Why You Should Invest in a Retirement Account

(Even If You’re In Debt)

At 26 years old, I owe close to $40,000 in student loans. But I still sock away 9% of my after-tax income into a Roth 401k. Here’s why.

The interest on my private student loans is ridiculously high (5-7%). If my husband an I only made the minimum payment suggested by our lenders, we would end up paying almost half the loan amount again in interest. At first glance, this seems to be a good argument for putting off retirement to pay down debt. After all, we could save almost $30,000 by increasing our monthly payment to $2,000:

Left Scenario: We pay the minimum payment suggested by the lenders.

Right Scenario: We more than double the payment (with the excess going toward the principals)

CNN Money Loan Calculator

Matthew and I first looked at these numbers about four years ago. Startled, we immediately increased our monthly loan payment to $2,000 a month (at the time, more than half our monthly income!) By doing this, we’ve managed to pay down our debt at a rate of almost $15,000 a year. But even in months where money is lean, we always prioritize our 401k contributions over debt. Why?

Because worst case scenario, the interest on our debt will only compound for 15 years (the life of our loans.) And since we’re overpaying each month, it’s likely to be much less than that. On the other hand, money we put in our 401(k) will have 50 years to sit around and accumulate compound interest. The longer you keep the money in, the more time it has to grow–and it grows exponentially. This means that by the time we hit 50, the money in our 401k will start to explode…if it’s had time to percolate.

To see what I mean, look at this chart:

(Left Scenario)     I start contributing just $3,600 a year at 23 years old.

(Right Scenario)  I start contributing the same $3,600 but I wait until I’m 30 to start.

How Interest Works

To understand why I can make almost $500,000 more by investing just seven years earlier, it’s important to understand how compound interest works. With compound interest, you earn exponentially greater interest with each passing year. In the example below, look at what happens over time to $10,000 at 5% interest. Notice that with each year, the amount increases by a bigger and bigger number.

The growth is slow in the beginning, but if you keep your money invested for a long period of time, you’ll see explosive growth  in the last 10-15 years of the life of your account. This is why everyone should invest in a retirement account as soon as possible, even if you have debt.

Come back Monday, January 9 for Part 2: What Retirement Account is Right For You?