretch goal at the time I set it.  When I set our plan to payoff our student loans in six quarters, I calculated the plan making the assumption that we would have enough capital to invest and pay down or debt and my dividend income would continue to grow.  However, passing on investing for an extended period of time would halt the impressive growth rates I have realized over the last year and I would delay all the benefits we constantly blog about in this community for a year.  I am well aware of how important it is to build my portfolio now at a young age, so why stop a good thing?

-Isn’t this really about timing the market?  And I am not naive enough to think that I am smarter than the market or I have anywhere close to the amount of necessary information needed to think that I can adequately timing the market.  What if this is the new norm?  What if I keep my cash on the sideline waiting for the market to fall down only to continue reading headlines about how the market keeps increasing and increasing?

-Wouldn’t it be awesome to rid myself of the debt?  Nothing would be better than not having to submit that monthly student loan payment.

So here I am, facing the same (but different) debate as Lanny between two options that will no doubt improve my financial position.  I don’t think there is a wrong answer to the question, but I am still debating which approach I will take as I head into 2017.  The key is to remain flexible and take what the market and current environment is giving you, so having multiple options at my disposal is a good thing.   But I would love to get your feedback on my thoughts in this situation and hear about what you are doing if you find yourself in the same spot.    Have you altered your strategy based on the ever-increasing stock market?

-Bert

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49 thoughts on “Is This Stock Market Begging Me to Pay Down My Student Loans?

  1. Bert,

    Great article. I haven’t had the chance to read Lanny’s articles about his mortgage, etc. but based on the details given I would recommend he NOT pay down his mortgage faster. Your student loan, however, is a different story. First, I think you are very correct in not trying to ‘time the market’. Those that have gotten out completely I think will be sadly mistaken as research has proven that getting in and out only hurts returns in the long run. And this market may very well continue to march higher.

    Briefly, for me the decision comes down to “what to do with the excess capital I have each month?” So it isn’t about getting out vs staying in, but about what to do with new capital that I’ve received/earned. For your situation, I would recommend MOSTLY paying down your loans :). How’s that for a wishy-washy answer? But here’s why: my point is that without the tax benefits of interest (w/ a mortgage), AND a guaranteed 6% return by doing so, AND a ‘feeling’ that the market may be pricey currently, I would start by pursuing the loan paydown idea more aggressively than before, with new capital. Frankly, my goal is always to MAXIMIZE mortgage debt, and have ZERO other interest bearing debt (which is thankfully my current situation), so it is relatively a clear choice to me as to what you should do. Anyway, best of luck,

    Dan @Passive Income Dude

    • Dan,

      Thank you very much for the comment; I’m glad you enjoyed the article. It is funny, when I read all the articles about people getting out, I just kept thinking in the back of my mind “What happens if the stock market doesn’t tank and keeps going?” Now we are in that reality. I’m lucky I was able to see an example of where timing can backfire without have to suffer the experience myself.

      I like your mindset by the way for the end of each month. A positive way to think about it. You didn’t provide a wishy-washer answer, I read it loud and clear. I agree with your analysis for why you maintain a mortgage for a while and paydown other debt. The maximum benefit for student loan interest is only $2k anyway, so anything in excess of that is lost. Over 6% is a lot to pay and finding a quality return in its place is tough. Very, very interesting take on your debt situation and something to consider when I take out a mortgage.

      Thanks again for the help!

      Bert

  2. If somebody were offering an investment right now with a 6.5% yield and no chance of losing my principal, I would think that was too good to be true and I’d be looking into whether it was a Ponzi scheme. But you essentially have that opportunity here by investing in paying down the loan. It’s true that the stock market averages a higher return than that over time, but I doubt you could find any investment with a better risk-adjusted return. Paying off the loan sounds like the best move to me.

    • Brian,

      Exactly. Great advice. I’m gaining a return by reducing the interest expense that I am going to return. It isn’t sexy, but it is going to free cash open for one day down the road. Sure, the stock market returns are higher, but paying off the debt would allow me to gain the positive return in the short term and use the excess cash to capture those long term stock market returns.

      Thanks!

