What To Do With $25,000?

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Reader Julia writes in:

Dear Jim –

Thanks for your blog – it’s swell!

Was wondering if you could share your two cents on my situation:

I have $25K in liquid cash sitting in a savings account with a variable APY of 5.05%. I have a separate account for 6 months of emergency funds, max out my $4K Roth IRA contribution, and max out my contribution to my company’s matching retirement account in addition to a small supplementary contribution. My only debt is a large student loan to the tune of $25K. The loan has a 2.5% interest rate. Should I pay more on my student loans every month cutting my 20-year loan repayment schedule in half, pay off half in a lump sum amount, or I guess there are many approaches to this situation…I’m not really sure what’s best. I have no children or other financial obligations. In a nutshell, I just don’t think it makes sense to have so much cash just sitting there. I don’t think I’m going to buy property anytime in the next 5 years (I would never be approved for a mortgage at my current salary for a living space in my current city). I’m interested in learning more about stocks, but realize there’s always a risk involved…anyway, what would you do?

What’s interesting is that Julia’s particular situation is very similar to my own (and many other recent college graduates several years out of college) and here’s my response:

Thanks for the email… I think you shouldn’t pay off your student loans for a couple reasons:
1) The interest is deductible if your salary is under a certain amount, it’s low though and you may be making more than that amount, I think it’s 60k or something in that range. (I looked this up after I sent the email, you can deduct up to $2500 in interest a year and the phase out for single filers is $50-$65k)
2) Your 5.05% is greater than 2.5%, which is sort of the situation I’m in right now too and I haven’t been paying off more than the minimums to the student loan because of that differential. See, that 5.05% is risk free, which would be different than your money in a brokerage account.

As for what to do with the money… I’m not really sure. I’d put it in a brokerage account and in some mutual funds, you’ll have to decide what you want to do with that money. While you aren’t thinking of a house at the moment, having that down payment money there is always a plus.

What would you recommend?

{ 14 comments, please add your thoughts now! }

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14 Responses to “What To Do With $25,000?”

  1. Tim says:

    get edumecated on some other investments. for the time being, you can either stash them in cd’s, keep them in the high yield savings, or go with t-bills until you decide on some other investments. 2.5% is low enough that you can still earn money even in very conservative investments. since you are out of college, take a look at your risk level, and invest in some investments corresponding to your risk. simple things like index funds or something. i wouldn’t pay off the student loan if you have other means of earning more income off of it; however, if you are uncomfortable with the amount, then perhaps reduce by half over a period of time rather than a lump sum.

  2. Chris says:

    Stocks are a bad idea, I think. Professionally managed funds are the way to go. The average person just doesn’t have the time/information to really make money from the stock market. Its nice to play with, but I wouldn’t trust myself to know enough to make sound decisions, and most of my stocks would be in companies that I “believe in” or “like”.

    Why not break that money in half? Since she already has an emergency fund, she can take half of the 25k and keep it in the online savings at 5%, so she’s not losing in interest on her student loan and put the rest into some other investment that hopefully would have a better yield?

  3. Alex says:

    Invest in Index Funds- 50% S&P 500, 25% International Index Fund, 25% in Indexed Bond Fund.

  4. I asked some bloggers a similar question, but with 50,000 today. There are some good responses there.

    I like where Alex was going, but I’d say get a Wilshire 5000 type fund rather than S&P 500. I’m partial to Vanguard’s Total Market EFT (symbol VTI) for that.

  5. plonkee says:

    I’ll also suggest investing in index funds. I might be a little more aggressive than Alex.

    In the UK, I’d tell you to max out your Stocks and Shares ISA allowance with the first £7000 (£4000 for the mini) of the money and invest the rest directly in unit trusts.

    The suggestion would then be to put say 60% in a FTSE All-Share tracker, 20% in an ex-UK Tracker, 15% in UK corporate bonds, and 5% in something unusual maybe in or in a bunch of individual shares or in mining. You can hold any/all of these inside or outside an ISA.

  6. Dustin Wyatt says:

    Would you borrow money at 2.5% to invest at 5.5%?

    If not (I wouldn’t), pay off your student loans. Then dump your student loan payments into a mutual fund.

    Based on a 20 year payment schedule on a loan of 25k at 2.5% your loan payments are ~132.48. Paying off your student loand with your 25k cash and then investing your monthly payment in a conservative mutual fund earning 10% will net you $100,601 in 20 years.

    Keeping your 25k and earning 2.55% interest will net you $41,367. If you factor in the tax savings which are approximately 84.92 a year ($6,793.87 total interest / 20 years * .25 tax bracket…simplistic, but accurate enough for our purposes) you will have $43,065.40

    So basically paying off the stupid debt and investing the payment in a mutual fund will potentially pay you $100,601 instead of the $43,065.40 you will have if you leave things as they are now.

  7. CK says:

    If her timeline for tapping into the money is 5+ years stick it in an index fund, with a shorter timeline take a more conservative approach Money Market / Bond Funds.

  8. plonkee says:

    Thats not good maths. You’re not comparing like with like as far as returns go.

    If you pay off the student loan and put the money in a savings account at 5.05% instead, you will make $54,769.

    If you take the money and put it in savings at 5.05% you will make $66,967. You will also have paid off the student loan and an extra $6,795 in interest. Leaving you with a net gain of $60,262. The tax savings are additional.

    In either scenario, investing in a potentially higher return investment may net a potentially greater profit.

    On the other hand, if debt bothers you that much, it may be good psychologically to pay it off.

  9. Dustin Wyatt says:

    “Thats not good maths. You’re not comparing like with like as far as returns go.”

    You’re right.

    “If you pay off the student loan and put the money in a savings account at 5.05% instead, you will make $54,769.”

    I assume you mean put the monthly payment into savings, because if you pay off the student loan you don’t have any money to put into savings. If saving the monthly payment IS what you mean, then I’m in agreement. This is basically the same option as when I mentioned investing the monthly payment into a mutual fund, albeit at a lower interest rate.

    “If you take the money and put it in savings at 5.05% you will make $66,967. You will also have paid off the student loan and an extra $6,795 in interest. Leaving you with a net gain of $60,262. The tax savings are additional.”

    I got tired of typing and figuring the math and figured that the math I had provided was enough to point to this direction. After rereading my post I see that this wasn’t all that clear. My original point that got lost in the process of creating my post was to point out the benefits of moving away from the 5.05 savings account in view of the fact that she already had a liquid emergency fund.

    I’d like to reiterate the point that the tax savings here are so negligible as to be barely worth considering as a benefit.

  10. Dustin Wyatt says:

    I sure messed up the HTML in that post…

  11. bryan says:

    use it as downpayments on income producing rental properties. keep some as reserves in online savings account.

    have fun

  12. Tim says:

    i agree with Dustin that his math was wrong. Bottom line, if you do not have a higher risk level, then i’d either pay the loan off or go with t-bills or a higher yield savings or cd’s. right now, you are essentially breaking even with the savings rate you have. now if you want to go into something like an index fund or stocks, then you could see bigger gains by not paying off your student loan.

    you have to evaluate what your risk tolerance level is and what will be comfortable for you to handle. what you do not want to do is have to worry about your money 24/7.

  13. Mary says:

    I just invested $19,000 in a Canadian stock, Potash. I bought the stock for one of my accounts several years ago and have made over 300%. I made a profit on another holding in my IRA so I decided to put it all on Potash. Easiest money you’ll make.

  14. aua868s says:

    in today’s environment, i would diversify $25,000 into a number of index mutual funds and ETF……

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