paying back loans

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c3pO4
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Re: paying back loans

Postby c3pO4 » Sun Oct 23, 2011 1:29 pm

Isn't retirement a dying concept? People have to work into their 70's these days. Aren't we all probably going to work until we die anyway?

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quakeroats
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Re: paying back loans

Postby quakeroats » Sun Oct 23, 2011 1:33 pm

birdlaw117 wrote:A retirement account that has tax-free earnings is a bad idea if you want to retire? You really don't know what you're talking about do you?


It's not a bad idea in the abstract. It's a less ideal idea than a Traditional IRA. This is hard to see without math, but here's a calculator to simplify things:

http://www.timevalue.com/products/tcalc ... lator.aspx

Play around with it an try to come up with situations where a Roth IRA makes more sense. Btw, I haven't mentioned Roth conversions yet which, if you're going to take some time off--or in a lower bracket--mid-career, can be a fantastic way to get a lot into a Roth and sidestep several concerns. You'd still be subject to more political risk, though.

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quakeroats
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Re: paying back loans

Postby quakeroats » Sun Oct 23, 2011 1:41 pm

Tiago Splitter wrote:
Brassica7 wrote:
My bad about what I said above about converting into a Roth IRA--there is a 100k income limit on that. Still, even if the money you invest during your stub year is isolated, just stick it in a mutual fund (Vanguard, Fidelity or some managed fund) and let is grow. Every 2-3 years you can spend 15 minutes to re-balance. For example, if you invest 5k in the stub year in one Vanguard fund, you can let is grow to over 6k, then split half of it into another fund. If someone is earning under 100k, I still suggest maxing Roth IRA and then targeting student loans. If someone earns over 100k, focus on 401k/traditional IRA and then student loans.


No you were right the first time. Put 5K into your traditional IRA and then immediately convert it. The 100K limitation went away in 2010.


It's still taxed at your marginal rate. It's nice that the limit's gone in theory, but the times when you're making over 100k and should consider moving to a Roth a few and far between.

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Tiago Splitter
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Re: paying back loans

Postby Tiago Splitter » Sun Oct 23, 2011 1:44 pm

quakeroats wrote:
Tiago Splitter wrote:
Brassica7 wrote:
My bad about what I said above about converting into a Roth IRA--there is a 100k income limit on that. Still, even if the money you invest during your stub year is isolated, just stick it in a mutual fund (Vanguard, Fidelity or some managed fund) and let is grow. Every 2-3 years you can spend 15 minutes to re-balance. For example, if you invest 5k in the stub year in one Vanguard fund, you can let is grow to over 6k, then split half of it into another fund. If someone is earning under 100k, I still suggest maxing Roth IRA and then targeting student loans. If someone earns over 100k, focus on 401k/traditional IRA and then student loans.


No you were right the first time. Put 5K into your traditional IRA and then immediately convert it. The 100K limitation went away in 2010.


It's still taxed at your marginal rate. It's nice that the limit's gone in theory, but the times when you're making over 100k and should consider moving to a Roth a few and far between.


We'll just have to agree to disagree here. I know I certainly don't want to be in a low tax bracket when I retire, nor do I expect to be given the government's financial outlook.

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birdlaw117
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Re: paying back loans

Postby birdlaw117 » Sun Oct 23, 2011 1:45 pm

quakeroats wrote:
birdlaw117 wrote:A retirement account that has tax-free earnings is a bad idea if you want to retire? You really don't know what you're talking about do you?


It's not a bad idea in the abstract. It's a less ideal idea than a Traditional IRA. This is hard to see without math, but here's a calculator to simplify things:

http://www.timevalue.com/products/tcalc ... lator.aspx

Play around with it an try to come up with situations where a Roth IRA makes more sense. Btw, I haven't mentioned Roth conversions yet which, if you're going to take some time off--or in a lower bracket--mid-career, can be a fantastic way to get a lot into a Roth and sidestep several concerns. You'd still be subject to more political risk, though.

You realize the earnings are NEVER taxed... right? I also have no idea what you mean by political risk in this situation (you mean relying on being able to roll over a traditional to roth?) Just FWIW, I spent an entire summer running numbers on roth vs traditional for clients making similar, maybe a little more, than 1st to 5th year associates. It made sense for about 90% of clients to roll over, regardless of whether they were in a lower than normal tax bracket. I don't know what calculations that calculator is doing, but it doesn't look very accurate to me. I don't really have the info to comment further on it though.