      Bert

  3. I do like an accelerated paydown of the student loan in your situation. I wouldn’t completely stop investing in the market because you never know but a guaranteed 6% return is hard to pass up if you think the market is a bit overpriced. I do agree(obviously) that timing the market is a bad idea but I don’t really see this as timing the market as you’re getting a other benefits by paying off the loans earlier. There’s the guaranteed 6% return(which can’t be said of the stock market – could be higher or lower) PLUS the piece of mind that comes with getting rid of debt earlier and for some people that second part is worth alone because the added cash flow of having it all paid off is a total mental boost.

    The other flip of the coin is that you’re potentially missing out on higher than 6% gains in the market but that’s the risk you’re willing to take and I think at 6%, the risk profile points towards paying off the loan sooner than later unless you’re absolutely sure that the market is going to beat that.

    • TIMB,

      The timing the market component came into play when I was debating whether or not I should sit on the sidelines because I think the valuations are high and I’ll just wait until a later date when it gets lower. Basically, I’m guessing that the market will decrease in the future when that very well couldn’t be the case. But yes, I see the perspective where this isn’t considered timing because I’m choosing an alternative route that will provide me with a greater benefit versus another option.

      I appreciate your input here and your advice. It isn’t an easy choice, but I’m definitely staring at two great alternatives that will provide me some form of a benefit…whether it is a positive impact by increasing my MV and dividend income or reducing my debt and interest expense that goes out the door.

      Thanks for the great comment!

      Bert

  4. Not sure if you are there yet based on your situation, but student loan interest very quickly become not deductible from your taxes too. Once that final benefit fades away, it becomes bad debt in my eyes, get rid of it ASAP!
    I’ve started piling up some cash and looked into selling off holdings based on the market valuation. This high valuation level is typically never sustained for a long period.

    • Stcker,

      I’ll be pushing up on the deductible student loan interest deduction. It looks like no matter what I do a principal paydown won’t push me below the threshold and I will be under that amount no matter what. I love the enthusiasm about paying down the debt ASAP!!

      What is your plan with your holdings? Are you paying down debt? Or are you buying stocks with a lower valuation? I’ve never been a fan of selling with the idea that the market will decline down the road.

      Thanks for the comment!

      Bert

  5. Investing in debt vs. the market must be the hardest dilemma of all. Where there is no right or wrong, just a what makes me feel better in the end?

    I’m not that familiar on all the taxes and everything in the US. But based on possible returns, with paying of debt you will have a guaranteed return. With investing in stocks however, you won’t. The current dividend yields change considering you would need to look at your return on costs. A dividend yield of 2.5% now, can give a return on costs in % of much more over a period of 5 or 10 years.

    There are more pro’s and con’s than only the possible return, obviously. And there might be the possibility of going 50/50, with paying of debt, and investing in stocks simultaneously.

    p.s. these kind of posts makes me think every time I read them (great job by the way :)), on if we should start paying of our mortgage more than just the minimum… some difficult choices.

    • Divnomics,

      You’re right, this is an age old question and there is not an easy answer. Looks like you find yourself in this dilemma as well. What interest rate do you have on the mortgage?

      The taxes allow fora deduction up to $2,500 on your student loan interest expense. It is a front page deduction, which adds some punch to it. I agree with you and the other commenters, the reduction in debt is a guaranteed return of over six percent that will be very difficult to match. Plus, there is the tax benefit as well for the reduction that will result from the $2,500 in interest.

      Right now I am planning on a 50/50 approach, but I may increase it to 75/25 to help accelerate the payments if the market continues to climb. That way, I am still investing some when the right opportunity presents itself and I reserve the right to reduce that ratio when I please.

      Let me know what you decide with your mortgage. Would make for a great article 🙂

      Bert

  6. I think it would be alright to put more focus on paying down debt – not loads, but a bit more. Investing will still produce the best returns long term I reckon, but you’re alright if you get your net worth up another way too 🙂

    Tristan

    • Tristan,

      Based on the comments here, the general assessment is pay down debt but don’t completely ignore the market. So maybe a 75/25 blend is the right approach so I can have my feet in two different pools. Thanks for the comment!

