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Don't speculate despite low-cost funds

Dear Dr. Don,
I am a 22-year-old recent college grad with nearly $25,000 in student loans and another $5,000 in credit card debt with a variable rate of 5 percent. I make about $2,300 (post-tax) per month and have around $1,800 in disposable income after all payments are made. Should I begin paying down my debt as much as possible, or should I take advantage of the low student loan and credit card rates that I have and invest in something else? I've begun a day trade account in which I'm placing $400 a month. Is this a wise decision? Thank you for your advice.
Nicholas Net-Worth

Dear Nicholas,
I'm a firm believer in using low-cost funds to your advantage, whether that's a low interest rate on a first or second mortgage, or a low interest rate on a student loan. When I got my MBA, students were investing 8-percent student loan proceeds in money market accounts yielding 12 percent or more. A little interest arbitrage is a nice way to pick up some income. The key there was that the students weren't taking on risk to get a return on their investments higher than the interest expense on their loans. With your strategy, you are.

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I'm curious. What makes you believe you can outthink the market by day trading stocks? Do you know more about an investment than others? Have lower transaction costs? Have a sure-fire trading system? There's room in almost anyone's portfolio for some speculative trading, but it should represent a fraction of your overall investments and come after you've established an emergency fund of three to six months' worth of living expenses.

If you qualify to establish a traditional or Roth IRA, you could speculate with these funds and at least not have to worry about the tax implications that come with frequent trading. Limiting your speculative ventures to the contribution limits of these accounts will also keep you from betting the ranch on any one investment.

Take a look down the road. You're at a point in your life when, by your estimates, you have living expenses of $500 a month and $1,800 a month in disposable income. That will change with time and you'll lose the financial flexibility to pay down these loans. Take advantage of that flexibility and work down these balances. You could fund your emergency fund in two to three months, continue to fund your brokerage account at $400 a month and still pay down your student loans and credit card balances in less than two years.

This approach will free up money in your monthly budget in the future for car payments, house payments, etc. Don't let the lure of low-cost money get you thinking like a speculator.

-- Posted: May 25, 2004

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Student loan repayment
Education loans can provide a tax break
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