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birdlaw117
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Re: paying back loans

Postby birdlaw117 » Sun Oct 23, 2011 1:45 pm

quakeroats wrote:
Tiago Splitter wrote:
Brassica7 wrote:
My bad about what I said above about converting into a Roth IRA--there is a 100k income limit on that. Still, even if the money you invest during your stub year is isolated, just stick it in a mutual fund (Vanguard, Fidelity or some managed fund) and let is grow. Every 2-3 years you can spend 15 minutes to re-balance. For example, if you invest 5k in the stub year in one Vanguard fund, you can let is grow to over 6k, then split half of it into another fund. If someone is earning under 100k, I still suggest maxing Roth IRA and then targeting student loans. If someone earns over 100k, focus on 401k/traditional IRA and then student loans.


No you were right the first time. Put 5K into your traditional IRA and then immediately convert it. The 100K limitation went away in 2010.


It's still taxed at your marginal rate. It's nice that the limit's gone in theory, but the times when you're making over 100k and should consider moving to a Roth a few and far between.

This is so grossly inaccurate it's ridiculous.

Brassica7
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Re: paying back loans

Postby Brassica7 » Sun Oct 23, 2011 1:48 pm

birdlaw117 wrote:
Brassica7 wrote:
Brassica7 wrote:Even if you can get 5% on a muni bond with limited risk (meaning a decent rating), why would you prefer that over a guaranteed 7.9% return by paying off the Gradplus loans early? 5% return and some risk is not as good as 7.9% return and no risk (or if there is some risk it would only be in paying off your loans before the OWS people get debt amnesty for everyone--but this will not happen). The same goes for Stafford loans, although the difference is lower at 6.8% interest.

A Roth IRA is probably the best investment vehicle possible for someone early in his/her career because all of the gain on the investment will be tax free. If you are investing for 40 years before you retire, this can be a huge amount of untaxed gain. Unless your employer has matching 401k contributions, a Roth IRA is better by far than a 401k and traditional IRA (where earnings are untaxed going in but all investment profits are taxed when you cash them out in retirement). If you are close the retirement, then a 401k may be better.

The money need not be isolated, as some have suggested. Plow 5k into the Roth in the stub year, then invest in a traditional IRA/401k and quickly convert it into a Roth. This allows you to get around the income limits. http://retireplan.about.com/od/iras/a/convert.htm.

I believe it is a good idea to pay off the student loans as fast as possible while still saving for an emergency fund (6-9 months' expenses), maxing the Roth IRA (only 5k/year) and possibly maxing out 401k contributions (I think that is around 15.5k/year). If you do not make these contributions to retirement accounts each year, you lose the opportunity. If you have the chance to pick up a cheap house somewhere, this may be a really good deal that you should go for, but I do not know enough about real estate to feel comfortable commenting on it.


My bad about what I said above about converting into a Roth IRA--there is a 100k income limit on that. Still, even if the money you invest during your stub year is isolated, just stick it in a mutual fund (Vanguard, Fidelity or some managed fund) and let is grow. Every 2-3 years you can spend 15 minutes to re-balance. For example, if you invest 5k in the stub year in one Vanguard fund, you can let is grow to over 6k, then split half of it into another fund. If someone is earning under 100k, I still suggest maxing Roth IRA and then targeting student loans. If someone earns over 100k, focus on 401k/traditional IRA and then student loans.

I didn't read your post, but the income limit went away in 2010. Pretty sure that's what you're talking about.

Also, addressing the first sentence of your first post (because that's all I got through), one reason you would prefer that is because then you would have the cash. So, liquidity would be the reason. You may be "making more" by paying off the loan (though I'm not convinced of this because the interest on the other investments can be compounded for a longer time period), but you sacrifice liquidity. Obviously liquidity is worth something, it's just how many %s that's the issue.