      Bert

  7. Hi Bert,

    Great article, Thanks for taking the time to write out your thoughts.

    Personally I’d sell the portfolio and pay down the debt right away, guaranteed return that beats your dividend yield.

    And if you’re comfortable with the debt then why not take out an investment loan secured with the securities you purchase. This would act as a forced savings plan if you’re worried about not using the extra cashflow rebuilding your portfolio, and you’d have a feeling, similar to a mortgage that you’re building equity in the asset instead of just throwing money away on a student loan debt.

    Some interest rate and tax considerations here obviously, but it’s what I’d do, I only like to have debt in assets that pay me money, any other debt needs to be gone.

    • Thanks Isaac,

      I don’t know if I would do something as drastic as selling my portfolio or leveraging my portfolio. It isn’t just about the dividend yield; my return has an element of appreciation + dividend income +growth from dividend increases/DRIP. So if I made it just about the rates, I may miss out on returns elsewhere. Buying on margin isn’t quite my cup of tea haha

      Thanks for the ideas here!

      Bert

      • Thanks for the reply,

        To each their own I guess, totally get that it’s not all about the yield, and if your total return is beating the rate on your debt it makes complete sense.

        As for me, I don’t mind buying on margin as I have no other debts and the loan repayment schedule acts like forced savings for me. Also some tax advantages to writing off the interest expense and tax favorable dividend income, but I’m not reinvesting the dividends, I use the monthly payouts to help me make debt repayments on the loan.

        Like I say for me it’s better than having a mortgage, my debt pays me money every month, it has tax advantages, and my repayments still help me “build equity in an asset” the asset is just a securities portfolio instead of a house.

        Thanks,
        -Isaac

  8. Hi Bert,
    Some general comments as I don’t know the numbers involved with your loan (length or amount):
    – The long-term total return of the stock market has been 6.6% annualized (real return after inflation). Maybe the stock market will continue next year, but over the lifetime of your loan it’s likely to drop some too. With a guaranteed 6+% return on investment on paying down your loan, I’d think odds are it’s a better ROI of your money in the short-term.

    – Devil’s Advocate: If you have assets / investments that could be sold to pay the loan off entirely, then I personally look at it as a voluntary choice to pay a 6% premium on your tuition, by keeping the liquid assets instead. If you’re comfortable with the monthly dollar amount, and the loan rate is fixed, then each year inflation is working on your behalf, e.g. higher salary / investment income makes the payment less of a burden. Yes you could save on interest payments in the short-term, but you’d lose out on 30 or 40 years of compounded returns on the money used to pay it off. The fees on the loan is a known amount since the loan has a limited duration which can be compared to expected returns on investments over a much longer term.

    – Can the loan be re-financed, or could you get a cheaper rate margin loan / home equity line of credit to lower monthly payments? That could be a compromise between improving cash flow and paying less interest.

    – I’m not sure how market timing comes into play. Would you really be keeping “cash on the sides”? I assumed the spare cash would be paying down the loan and working to reduce interest fees. It’s the nature of compounded growth to eventually reach new record highs.

    Will be interested in seeing how what you decide!

    Best wishes,
    -DL

    • DL,

      -Great point. Short term it is a guaranteed return and would improve my net worth by reducing the interest expense.

      -Fair point and I feel like I would be more likely to entertain the idea of stretching out my debt payments if I weren’t staring a 6%+ interest rate in the face. If I were Lanny and were contemplating this with my mortgage right now, that would be a completely difference story.

      -I’ve thought about re-financing as well now that my wife has completed her schooling. I wonder how much the rise in interest rate sthat were announced this week are going to send shockwaves through that market. But that idea is definitely going to be researched hardcore over the next few weeks and if the fees/reduction in interest rate add up, I’m going to pull the trigger on it.

      -No, but timing the market comes into play because I would be allocating funds I would typically invest to paying down debt because I perceive the market is overvalued at the moment. You are right, cash isn’t on the sideline and I am using the cash for an alternative investment (albeit one that decreases my debt and interest expense, not increasing dividend income). However, I put a plan in place, why adjust it because I think the market is too high right now? What if this is the new market norm and I missed out on investment opportunities because I was waiting for a date in the future where the prices come down. That’s how timing comes into play in my mind.

