You’ve paid all your monthly expenses and find you’ve got a surplus that you can use toward your financial goals. Maybe you’ll increase the amount you invest. But then you think paying down your student loan debt faster than your required minimum payments is also a good idea.

Which one makes more sense for you? Ultimately, there’s no right or wrong answer—just the one that best fits your unique circumstances. Here’s how to evaluate each option and determine the steps you feel confident taking.

Where to start: Interest rates versus portfolio returns

When trying to decide whether to invest a sum or use it to pay down student debt, a common starting point is to compare your student loan interest rate with your expected portfolio returns based on your asset allocation.

The Federal Student Aid office of the U.S. Department of Education reported student-loan interest rates ranging from 3.86% to 6.41%. And the chart below provides a range of potential return distributions, generated by the Vanguard Capital Markets Model, for balanced portfolios of varying degrees of risk.

Fixed student-loan interest rates by disbursement dates
Loan type First disbursed between July 1, 2013, and June 30, 2014
Direct subsidized loans (undergraduate students) 3.86%
Direct unsubsidized loans (undergraduate students) 3.86%
Direct unsubsidized loans (graduate or professional students) 5.41%
Direct PLUS loans (parents and graduate or professional students) 6.41%
Perkins loans (undergraduate and graduate or professional students) 5.00%

Source: Federal Student Aid, an Office of the U.S. Department of Education; June 4, 2014.

Projected ten-year nominal return outlook for balanced global equity and global fixed income portfolios, estimated as of September 30, 2014

Source: Vanguard.

Note: Figure displays the 5th/25th/75th/95th range of VCMM projected returns for balanced portfolios.

Underlying historical data for projected returns
Portfolio stock/bond allocation
Bottom 5th percentile 1.7% 0.1% –1.1%
25th percentile 3.0% 3.5% 3.5%
75th percentile 4.9% 8.5% 10.3%
Top 95th percentile 6.4% 12.3% 15.3%
History 1926–2014 6.7% 8.7% 9.5%
History 2000–2014 5.7% 5.4% 5.1%

You may assume that if the loan’s interest rate exceeds the expected equivalent investment return over the life of the loan, it would make sense to pay down debt first. And conversely, if investment returns are more likely to be higher, it would be better to invest the sum you’re considering instead.

“While this comparison is a good starting point, there are other factors to consider,” said Andrew Patterson, an investment analyst with Vanguard Investment Strategy Group.

“For example, if you’re a recent graduate, you might want to put a few other things ahead of accelerating student loan payments, such as establishing an emergency fund (6–12 months of income is a good goal), contributing at least up to the employer match to your 401(K) or 403(b), or paying down any credit card debt.”

An either-or decision?

Where you focus your efforts depends on whether you want to reduce the liability side of your net worth equation (how much you owe) or increase the asset side (how much you have).

Understanding this equation helps clarify that your decision doesn’t have to be either-or. “Doing a little of both—adding to your investments and paying more than the minimum on your student debt—can be a hedge against a time where your budget may be a little tighter,” said Ryan Rich, an investment analyst with Vanguard Investment Strategy Group.

Let’s look at some of the benefits each choice may offer you.

Benefits of building assets

Building up your assets, as opposed to accelerating payments on your student loans, has several advantages:

  • Your employer may offer retirement plan benefits, including matching contributions. It’s a good practice to contribute at least enough to get the maximum match, if you can.
  • Depending on your modified adjusted gross income (MAGI), you may be able to deduct up to $2,500 of your student-loan interest costs. Paying your loan off early may reduce your tax savings from that deduction.
  • More savings can also mean more liquidity in general. When you invest, you can build up a safety net that can help carry you through a number of situations. If you invest in a Roth IRA, you’ll have some withdrawal flexibility if you need to use those savings in the future. Generally, early withdrawals from an IRA prior to age 59½ are subject to income taxes, plus you’ll pay a 10% tax penalty. However, you may be able to withdraw contributions (before any earnings) tax-free and without penalty from a Roth IRA. It’s a good idea to consult your tax advisor for guidance.

Benefits of reducing student debt

Reducing your student debt burden also has some benefits worth considering.

  • The predictability of a fixed interest rate, which is common for student loan debt, can make budgeting and financial planning easier. Future market returns are uncertain.
  • Your credit score is likely to improve, thanks to your lower overall debt burden and history of faster repayment. In turn, you may be able to secure lower interest rates—and greater savings—on debt for large purchases such as a car or home. According to myFICO™, the amount of debt you owe accounts for 30% of the calculation used to determine your FICO score.
  • You have the peace of mind that comes with lightening your debt burden.

Establish your habit

Either action will put you in a stronger financial position than if you did nothing. “You can focus on one goal at a time or ‘hedge your bets’ by balancing both goals,” Mr. Rich said. “The most important thing is to develop a plan and stick with it. Discipline is one of the keys to investing success.”

IMPORTANT: The projections or other information generated by the Vanguard Capital Markets Model® (VCMM) regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Distribution of return outcomes from VCMM, derived from 10,000 simulations for global equity returns and fixed income returns. Simulations as of September 30, 2014. Results from the model may vary with each use and over time.

Indexes used in VCMM calculations

The long-term returns for our hypothetical portfolios are based on data for the appropriate market indexes through June 2014. We chose these benchmarks to provide the best history possible and split the global allocations to align with Vanguard’s guidance in constructing diversified portfolios. U.S. bonds: Standard & Poor’s High Grade Corporate Index from 1926 through 1968, Citigroup High Grade Index from 1969 through 1972, Lehman Brothers U.S. Long Credit AA Index from 1973 through 1975, and Barclays U.S. Aggregate Bond Index thereafter. Ex-U.S. bonds: Citigroup World Government Bond Ex-U.S. Index from 1985 to January 1989 and Barclays Global Aggregate ex-USD Index thereafter. Global bonds: Prior to 1985, 100% U.S. bonds, as defined above. After 1985, 80% U.S. bonds and 20% ex-U.S. bonds, rebalanced monthly. U.S. equities: S&P 90 Index from January 1926 through March 3, 1957; S&P 500 Index from March 4, 1957, through 1974; Dow Jones Wilshire 5000 Index form 1975 through April 22, 2005; and MSCI US Broad Market Index thereafter. Ex-U.S. equities: MSCI World ex-USA Index from January 1970 through 1987 and MSCI All Country World Index ex USA thereafter. Global equities: Prior to 1970, 100% U.S. equities, as defined above. After 1970, 70% U.S. equities and 30% ex-U.S. equities, rebalanced monthly.


  • All investing is subject to risk, including the possible loss of the money you invest.