True about the liquidity. If that is really important to you, then it may be worth lower returns. The returns will likely be lower--your comment about the "interests on the other investments can be compounded for a longer time period" is misguided. This is not how the math works because although money that you push into savings instead of paying off debt is earning compounding interest, the unpaid debt is also earning unpaid interest. The only issue is looking at risk/return. How certain are you that you can beat 7.9% tax free returns (what you get from paying off Grandplus loans) with zero risk? Me, I am not at all certain of this.

Another thought about liquidity--it may be nice to have a lot of liquid assets, but I would prefer to get out from under the debt. If you get laid off and start missing payments, that debt can snowball. Are you really "safer" with, say, 50k in liquid assets and 50k more debt?
Last edited by Brassica7 on Sun Oct 23, 2011 1:50 pm, edited 1 time in total.

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quakeroats
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Re: paying back loans

Postby quakeroats » Sun Oct 23, 2011 1:49 pm

Tiago Splitter wrote:
quakeroats wrote:
Tiago Splitter wrote:
Brassica7 wrote:
My bad about what I said above about converting into a Roth IRA--there is a 100k income limit on that. Still, even if the money you invest during your stub year is isolated, just stick it in a mutual fund (Vanguard, Fidelity or some managed fund) and let is grow. Every 2-3 years you can spend 15 minutes to re-balance. For example, if you invest 5k in the stub year in one Vanguard fund, you can let is grow to over 6k, then split half of it into another fund. If someone is earning under 100k, I still suggest maxing Roth IRA and then targeting student loans. If someone earns over 100k, focus on 401k/traditional IRA and then student loans.


No you were right the first time. Put 5K into your traditional IRA and then immediately convert it. The 100K limitation went away in 2010.


It's still taxed at your marginal rate. It's nice that the limit's gone in theory, but the times when you're making over 100k and should consider moving to a Roth a few and far between.


We'll just have to agree to disagree here. I know I certainly don't want to be in a low tax bracket when I retire, nor do I expect to be given the government's financial outlook.


I'm implicitly assuming retirement is everyone's goal here. My actual advice would be to take some time off in your late 60s and then continue working. Retirement is less interesting then work you'll have access to as a top-law-school grad.

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quakeroats
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Re: paying back loans

Postby quakeroats » Sun Oct 23, 2011 1:50 pm

birdlaw117 wrote:
quakeroats wrote:
Tiago Splitter wrote:
Brassica7 wrote:
My bad about what I said above about converting into a Roth IRA--there is a 100k income limit on that. Still, even if the money you invest during your stub year is isolated, just stick it in a mutual fund (Vanguard, Fidelity or some managed fund) and let is grow. Every 2-3 years you can spend 15 minutes to re-balance. For example, if you invest 5k in the stub year in one Vanguard fund, you can let is grow to over 6k, then split half of it into another fund. If someone is earning under 100k, I still suggest maxing Roth IRA and then targeting student loans. If someone earns over 100k, focus on 401k/traditional IRA and then student loans.


No you were right the first time. Put 5K into your traditional IRA and then immediately convert it. The 100K limitation went away in 2010.


It's still taxed at your marginal rate. It's nice that the limit's gone in theory, but the times when you're making over 100k and should consider moving to a Roth a few and far between.

This is so grossly inaccurate it's ridiculous.


Then it should be pretty easy to point out exactly how.

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birdlaw117
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Re: paying back loans

Postby birdlaw117 » Sun Oct 23, 2011 1:54 pm

Brassica7 wrote:
birdlaw117 wrote:
Brassica7 wrote:
Brassica7 wrote:Even if you can get 5% on a muni bond with limited risk (meaning a decent rating), why would you prefer that over a guaranteed 7.9% return by paying off the Gradplus loans early? 5% return and some risk is not as good as 7.9% return and no risk (or if there is some risk it would only be in paying off your loans before the OWS people get debt amnesty for everyone--but this will not happen). The same goes for Stafford loans, although the difference is lower at 6.8% interest.

A Roth IRA is probably the best investment vehicle possible for someone early in his/her career because all of the gain on the investment will be tax free. If you are investing for 40 years before you retire, this can be a huge amount of untaxed gain. Unless your employer has matching 401k contributions, a Roth IRA is better by far than a 401k and traditional IRA (where earnings are untaxed going in but all investment profits are taxed when you cash them out in retirement). If you are close the retirement, then a 401k may be better.

