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Ask Dr. Don
By
Don
Taylor,
Ph.D.,
CFA
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Bankrate.com |
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.
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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