      Thanks for the great and thoughtful comment!

      Bert

  9. I go through periods of investing, saving cash, and paying off debt. There is a balance to everything. Paying off debt increases free cash flow, investing increases earnings, and saving cash gives opportunities for future opportunities.

    Good luck with the decision,
    DM

  10. Do your student loans have much of a psychological burden? For some people, no matter how much return you can get from the stock market, having student loan statements every month really gnaws at your psyche. The bulk of my student loans were in the 5%-6.8% range. It was questionable whether I’d get a similarly guaranteed return on the market, so I focused mostly on the debt while investing whatever left over I had into the market.

    I also didn’t like the feeling of having multiple sources of student loans to repay, car payments, and mortgage to boot…

    • Smart Money,

      Thanks for the comment! In my case, they do not. We incurred the student loans to increase her earning potential and transition her from a job with the lifestyle she hates to one that should interest her much more. So we were happy to incur the debt for all the future benefits that occur. I’d imagine many others find themselves burdened by the debt because their post college plans haven’t panned out, which is unfortunate for all of those people.

      I understand the feeling of too much debt. For the next year I am staring all three of those debt sources at the face. I don’t want too much out our monthly income being coughed over to reduce debt. Would love to keep it simple and have one payment within a year and a half…a mortgage.

      Thanks again for the comment and insight!

      Bert

  11. The borrower is slave to the lender. Think about how much freedom you would have without the payments. You should always be able to pay yourself first ! ! ! Anything that gets in the way of that, is your enemy.

    • Isn’t that the truth Boyd? I can’t wait to the day to be debt free from student loans, car loans, and a mortgage (and I don’t even have the last one yet!). The day when all cash flow can be put into income producing assets…man that will be the dream.

      Bert

  12. Hi Bert,
    Not much to add here only that from a personal point of view I would probably go for some investing to keep the fun of it but also the long term potential while at the same time trying to get out of that debt fast. Best of both worlds, I guess. Plus, I assume that it is not one choice you make now and then you cannot revise it later, right? I mean you can probably change your opinion and your approach depending on whether Mr Market beccomes more depressed or optimistic along the way.
    Either way you’ll make the right decision.
    Thanks for the article!

    • What are you talking about DIB, your personal point of view adds huge value for me and is always welcomed! I am thinking of doing a 75 debt/25 investing strategy after reading these great comments and advice from people. You’re right, this isn’t permanent. I have the right to change my mind whenever the situation calls for a change. If the market falls and some great stocks become available at a discount, I can easily slow down debt payments and take advantage of some great deals.

      Thanks for the comment!

      Bert

  13. I am also astounded by the upward movement of the markets! It’s pretty much been a new all time high every day recently haha! I’m just enjoying the ride right now because the tide can turn very quickly. Personally, I would evaluate the yield (and capital gain) on the portfolio and compare it to the student debt interest rate. As long as you can earn a return above the debt interest rate, it would make sense to keep investing. However, I do understand the mindset of paying debt down because it sucks knowing you owe someone something.

    • Andrew,

      This market is freaking insane. It is blowing my mind haha I don’t think there is a right or a wrong answer here. Trust me, I have been crunching those numbers and it is very hard to find a quality investment that passes our stock screener above the debt yield. We shall see what Mr. Market presents us because as we all know, the market can be pretty darn crazy at times.

      Thanks for the comment!

      Bert

  14. Don’t forget that another upside of paying off the debt and freeing up cash each month is that you can save up and put more deposit down on a property, thereby borrowing less and getting a better interest rate on the mortgage, saving you thousands (or tens of thousands?) in the long term.

    I would echo the comments above and your own conclusions:
    – hold your current positions
    – switch your focus to paying off the debt faster (75/25 seems ok but only if there is a good deal on stocks, don’t be afraid to invest nothing some months and pay off even more loan).