The money need not be isolated, as some have suggested. Plow 5k into the Roth in the stub year, then invest in a traditional IRA/401k and quickly convert it into a Roth. This allows you to get around the income limits. http://retireplan.about.com/od/iras/a/convert.htm.

I believe it is a good idea to pay off the student loans as fast as possible while still saving for an emergency fund (6-9 months' expenses), maxing the Roth IRA (only 5k/year) and possibly maxing out 401k contributions (I think that is around 15.5k/year). If you do not make these contributions to retirement accounts each year, you lose the opportunity. If you have the chance to pick up a cheap house somewhere, this may be a really good deal that you should go for, but I do not know enough about real estate to feel comfortable commenting on it.


My bad about what I said above about converting into a Roth IRA--there is a 100k income limit on that. Still, even if the money you invest during your stub year is isolated, just stick it in a mutual fund (Vanguard, Fidelity or some managed fund) and let is grow. Every 2-3 years you can spend 15 minutes to re-balance. For example, if you invest 5k in the stub year in one Vanguard fund, you can let is grow to over 6k, then split half of it into another fund. If someone is earning under 100k, I still suggest maxing Roth IRA and then targeting student loans. If someone earns over 100k, focus on 401k/traditional IRA and then student loans.

I didn't read your post, but the income limit went away in 2010. Pretty sure that's what you're talking about.

Also, addressing the first sentence of your first post (because that's all I got through), one reason you would prefer that is because then you would have the cash. So, liquidity would be the reason. You may be "making more" by paying off the loan (though I'm not convinced of this because the interest on the other investments can be compounded for a longer time period), but you sacrifice liquidity. Obviously liquidity is worth something, it's just how many %s that's the issue.



True about the liquidity. If that is really important to you, then it may be worth lower returns. The returns will likely be lower--your comment about the "interests on the other investments can be compounded for a longer time period" is misguided. This is not how the math works because although money that you push into savings instead of paying off debt is earning compounding interest, the unpaid debt is also earning unpaid interest. The only issue is looking at risk/return. How certain are you that you can beat 7.9% tax free returns (what you get from paying off Grandplus loans) with zero risk? Me, I am not at all certain of this.
Another thought about liquidity--it may be nice to have a lot of liquid assets, but I would prefer to get out from under the debt. If you get laid off and start missing payments, that debt can snowball. Are you really "safer" with, say, 50k in liquid assets and 50k more debt?

If you get laid off you're probably going to care a lot more about making rent and eating food. So I'd be more concerned about having the cash. Maybe that's just me and my lifestyle though... :wink:

Also, I'm pretty sure the compounding thing is actually an issue. I've never run the numbers on this and I've been curious, so maybe some day I will sit down and do it. You would have that earned interest that could turn around and earn even more. Yes, it would be at the same rate as starting a new investment post-debt, but you would be earning a great amount. I'm honestly not sure about this, but I just have a feeling it would be advantageous.

When I worked at a wealth management firm it was always recommended that you pay your student debt down very slowly. This was the advice given to professionals making six-figures. I don't know the numbers or the specific logic behind it, however. I wasn't the one speaking directly with the clients during consultations.

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birdlaw117
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Re: paying back loans

Postby birdlaw117 » Sun Oct 23, 2011 1:58 pm

quakeroats wrote:
birdlaw117 wrote:
quakeroats wrote:It's still taxed at your marginal rate. It's nice that the limit's gone in theory, but the times when you're making over 100k and should consider moving to a Roth a few and far between.

This is so grossly inaccurate it's ridiculous.


Then it should be pretty easy to point out exactly how.

If someone is making over 100K they will likely still have a higher than 15% tax rate upon retirement. Not to mention tax rates are likely to increase in our lifetime. Given that, having tax-free investment earnings at that higher rate is really really beneficial in comparison to delaying the tax burden with a traditional IRA and hoping that time value of money makes enough of a difference (it won't).

Brassica7
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Re: paying back loans

Postby Brassica7 » Sun Oct 23, 2011 2:05 pm

Also, I'm pretty sure the compounding thing is actually an issue. I've never run the numbers on this and I've been curious, so maybe some day I will sit down and do it. You would have that earned interest that could turn around and earn even more. Yes, it would be at the same rate as starting a new investment post-debt, but you would be earning a great amount. I'm honestly not sure about this, but I just have a feeling it would be advantageous.

