Asked on 03 Jan 2020
Hypothetical personal finance planning question
(i) Drawdown on your investment portfolio in each semester as tuition fees become due; or
(ii) Take up a student loan, allow the portfolio to continue growing, and then drawdown on the portfolio when student loan principal and interest payments become due when your child graduates.
Love to hear your thoughts, considerations, including any assumptions on parameters (e.g. cost of borrowing, expectations on market returns)
I have similar question in mind albeit it's not about tuition loan, but same capital allocation dilemma between early loan repayment vs investment. Agree that simple consideration is comparing the expected investment return vs loan interest rate. However i'm thinking more from perspective of Risk Management.
For young adults, the investment portfolio is assumed to be made up of aggressive 100% equities, hence the expected return should be higher (considering long-term, assumed @ 6-7% on average); and comparing to loan rate (student loan perhaps @ 4%, home loan @ 2-2.5%) - Purely from this comparison, the obvious answer is to allocate most if not 100% of the capital available to the investment portfolio and let it grow as the return is expected to more than cover the loan interest cost.
However, from risk management perspective, below some of my considerations:
(a) while investment return can be assumed long-term at average 5-6% in the case of equities, in reality it will have ups and downs along the years. Like one of the members above mentioned, investment return is not guaranteed, but loan repayment is guaranteed to be required on-time-in-full every time;
(b) Early loan capital repayment saves substantial interest cost especially for long-tenure loan eg. 20-30-yr mortgage loan;
(c) As we age into 30s/40s and increasing financial commitments eg. home loan plus growing family size and increasing family/kids expenses while job is no longer as secure, ability to service the monthly loan could be a risk. Yes refinance could be an option but early capital repayment helps to reduce the loan burden and saves interest cost, also means possibility of debt free earlier.
My own thought is to allocate my capital 50/50 to investment and loan repayment.
Any thoughts/ideas from the community welcomed and appreciated. Thanks.
What's the rate on the student loan? Is your investment portfolio able to cover this concretely without fail? If so, take the loan. Wouldn't know about current rates though. But I'd think it should be less than 5%.
If you are unsure about your investment returns, then don't proceed with the loan.
Alternatively, learn to find a way to generate the returns to service the loan.
Investment return is always non-guaranteed while the tuition fee loan interest rate is always guaranteed. With this in mind, how confident are you in ensuring that your non-guaranteed return is able to beat the guaranteed loan rate year after year?
That being said, take calculated risk on the approach that you are intending to make, e.g. how are you going to manage your investment portfolio so as to reduce the risk associated with the portfolio over time?
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Its all about opportunity cost, if tuition loan's interest rate is less than than your portfolio's yield/total return, then you take the loan.