Question:
I am a recent college graduate, and am formulating a plan for eliminating my student loan debt with as little interest accrued as possible. The loans after consolidation have an interest rate of 5.375%, I'm presuming compounded yearly, but I'll have to check. I have minimum payments of ~$150/month, which I can make with no problem. My question is: does it make more sense for me to pay more than the minimum (like 400/month) in order to pay off the principal faster, and thus pay less interest overall, or does it make more sense for me to pay the minimum payments and put the money I would otherwise use to pay off the loan debt to use in mutual funds? I'm thinking I might invest with just $1000 or so in stocks just as a fun thing. I used to follow the stocks in the NY times, and think that I could beat inflation, at the very least. :) But for my student loan debt, I'd rather have a less risky investment, so maybe a consistantly performing, if slightly anemic, mutual fund, or maybe municipal bonds. What do you all think would be the wisest course of action for me? I'm no econ major, so any advice would be appreciated.

Answer:
The goal is to put your money to use where it earns the best rate of return. If all you do is beat inflation, then you are getting about 4%, and that is taxable. If you pay off your student loan, you are getting 5.375%, and that is tax free. You would have to average about 8% to really make sense to invest the money, which means putting it all in the market given that the market is the only tool that consistently earns over 8% over time.

If you have the income, agressively pay off that student loan. If you still want to pay with investing, make sure you are maxing out your 401K and funding your IRA options. If you still have money left, then look for some low cost index funds (or stocks called Vipers).

My question is: does it make more sense for me to pay more than the minimum (like 400/month) in order to pay off the principal faster, and thus pay less interest overall, or does it make more sense for me to pay the minimum payments and put the money I would otherwise use to pay off the loan debt to use in mutual funds?

A guaranteed 5.3% after tax is very good. You'll need a return of over 8% (before tax) before it's worth it. Pay the loan off first, then start investing.

does it make more sense for me to pay the minimum payments and put the money I would otherwise use to pay off the loan debt to use in mutual funds?

All sorts of aspects to this question. If your income is below $50,000 you're able to deduct the interest you pay on student loans (up to $2,500) on your federal tax return, even if you don't itemize your deductions, which you probably don't. Your state taxes may also show a benefit. The net result is that you save some taxes. So factoring in the reduction in taxes, you might end up paying less than the 5.375% rate - more like 4.5%, less perhaps. This is why some people call student loans "good debt." That's relatively cheap money (4-5%/yr) and in the grand scheme of things you might want to delay repayment as long as possible. If you pay back say $25,000 early, you might just end up borrowing it back again at a higher interest rate. Imagine you diligently divert that extra $25,000 towards early repayment and have the thing done in 4 years. And then you go to buy a house, and mortgage rates are at 7% (not at all unrealistic).

You'd need to borrow an extra $25k at 7% because you'd paid off the student loan early, instead of throwing the money under the mattress. Put another way your down payment is $25,000 smaller, so your mortgage is that much bigger. Another factor to consider is your retirement savings, which may seem a dismal thing to think about, but it's a really advantageous time for you to save for that. Especially in a Roth IRA (if your income isn't all that high). This is the time of your life when you should stuff away as much as possible into that kind of savings it has the longest to grow, and 40 years of compound growth works wonders on even mediocre investment choices (at a measly 5%, $1 turns into $7 over 40 years; at 7% it turns to $15). You may have seen the projections where one guy puts the maximum allowed amount in an IRA for just the five years after college, then stops saving; the other doesn't start until age 35, but puts the same amount in every year until retirement. The second guy never catches up! "But what about the interest I'd be paying on the loan?" Good point but it's still likely to work in your favor over the long term. Hopefully your money is going to grow at greater than the 4-5% it's costing you to keep that student loan balance. Even if it's costing you a bit, there is something to be said for socking money away in the tax-insulated Roth. A major limiting factor in Roth IRAs is that you can only stuff a limited amount of money in them each year (currently $4,000). And once your income crosses a certain level you can't contribute to them at all. It's the kind of thing you take best advantage of in your lower-income years like those few years after college.