When I worked at a wealth management firm it was always recommended that you pay your student debt down very slowly. This was the advice given to professionals making six-figures. I don't know the numbers or the specific logic behind it, however. I wasn't the one speaking directly with the clients during consultations.[/quote]


I do not think that the math works that way. If you can run the numbers and find out that I am wrong, please let me know--I would change my investment plans.

I think that the financial advice your bosses gave about student loans is outdated, at least for people taking today's loans. They gave the traditional advice I have read about student loan payments, but it comes from a time when interest rates were around 3%. The the student loan was one of the best deals around, until 6ish years ago. At a rate of 3%, you could invest your savings fairly securely (US Treasury) and beat the interest on the loans. With 7.9% interest on student loans, record low returns on treasury bonds and lots of risk in unstable markets, that is, sadly, no longer the case for you and me.

c3pO4
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Re: paying back loans

Postby c3pO4 » Sun Oct 23, 2011 2:09 pm

What are the names of firms that do wealth managment for biglawyers? Is it Goldman/Morgan/JPMorgan etc? Or like Schwab BofA etc?

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birdlaw117
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Re: paying back loans

Postby birdlaw117 » Sun Oct 23, 2011 2:11 pm

Brassica7 wrote:Also, I'm pretty sure the compounding thing is actually an issue. I've never run the numbers on this and I've been curious, so maybe some day I will sit down and do it. You would have that earned interest that could turn around and earn even more. Yes, it would be at the same rate as starting a new investment post-debt, but you would be earning a great amount. I'm honestly not sure about this, but I just have a feeling it would be advantageous.

When I worked at a wealth management firm it was always recommended that you pay your student debt down very slowly. This was the advice given to professionals making six-figures. I don't know the numbers or the specific logic behind it, however. I wasn't the one speaking directly with the clients during consultations.



I do not think that the math works that way. If you can run the numbers and find out that I am wrong, please let me know--I would change my investment plans.

I think that the financial advice your bosses gave about student loans is outdated, at least for people taking today's loans. They gave the traditional advice I have read about student loan payments, but it comes from a time when interest rates were around 3%. The the student loan was one of the best deals around, until 6ish years ago. At a rate of 3%, you could invest your savings fairly securely (US Treasury) and beat the interest on the loans. With 7.9% interest on student loans, record low returns on treasury bonds and lots of risk in unstable markets, that is, sadly, no longer the case for you and me.[/quote]
At a rate of 3% it's obvious. But this was the advice for everyone, even with higher rates. One reason for this that I could see is that these were for professionals with their own practices, so liquidity could have been a more important issue for them. Also, for the most part they had other financing agreements with higher rates, so paying those off faster would have been the smartest thing to do.

If/when I run the numbers I will try and remember to dig this up and send you a message (I can tell you it won't happen right now during 1L first semester though).

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Bronte
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Re: paying back loans

Postby Bronte » Sun Oct 23, 2011 2:38 pm

The benefits of compounding are the same between normal investments and investing in debt reduction. In a normal investment, interest compounds on a growing principal. When you pay down debt, you don't get this benefit of compounding. However, you reduce the principal upon which interest would be compounding against you, so you still get the benefit of the compounding.

Here's an example: Investment 1--You put $10,000 in a 3-year investment that pays 10% per year. Investment 2--At time 0, you put $10,000 toward the principal on a loan that bears 10% interest per year. You don't make any other payments for three years.

What you make on the first investment at the end of three years is simple: $3,310 (calculated by 10,000*(1.10)^3-10,000). What you make on the second investment is the difference between what you would have paid in interest without the $10,000 payment toward the debt. If you didn't make the $10,000 payment, you would pay $33,100 in interest (calculated by 100,000*(1.10)^3-100,000). Making the payment, you pay $29,790 in interest (calculated by $90,000*(1.10)^3-90,000). The difference between the interest you did pay and the interest you would have paid is $3,310. Thus, the investments are identical in terms of interest paid.

(Obviously this hypothetical is stylized. Loan payments compound monthly. Further, you will be paying both principal and interest when you make payments. I am confident that the principle holds true, however, despite these complications.)