    Once you have cleared the debt, the focus should then be on building as large a cash pile as possible before you buy a house to get the best mortgage deal possible. Once you have got your mortgage then you can go back to investing more 🙂

    For the record, interest of 6% is a lot. Even 4% on a mortgage is a lot at the moment and definitely worth paying down faster if possible.

    Sam

    • Sam,

      You’re absolutely right. The best motivation for paying off the debt is the fact that you won’t have to make any more monthly payments. Would love to free up all capital and take the burden of debt off of my mind. I am already salivating of the possible investments (stocks, properties, or who else knows) that I could do with all of the free cash flow. Appreciate your input here.

      Bert

  15. That’s a tough dilema. I can imagine how difficult it is to find stocks that have a higher yield than student loan interest rates. My suggestion is biased because I’m naturally cheap. But I have been saving money in a account waiting for the stock market to enter in a bear environment and buy stocks when they bottom out. And hopefully cash out in a few years.

    • There is not an easy answer here Andre, that’s for sure. Just out of curiosity, do you have a screener in place to identify when to buy? If so, what are you looking for? What needs to happen for you to deploy that capital in the market and really crush your income goals??

      Bert

  16. I agree it is becoming hard to find value stocks. We paid down our student loans and it is awesome to be free of that debt. Now that we are completely debt free the question becomes now what?

    • Congrats on being debt free! How nice was it to send in that final payment and see your balance drop to zero? What type of investments do you want to make? How do you want to deploy that capital? Are you just a stock investor or do you have any real estate investments??

      Bert

      • It is awesome being debt free. I love the feeling of not owing anything to anyone. We snowballed that payment into investments so it helps accelerate our savings. I mostly just invest in stocks. I have recently bought some land. My intent is to develop it and have a tiny home on the land. That way I can one day realize my goal of traveling but having a “base camp” so to speak. I do also have a small amount of investments in bonds for diversity.

        • Your second sentence is exactly what I am trying to capture. So much extra cash flow to allocate elsewhere. You could also rent the land out to other tiny house owners as well while you are gone to take in some rent!

          Bert

  17. Bert,
    I recently finished paying off my wife’s loans, there had been around 7k starting this year. Its, nice to have them gone, from a mental standpoint, and it frees up some extra cash to save and invest. Paying debt off early likely will not save as much money as new investments will yield over time, but (and this is a huge one) it is so damn satisfying to be done with them.
    -Gremlin

  18. Great article and an interesting conundrum. There are a lot of factors that go into the decision but I would have to agree with the general consensus of the community on this one. Weighing the pros and cons, debt payment is tilting the decision scale in its favor.

    By paying down the student loan, you are wiping out debt and in turn increasing your available cash flow and decreasing monthly expenses at the same time. As you know already, there is the added bonus by taking advantage of the tax deduction on interest. Even if you don’t pay it all down, you should take advantage of this while the loans exist. Finally, as mentioned by others, there is the mental freedom of knocking out student loan debt which is a goal completion in itself.

    While investing back into the market will product higher gains long term, the longer debt is present it is costing you more money while the interest builds. With the market appreciating in value lately, it is harder and harder for stocks to pass the screener. Who knows when the next opportunity will present itself? But with debt diminished faster, you can build up your capital at a greater rate for when the opportunity arises so there is more to invest when the time comes.

    No matter what decision you decide, either 100/0, 75/25, 50/50, it all will help your bottom line at the end of the day and be beneficial to your financial well-being. Keep up the good work!

    Dividend Daze

    • Dividend Daze,

      Thank you very much. I will absolutely be taking advantage of the tax benefit for the interest this year. Hopefully I won’t be maxing it out in 2018 though because that would mean the debt is gone! Appreciate your support and your input. I’m settling on the consensus of the community here based on all the responses. I hate debt, especially student loan debt because of the high interest rates. Hopefully we will see you around the website more frequently!

      Bert

  19. Hot topic. I like the idea of paying down dept. In a similar situation I will be paying off my 6% graduate government loan asap. I don’t qualify for the tax deduction and with the market pushing all time highs paying off that portion of my loan is a solid play.

    Cheers

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