Most lawyers come out of law school with a massive amount of student loan debt. I know my wife and I did.
So, when you get your year-end bonus – or you’ve got a good chunk of cash saved up from your salary – should you invest that money or pay down the principal on your law school loans?
First kudos to you for thinking of it that way. We’ve all heard the stories of lawyers who spent their bonus on a super-fancy vacation or car. Don’t be that guy.
Here’s the case for investing your bonus:
Suppose that student loan debt is at a 3% interest rate. You could likely invest the money and make, say 5% interest. So, if you’ve invested the money, you could choose later to just take the money you earned, use it to pay off the debt, then keep the difference. And, along the way, you’ll have a tidy 2% profit.
This makes sense when you look at the math. A bunch of my friends hired financial planners and got this advice. They even got this advice from financial planners who don’t charge based on the amount of money under management with them, so you know it’s good advice. Or at least rational advice.
To further buttress the case for investing rather than paying off your law school loans, your student loan debt may be deductible, so, by paying it off, you’re basically buying yourself into higher taxes. (or so the argument goes) In effect, the student loan debt is actually at a lower effective interest rate than its actual interest rate. Sadly, if you make too much, the student loan stops being deductible, but nothing’s perfect.
Here’s the case for paying down your law school loan:
First, there are problems with the argument that you should invest the money instead. The return you get on your investments is speculative – it may be that you earn less than your interest. Then you’ve just moved backwards. If you want to be risk averse with getting rid of your student loan debt, then you should make sure you lock in getting rid of your student loan debt.
But the bigger problem I see with telling yourself that you’ll invest the money instead of prepay your debt is that the money will always be there, tempting you to spend it. If you prepay debt, then the debt is paid and you can’t spend the money again. If it’s sitting in an index fund, then you can tap it. It may be for a good reason – like buying a house. Or it may be for a less good reason – like buying a house that’s bigger than you need. Either way, lawyers are pretty good advocates; we know how to present a justification for what we want to do.
If you pay the student loan now, you only need to be disciplined with that chunk of money once. If you put it in index funds, you’ll know it’s there, and the siren call of Vanguard will haunt your ears, whenever the car breaks down, or the baby is about to be born and all of your friends are going on a babymoon, or you’ve just spent more than you earn on credit cards and it doesn’t make sense to pay that massive interest rate.
It’s a question of discipline. Ultimately, I’d worry less about whether the market is reliable than whether I am.
Though, again, if your choices are buy a BMW or put the money in an index fund, obviously, go with the index fund.
How will it feel?
And, of course, all of this is to say that my wife and I just paid off the debt.
It just felt good. The value we got from knowing the student loan debt was gone (or reduced) exceeded the likely benefit we’d get from the marginal difference in return on that money.
It’s nice not to have student loan debt.