It is thus clear that it is highly unlikely that you will be presented with any better investment opportunity than paying down your law school debt. Paying down your law school loans gives you a 7.5-9% risk-free, tax-free investment opportunity (depending on the interest rate of your loans). There is nothing in the market that comes close to this. Municipal bonds may be a good deal right now, but they get nowhere close to this.

As others have stated, the primary advantage to investing in something other than your loans is that loan payments are a wholly illiquid investment. It's good to have some liquidity, but not at the expense of passing up the opportunity to invest your loans. It seems like the best advice is to build a reasonable liquidity cushion (cash or cash equivalent savings) while paying down as much debt as possible. Once that liquidity cushion is built, payments on debt should be accelerated.
Last edited by Bronte on Sun Oct 23, 2011 2:40 pm, edited 1 time in total.

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Re: paying back loans

Postby Anonymous User » Sun Oct 23, 2011 2:39 pm

Instead of putting leftover savings into a bond or a stock or whatever, why not put it in a stable foreign currency?

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Bronte
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Re: paying back loans

Postby Bronte » Sun Oct 23, 2011 2:41 pm

Anonymous User wrote:Instead of putting leftover savings into a bond or a stock or whatever, why not put it in a stable foreign currency?


The question isn't "why not" it's "why." Also, that's not really the topic of the thread.

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birdlaw117
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Re: paying back loans

Postby birdlaw117 » Sun Oct 23, 2011 3:02 pm

Bronte wrote:The benefits of compounding are the same between normal investments and investing in debt reduction. In a normal investment, interest compounds on a growing principal. When you pay down debt, you don't get this benefit of compounding. However, you reduce the principal upon which interest would be compounding against you, so you still get the benefit of the compounding.

Here's an example: Investment 1--You put $10,000 in a 3-year investment that pays 10% per year. Investment 2--At time 0, you put $10,000 toward the principal on a loan that bears 10% interest per year. You don't make any other payments for three years.

What you make on the first investment at the end of three years is simple: $3,310 (calculated by 10,000*(1.10)^3-10,000). What you make on the second investment is the difference between what you would have paid in interest without the $10,000 payment toward the debt. If you didn't make the $10,000 payment, you would pay $33,100 in interest (calculated by 100,000*(1.10)^3-100,000). Making the payment, you pay $29,790 in interest (calculated by $90,000*(1.10)^3-90,000). The difference between the interest you did pay and the interest you would have paid is $3,310. Thus, the investments are identical in terms of interest paid.

(Obviously this hypothetical is stylized. Loan payments compound monthly. Further, you will be paying both principal and interest when you make payments. I am confident that the principle holds true, however, despite these complications.)

It is thus clear that it is highly unlikely that you will be presented with any better investment opportunity than paying down your law school debt. Paying down your law school loans gives you a 7.5-9% risk-free, tax-free investment opportunity (depending on the interest rate of your loans). There is nothing in the market that comes close to this. Municipal bonds may be a good deal right now, but they get nowhere close to this.

As others have stated, the primary advantage to investing in something other than your loans is that loan payments are a wholly illiquid investment. It's good to have some liquidity, but not at the expense of passing up the opportunity to invest your loans. It seems like the best advice is to build a reasonable liquidity cushion (cash or cash equivalent savings) while paying down as much debt as possible. Once that liquidity cushion is built, payments on debt should be accelerated.

But my question would be at the end of when you pay off your debt you can start using that $$ to invest. So what is the relationship between waiting more years to start investing (the paying loans slower route) and having some investment earnings vs having it paid down faster and starting later but with larger contributions?

Unless I'm not following your scenario, this question is more complicated than that scenario... right?

Brassica7
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Re: paying back loans

Postby Brassica7 » Sun Oct 23, 2011 3:02 pm

I have read a lot about the importance of having 3-12 months' (depending on whom you talk to) expenses in a rainy day fund. This makes sense to me; a cushion is good in case of layoff/car repair/whatever. What do people recommend you do with this money? Obviously a checking/savings account is very liquid, which would be important for such a fund, but the interest rate closes in on zero. Is there a way to maintain sufficient liquidity while still keeping up with inflation?

