I’ve met fellow students in some of my college classes in the past that were very ambitious/ aggressive with their investment strategies. Usually I approve of this. But there’s one investment strategy I wasn’t too crazy about. This one investment strategy that I repeatedly heard of caught me off guard.
What is this investment strategy?
Using the money from college student loans for investment purposes.
There are two common scenarios:
1.) Using the money left over from student loans (after paying rent & college related costs) for investment purposes.
or
2.) Your parents pay for the majority, if not all of your education, and you then apply for a student loan so that you have the money needed for investments.
Yes I know that there are many low interest rate student loans out there. In theory you can obtain a student loan at a low interest rate, invest it in the stock market, make some profit, and then payback your student loans when the time comes. Keeping the extra money for yourself, of course.
In theory this is the perfect plan. In application- not so perfect.
Investing student loans IS a risk
No matter what anyone tells me, investing your student loans IS a gamble. You’re essentially taking a chance (even if it’s a minor one) with money that you need to pay back.
Even if you go the conservative route and invest your student loans into an online savings account at ING Direct, the rates can change. Interest rates always fluctuate. They go up and down. Is it worth investing your student loans for a small percentage?
But that’s assuming you’ll never be tempted to touch the money or spend it on something. You now have thousands of dollars available to you within a few clicks. What are the odds that you won’t want to touch this money when shit hits the fan?
The process can also be mismanaged. I have no problem admitting that there are many people reading this that know 20 times more than I do about investing money. The problem is that the best of us mess up at times.
You also don’t want to run the risk of messing up your credit score at such a young age.
Can you handle the risk-to-reward ratio?
Let’s say you lose a portion of the money, what will will you do?
The economic down turn of late-2008 showed us all that anything can happen. One day your prospering with the student loan money you’ve invested and then the next day you’re stressing about how you’ll pay back your student loans.
I’ll be the first to admit that you can make some really solid returns from investing your student loan money into the stock market. But I don’t like that kind of risk. I’d rather put the money down on the Maple Leafs winning (that probably flew over your head if you don’t watch hockey).
My take on investing student loans
I can’t tell you what to do. I choose to invest money that I have. Not money that I’ve borrowed. If you’ve got your shit figured out 100% then chances are nothing will stop you from doing it. I wish you all the best and hopefully everything works out.
Second of all- if your parents pay for all of your education-related costs, you’re better off than most college students that are struggling to pay for college. The small gains from interest/stock appreciation are alright, but is this the best utilization of your time? Could you possibly benefit more from focusing your energy on internships, starting a side business, or making the most out of your college experience?
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Not to be off topic here, but that guy in the jacket (with goatee) waving the flag w/ a cup in his hand looks EXACTLY like Adam from MoneyRelationship.com! Is it?
Lol I doubt it. That would be funny though.
This sounds like a pretty crazy practice to me. I’d make three rules. Only do this if you:
1. Pay 3% interest or lower on the student loans.
2. Can pay, and expect to be able to pay forever, the monthly loan repayments out-of-pocket.
3. Are investing with a 20-year-plus horizon.
If at all possible, earn money in side jobs throughout the school year so that you can put as much of the student loan money as possible into tax-advantaged retirement accounts. Start with $5k in a Roth IRA, since you’ll likely avoid any income tax in the year you do this.
This isn’t such a great deal dollar-for-dollar today, but the real value would come from contributing to a tax-advantaged account years before you would normally start doing so.
You bring up a viable alternative Ethan.
The 20 year horizon is never used in this case because the student loans need to be paid back slowly 6 months after you college graduation. The longer you prolong payment the more money you lose to interest along the way.
I would personally (well I have) stick with the side jobs in college idea. At least this way you learn to appreciate the value of a dollar. Plus I hate any kind of debt.
Interesting topic, here’s my take on it.
First off I don’t see this as a good option unless you are getting your education exclusively paid for through another source like your parents. If not then you are forcing yourself to work harder at a job during your school years which I don’t recommend.
Secondly, the problem is that you have to deal with inflation so not only are you trying to beat the rate on your student loans (depending on if they are subsidized or not) but also beat inflation. Most of my loans (I’m out of school now) sit at about 6%, so using 3% as the inflation rate I would have to be beating 9% to make it even worthwhile.
In “safe” investments such as savings accounts or index funds, you are fortunate if you beat the inflation rate let alone the rate of the loan. So you are left with the stock market, and ignoring hindsight, you would want to “actively” trade these stocks. By actively I mean pay attention to the company including their statements along with the industry, which can be a lot of extra work for a student.
The idea of using student loans to invest sounds like an offshoot of using leverage from your agent to invest more in firms. The difference is most people who use leverage are professional investors and likely know far more about what they are doing than a college student.
Personally I’m extremely glad I didn’t do this because I would have a lost a ton of money as I only recently graduated college. Well that plus I had to pay my own way through school so I would have broken my own recommendation.
And you don’t run a personal finance blog because…?
For simplicity purposes, I didn’t even touch upon inflation in this article. This opens up another debate: how will you beat inflation with your investments? This is where the whole topic gets very tricky. As I mentioned the idea of investing your students loans for profit is only perfect on paper. Once you get to the bottom line financial stuff you will be in for a nice surprise
I’ve actively traded stocks in the past and let me tell you this- I would rather focus my energy on something I have control over (my blog) as opposed to something that is out of my reach.
I think investing student loan funds reeks of RISK. Pay those suckers off. In this job environment it is a no brainer. In this job environment, many people are probably using them to pay for everyday expenses…that is certainly not investing. Every man to his own I guess.
You bring up a good point Ken. I used the investing option but there are many college students/graduates/drop outs that have used student loan money for everyday expenses.
While it is an interesting article, I really dont like the idea leveraging any debt for investment purposes. You increase the risk of not being able to see a profit when you factor your loan interest rate. In addition, if things really go south and you lose your entire investment, the student loan debt would remain even after bankruptcy.
You bring up some excellent points John. If you lose the money, you don’t lose your own money. You lose the money that you still have to pay back… with interest.
I graduated in 2004 and I did exactly this… I accepted every dime of stafford loan I was offered. Even when I didn’t need it because I lived at home and worked my way through.
The interest earned in savings/checkings/CDs in college and since has been thousands of risk free dollars. Arbitrage baby!
I still have almost all of this student loan debt, which is locked in at ~2.6% interest… I still have most of it in CD ladders earning well above this. Still you can beat 2.6% with some fixed rate vehicles.
Man that’s cool to hear that it worked out! I really want to hear this side of the argument.
The unfortunate part is that too many rookie investors attempt this strategy. Not everyone will be as successful as you.