Debt vs. Retirement – Perspective From A Young Person


Yesterday, Trent from The Simple Dollar posted a rebuttal to a comment stating that sometimes it is more appropriate to invest than pay off debt. I mostly agree. After all, if your monthly payments are $200 per month and you have $300 extra, it can decrease your debt repayment time by many years; years in which you can invest $500 or more instead of the $300. Even if the percentages are equal (return vs. debt), it at least makes psychological sense to pay off debts before investing.

However, I know in my case, I have a retirement account that I contribute to faithfully, even though I have a ton of debt. I suspect that most younger people are in a similar situation; a ton of credit card debt, about $200-300 extra per month that can be invested, and an immense hope that they’re a more savvy investor than others. Even though that sounds like trouble from the start, I will give the reasons I choose to invest and why it makes sense in a long-term perspective.

1. Employer Matching

This one is way too overlooked in calculations I see online. A friend of mine refused to start a retirement account because he “had plenty of time to worry about that”, “Social Security would help him out”, and “that’s 5% I can use to pay off my debts”. However, what he did not calculate is employer matching at 3% (as well as the fact that Social Security will never last long enough for current twenty-somethings to benefit). While I could use my contributions to pay off my debt a little faster, the fact it has employer matching and it’s in there working for me right now is literally the difference in $300,000 when I retire compared to using that money to pay off debts right now.

2.  Fixed Limits

Benefits of Roth IRA’s are well known. However, when 2007 is over and you only contributed $2,000 to your IRA, that’s $2,000 you can never put in later. In most jobs, at least in my field, salary increases over time at a rate higher than inflation. This means that my current $8,000 credit card debt may be a big chunk of my current salary, but drawn out over a decade, it will be a pretty minimal amount to what I should be making then. However, a good Roth IRA can also easily beat inflation, meaning that in looking at VALUE of your debt versus the investment, you wind up with more money at the end, taking long term inflation and salary increase into account. Missing out on maximum contributions at such an early age winds up making the difference of hundreds of thousands of dollars at retirement.

3. Learning Experience

I know for me, I read about investing all during high school, and played with a few hundred bucks to test the waters. I also lost it all (mainly due to fees). The point is, it’s difficult to learn proper investing without having your money wrapped up in it. Since opening a retirement account, I have learned how mutual funds work, how to direct your financial adviser to wait longer between buys to save on fees, how to calculate return on investment, and tons of basics about investing that books can’t really teach you. When I finally open an IRA, I will learn more about the stock market and how to predict when things are going bad, how to read the latest news on the company, how to pick long term and short term winners based on the current state of the union, etc. The earlier you start, the more wisdom you gain along the way. Once you wait a year, you will never get that year back. My aforementioned friend is just now opening a retirement account. I’m three years ahead of him in learning how to manage those funds. I will always be three years ahead of him in investing, save for some lucky break. Time is money, and starting early is always a good idea. I only wish I would have started seriously around junior high.

Basically, there are many good reasons a young person should start investing even if he or she owes a lot of debt. It heavily depends on the person’s will-power. Do they have enough will to both invest properly and pay off more than the minimum debt payments (for those debts that are higher APR than their current investment return)? Can they make the proper calculations for their specific situation and see how it plays out in the long run? Is the debt causing mental stress that requires it to be payed off sooner, at emotional expense otherwise?

Personally, I have not opened a Roth IRA and will not until my major debts are payed off. As soon as the high interest credit card debt is gone, I will fund that IRA to the limit, as time is indeed money. Right now, however, I do have an employer-matching retirement plan gaining considerable snowball effect, and calculating the difference that makes in my nest egg, I will never regret that decision. Yes, it put a bit extra time on my debt repayment, but it’s a small price to pay for the benefits that investing early has given me, both monetarily and education-wise. I have run the calculations and my Roth can wait until 2009 with not too much loss on my future retirement, at least compared to the anxiety the debt is causing me right now. Nor would I be able to fund it fully with my current monthly payments.

The true answer is never clear-cut, and I’ve come to find it’s almost never purely mathematical. I think the benefits to investing at an early age easily transcends the obvious mathematical benefit to early debt repayment. For those of us who expect drastic salary increases due to years of experience and getting a degree, it may make more sense to not worry too much about drastic debt repayment measures. For me, it’s a challenge and that forces me to take some frugal steps. But I think for most people there is a happy medium in which you can both repay debt and invest intelligently.

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