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Re: paying back loans

Postby Anonymous User » Sun Oct 23, 2011 3:04 pm

Bronte wrote:
Anonymous User wrote:Instead of putting leftover savings into a bond or a stock or whatever, why not put it in a stable foreign currency?


The question isn't "why not" it's "why." Also, that's not really the topic of the thread.


Awww, don't throw a fit now!

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birdlaw117
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Re: paying back loans

Postby birdlaw117 » Sun Oct 23, 2011 3:05 pm

Brassica7 wrote:I have read a lot about the importance of having 3-12 months' (depending on whom you talk to) expenses in a rainy day fund. This makes sense to me; a cushion is good in case of layoff/car repair/whatever. What do people recommend you do with this money? Obviously a checking/savings account is very liquid, which would be important for such a fund, but the interest rate closes in on zero. Is there a way to maintain sufficient liquidity while still keeping up with inflation?

ITE? Seems difficult. I have seen some savings accounts, etc. with favorable rates, but they are few and far between.

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Re: paying back loans

Postby quakeroats » Sun Oct 23, 2011 3:09 pm

Bronte wrote:The benefits of compounding are the same between normal investments and investing in debt reduction. In a normal investment, interest compounds on a growing principal. When you pay down debt, you don't get this benefit of compounding. However, you reduce the principal upon which interest would be compounding against you, so you still get the benefit of the compounding.

Here's an example: Investment 1--You put $10,000 in a 3-year investment that pays 10% per year. Investment 2--At time 0, you put $10,000 toward the principal on a loan that bears 10% interest per year. You don't make any other payments for three years.

What you make on the first investment at the end of three years is simple: $3,310 (calculated by 10,000*(1.10)^3-10,000). What you make on the second investment is the difference between what you would have paid in interest without the $10,000 payment toward the debt. If you didn't make the $10,000 payment, you would pay $33,100 in interest (calculated by 100,000*(1.10)^3-100,000). Making the payment, you pay $29,790 in interest (calculated by $90,000*(1.10)^3-90,000). The difference between the interest you did pay and the interest you would have paid is $3,310. Thus, the investments are identical in terms of interest paid.

(Obviously this hypothetical is stylized. Loan payments compound monthly. Further, you will be paying both principal and interest when you make payments. I am confident that the principle holds true, however, despite these complications.)

It is thus clear that it is highly unlikely that you will be presented with any better investment opportunity than paying down your law school debt. Paying down your law school loans gives you a 7.5-9% risk-free, tax-free investment opportunity (depending on the interest rate of your loans). There is nothing in the market that comes close to this. Municipal bonds may be a good deal right now, but they get nowhere close to this.

As others have stated, the primary advantage to investing in something other than your loans is that loan payments are a wholly illiquid investment. It's good to have some liquidity, but not at the expense of passing up the opportunity to invest your loans. It seems like the best advice is to build a reasonable liquidity cushion (cash or cash equivalent savings) while paying down as much debt as possible. Once that liquidity cushion is built, payments on debt should be accelerated.


Of course, law school loans aren't like traditional loans. You can't easily default, but you can change the terms that apply in ways that may alter what's best for you to do, i.e., IBR and LRAP. For those of you staying in big law long term, you should pay off your loans as slowly as possible and invest your extra money as aggressively as your age range allows. Have an emergency fund outside of this. This way you get a better return than 7.5% if things go as planned and extra liquidity in the short term unless we have another serious correction. Even for those in other situations, this is probably the best idea. The only problem with student loans is that you can't default easily. I'd say this is more than made up for by IBR and LRAPs.

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Bronte
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Re: paying back loans

Postby Bronte » Sun Oct 23, 2011 3:11 pm

birdlaw117 wrote:But my question would be at the end of when you pay off your debt you can start using that $$ to invest. So what is the relationship between waiting more years to start investing (the paying loans slower route) and having some investment earnings vs having it paid down faster and starting later but with larger contributions?

Unless I'm not following your scenario, this question is more complicated than that scenario... right?


It's not really more complicated than my scenario. If you don't pay down the loan, then sure you'll have more money to invest, but you'll also still have more principal to pay down. When you invest by paying down your loan, you don't lose the principal. It's just that it's completely illiquid.

