Factors Affecting Your Risk Tolerance

Maximizing your contributions and expected return is the rationed, economic approach to investing your money. But when you’ve got a heavy debt burden, thinking about it rationally can be a challenge as risk tolerance plays a part.

Risk tolerance, which is the degree of variability in investment returns an individual is willing to withstand, depends on a number of factors. Major ones include:

1. Age – Your age and stage of life can determine how much risk you can tolerate. If you’re young with less to lose, you can shoulder more risk with investing. Similarly, if you’re older with more assets at-risk, you want to preserve your wealth. In response, you could choose to hold more cash and fixed-income investments and not carry much debt.

2. Income – Closely related to age, your disposable income plays a role (income available after paying for living expenses). If you’re young and invincible and on a high deductible health plan, you likely don’t have many obligations outside of rent, food, entertainment, and repaying your student loans. You might make less but still have more disposable income than someone a bit older who is married with kids. With no dependents, you can have a higher risk tolerance and invest more aggressively instead of paying down student loans. However, as an alternative to paying off student loans, you may also face the decision of whether you should pay off student loans or mortgage.

3. Time Horizon – The amount of time you have to invest or repay your loans affects your risk tolerance. When you’re young and can afford to hold riskier assets, you have a greater potential payoff through investing rather than reducing debt. Also, federal student loans accrue interest, they don’t compound. That gives an advantage to investing again. There are also options other than repaying the entire balance. For example, some student loans qualify for the Public Service Loan Forgiveness program (PSLF), discussed below. You can also lower the cost burden by refinancing student loans.

4. Debt Amount – If the debt is very large relative to your income and feels cumbersome, you might prefer to pay off your debt sooner. In the case where PSLF or other loan forgiveness isn’t an option you should probably put more money toward repaying the loans to suit your risk tolerance.

Now that you know about risk tolerance factors, let’s explore options for dealing with the debt.

The first option you should consider is refinancing. If you can lower the interest rate and bring down the total cost to be repaid, you should pursue this opportunity.

What are Student Loans?

Many companies cater to the student loan market. I suggest looking at Credible’s site for refinancing options or contacting credit unions. Because credit unions are not-for-profit they can offer very better rates than banks but Credible offers competitive rates as well.

My wife and I used a service like Credible to find a lender to refinance the first batch of her loans. She began paying after she finished medical school and made a significant dent before we married. We made repayment easier by refinancing and lowered her rate by 515 basis points (8.00% to 2.85%).

Credible | Refinancing Student Loan Marketplace Credible is an online marketplace for borrowers to receive competitive, personalized loan offers from multiple, vetted lenders.

This gives the best available offers and allows you to move forward with your preferred refinancing lender. Check Your Rate Learn More

For the loans we chose to refinance on Credible, despite receiving a generous student loans tax deduction for the interest paid, we still opted to pay off the loans. We felt it was more important to pay off student loans and maximize our savings in our 401k and IRAs. Those loans were manageable relative to our income.

Later, after relocating to northern California, we chose to refinance more of her student loans with First Republic Bank, a bank offering highly competitive loan terms should you live in one of the regions where they serve customers.

Refinance Student Loans w/First Republic First Republic Bank offers low interest student loan refinancing options. Refinance student loans to save more with fixed rates as low as 1.95% APR. Get Your Rate Learn More

If you have a large student debt burden (2x or greater than your annual income), you might consider another option, the PSLF. This program forgives your remaining loan balance after making 120 monthly payments (10 years).

The IRS awards another benefit to the program by not having the forgiven loan balance count as income. So when the remaining balance is forgiven, it does not qualify as a taxable event.

To qualify for PSLF, you must:

Be employed full-time by a:

government organization at any level (federal, state, local or tribal)

not-for-profit organization that is tax-exempt under Section 501(c)(3) of the Internal Revenue Code, or

Other type of not-for-profit that is not tax-exempt if their primary purpose is to provide types of qualifying public services

Make 120-qualified monthly payments based on an income-driven repayment plan

What are Income-Driven Repayment Plans?

The income-driven repayment plans base your monthly payment on your discretionary income, or adjusted gross income. For PSLF, the amount is 10% of your annual discretionary income. Income-driven repayment plans not under PSLF range from 20-25 years.

The table below shows the available income-driven repayment plans. To estimate your income-driven loan repayment amount, use the Federal Student Aid site’s repayment calculator.

Source: Federal Student Aid website

Why You Should Invest Under This Scenario

As a useful tip for qualifying for Public Service Loan Forgiveness, you have an incentive to maximize any pre-tax contributions to your tax-advantaged investments. This means knowing how to save money and maxing out your traditional 401(k), individual retirement account (IRA), and health savings account (HSA) contributions. Doing so lowers your discretionary income and the amount you will have to repay over 10 years.

You should not pay extra toward your debt under PSLF. Per the Federal Student Aid website:

“If you make a monthly payment for more than the amount you are required to pay, you…can receive credit for only one payment per month, no matter how much you pay…However, if you do want to pay more than your required monthly payment amount…you may end up being paid ahead, and you can’t receive credit for a qualifying PSLF payment during a month when no payment is due.”

Refinancing and student loan forgiveness are popular ways for dealing with student loans. Some critics malign student loans but not all are bad. When used appropriately, student loans can allow for an investment in yourself which will pay returns for years to come.

Can You Pay Off Student Loans Early?

Student loans can be both good and bad. Taking out hefty loans to pursue a low-paying career or ambition isn’t advised. Attending community colleges and in-state public universities will often suffice for getting you the education you need and pay less with the average cost of college attendance going higher.

Finding scholarships is always recommended. You can even attempt to find scholarships to pay off student loans after graduation.

Some fields require lots of formal education and quite often have student loans come as part of the package. Becoming a doctor or lawyer isn’t cheap, but if done wisely, student loans can be manageable bill to carry after graduation.

How Long Does it Take to Pay Off Student Loans?

These high-paying fields can leave you with tremendous amounts of debt, but they can also allow you to pay off student loans in 5 years or less. If you’re really frugal, you might even be able to pay off student loans while in school.

While unlikely, it is possible. However, if you chose the right medical specialty, you might be able to pay off your student loans in a year.

The point is to weigh the costs and benefits of the education. You will find the most effective way to pay off student loans if you are diligent in your approach.

Pay Off Student Loans or Invest?

When deciding to invest or pay off student loans, you should attempt to maximize your expected return while also weighing your risk tolerance. Look at refinancing or PSLF if you have a high burden relative to your income.

Building the optimal portfolio varies person to person. Much like dodgeball, you want to find the appropriate balance of risk or you could end up getting hit in the head.