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Re: paying back loans

Postby birdlaw117 » Sun Oct 23, 2011 3:14 pm

quakeroats wrote:
Bronte wrote:The benefits of compounding are the same between normal investments and investing in debt reduction. In a normal investment, interest compounds on a growing principal. When you pay down debt, you don't get this benefit of compounding. However, you reduce the principal upon which interest would be compounding against you, so you still get the benefit of the compounding.

Here's an example: Investment 1--You put $10,000 in a 3-year investment that pays 10% per year. Investment 2--At time 0, you put $10,000 toward the principal on a loan that bears 10% interest per year. You don't make any other payments for three years.

What you make on the first investment at the end of three years is simple: $3,310 (calculated by 10,000*(1.10)^3-10,000). What you make on the second investment is the difference between what you would have paid in interest without the $10,000 payment toward the debt. If you didn't make the $10,000 payment, you would pay $33,100 in interest (calculated by 100,000*(1.10)^3-100,000). Making the payment, you pay $29,790 in interest (calculated by $90,000*(1.10)^3-90,000). The difference between the interest you did pay and the interest you would have paid is $3,310. Thus, the investments are identical in terms of interest paid.

(Obviously this hypothetical is stylized. Loan payments compound monthly. Further, you will be paying both principal and interest when you make payments. I am confident that the principle holds true, however, despite these complications.)

It is thus clear that it is highly unlikely that you will be presented with any better investment opportunity than paying down your law school debt. Paying down your law school loans gives you a 7.5-9% risk-free, tax-free investment opportunity (depending on the interest rate of your loans). There is nothing in the market that comes close to this. Municipal bonds may be a good deal right now, but they get nowhere close to this.

As others have stated, the primary advantage to investing in something other than your loans is that loan payments are a wholly illiquid investment. It's good to have some liquidity, but not at the expense of passing up the opportunity to invest your loans. It seems like the best advice is to build a reasonable liquidity cushion (cash or cash equivalent savings) while paying down as much debt as possible. Once that liquidity cushion is built, payments on debt should be accelerated.


Of course, law school loans aren't like traditional loans. You can't easily default, but you can change the terms that apply in ways that may alter what's best for you to do, i.e., IBR and LRAP. For those of you staying in big law long term, you should pay off your loans as slowly as possible and invest your extra money as aggressively as your age range allows. Have an emergency fund outside of this. This way you get a better return than 7.5% if things go as planned and extra liquidity in the short term unless we have another serious correction. Even for those in other situations, this is probably the best idea. The only problem with student loans is that you can't default easily. I'd say this is more than made up for by IBR and LRAPs.

First off, going into default isn't exactly a good thing. Second, I'm not sure where you came up with the whole "this way you get a better return than 7.5%" thing other than pulling it from your ass.

I agree that you shouldn't pay off loans as fast as possible, but I disagree with pretty much everything else you have said. I'm really not convinced you have any idea what you're talking about. I mean, people going into Biglaw aren't going to be relying on IBR or LRAP.

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Bronte
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Re: paying back loans

Postby Bronte » Sun Oct 23, 2011 3:15 pm

quakeroats wrote:Of course, law school loans aren't like traditional loans. You can't easily default, but you can change the terms that apply in ways that may alter what's best for you to do, i.e., IBR and LRAP. For those of you staying in big law long term, you should pay off your loans as slowly as possible and invest your extra money as aggressively as your age range allows. Have an emergency fund outside of this. This way you get a better return than 7.5% if things go as planned and extra liquidity in the short term unless we have another serious correction. Even for those in other situations, this is probably the best idea. The only problem with student loans is that you can't default easily. I'd say this is more than made up for by IBR and LRAPs.


You're stating conclusions without supporting them. You can't use IBR or LRAP if you're making big law money. Also, there's no way to know you'll be staying in big law long term. It's best to assume you'll conform to the average four year attrition rate. I don't know what you mean by you can "adjust your loans." No matter what, if you don't pay down your loans, you are forgoing the 7.5% return. This is a very real opportunity cost because that interest adds to your principal and you'll have to pay it down eventually. Unless you have a 7.5% risk free return (it's hard to find a 7.5% return of any kind in this market) available, it's your best option. You've done nothing to refute this.




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