Help a Reader: Investing During College

Here's an email I recently received from a reader:

I am a college student entering his last year of my bachelor's degree (with law school immediately following graduation). However, for the last year of my degree I am, due to unforeseen financial reasons, forced to take student aid to pay tuition. Since I am over 24 I receive quite a lot of financial aid between Pell Grants and different loan types.

This coming fall semester, I am slated to receive around six thousand dollars as a "refund" for the difference between my awarded aid and what was needed for tuition. Now, I am a relative newcomer to your blog (two to three month regular), and I have read a lot of what you (and other PF bloggers) have said about investing. But I am still not sure what the best investment route would be for this refund check.

My question to you is: Once I receive this refund money, what do you believe is the best way to invest it? Seeing as I have to repay this money once I am done with school (~ four years), is it best to go long term a la index funds, or are short term (couple years) investment a better idea?

I appreciate any insight you can provide on my dilemma.

What are your thoughts for him?

Comments

[No Debt MBA]

If he has outstanding loans that are accruing interest the $6k would probably be best spent paying them down. Current student loan rates are 6%+ and it would be hard to beat that in the current economy with any kind of safe investment. If the funds haven't yet been disbursed and are loans then he'd also be accruing 1-4% disbursement fee just for taking the money out. Too expensive altogether to leverage for investing purposes IMO.

If the money is interest and disbursement fee free I'd stash it in a high interest checking account or CD not linked to the rest of his bank accounts.

[cmadler]

If interest accrues while your in school, it's probably better to pay back any excess money immediately. The certain return you'll get from paying down the loan(s) is probably more than any expected return you'll find elsewhere.

If interest doesn't accrue (e.g. subsidized loans) you may want to consider short-term investments with little to no risk of loss, like CDs (which you can calibrate so they all come due around the time you'll need the money) and then use it to pay back the loans as soon as the subsidized period ends (this used to be six months after you finished school, but the rules may have changed).

[Rod Ferguson]

I think "invest" is a bad way to approach this extra cash; I'd go with "emergency fund" before "investment", myself.

OP - last year, I would have suggested a money market account, but this year, I'd suggest finding the highest interest/lowest overhead bank account you can and stashing the money there. Worst case scenario, you'll have the original $6k + interest to then pay in a lump sum towards the debt, but in the meantime you'll have the cash you need to cover most any unforseen emergency that might crop up while you are still in school.

[jim]

I agree with the others that if you have any student loans where interest accrues on the loans while you're in school then pay back the excess money that you don't need on those loans right now.

Assuming the loan interest isn't accumulating now then I'd put it into a high yield savings account like ING where you can get 1% on it. You could use it as an emergency fund for the time being. But if you dont' trust yourself to blow that money then just pay it towards your student loans now. 1% over a year is just $60 so its not going to make you rich.

4 years is not a safe 'long term' time period for stocks. THe S&P 500 is down around 10-20% over the past 4 years as an example.

[Mel]

We're allowed to invest with the financial aid refunds?

There was a paragraph in the loan agreement saying that the money could only be used for educational purposes... that was all that was stopping me from investing with that money: my signature.

[Old Limey]

Whatever you do don't put it into any investment that holds stocks.
CDs are no help because you would need to lock the money up for far too many years.
The best of the "Total Return" class of bond mutual funds over the current year and over much longer periods is TGMNX, a member of the TCW fund family. This is a no transaction fee fund, YTD(Year to Date) it is running at an annual rate of return of 7.15%. Its maximum drawdown YTD is only -0.77%. It has a very low volatility. To give you an idea how low its volatility is, the index for the NYSE ia 19.9 times higher and that of the Nasdaq is 17.9 times higher. This is a fund that you will not have any sleepless nights over.

Today it closed at $10.33/share and it has been paying a $.055/share dividend at the end of each month which you receive in the form of additional shares.

The inception date of TGMNX was 3/1/1999, the fund's size is $5.30B, and it has Morningstar's highest ranking of 5 stars and one of the highest regarded fund managers by the name of Tad Rivelle who was Morningstar's "Fixed Income" fund manager of the year for 2005.

[Andie]

I actually ended up sort of doing exactly this: at the end of graduate school I had in stocks as much as I had in Stafford loans. If I had to do everything over again, I probably wouldn't have gone that route because I only came out ahead by luck.

1) I was buying into the market on the way up with the real estate boom, but I graduated on the other side of the awful drop.

2) I was able to consolidate my loans at 2% interest. That's probably the bigger deal. With interest that low, I'm not bothering to sell the stock to cover the loan in one fell swoop, but it bothers me to have the loan around.

3) I got married after the loan but before I graduated to someone with a good paying job. This meant my life went from being financially unstable to financially rock solid. The stress of the loan and psychological need for the market to do well were greatly diminished by this.

None of these were predictable when I started to put money in the stock market instead of an CD or savings account which back then didn't have awful rates.

In short, find something else to do with the money other than stocks. If any of your loans are accruing interest while you are in school pay those down ahead of time.

[Dawn]

I'm in college as well (at 36) and after racking up $53,000 in student loans I would not recommend investing your student loans. I would keep what you absolutely need and return the rest to your lender, unless this is scholarship or grant money that doesn't have to be paid back. With the economy and investments tanking out over the last few years you'll be lucky to see a 6% return on your investment but I've read quite a lot of blog posts saying they're student loan interest was around 7%. It's never a good idea to invest borrowed money. Wait until you graduate and are MAKING money and know your bills and know how much your monthly student loan payments will be.

[STRONGside]

The only loan that you can safely invest is a Subsidized Stafford Loan. The Gov't subsidizes the interest for you while you are enrolled in school, and you will not begin to pay back until 6 months after you graduate. Subsidized Stafford loan new disbursements are also a 3.6% interest rate right now (which won't matter until you begin repaying them, but still).

Any other time of loan will accrue interest once disbursed, even if your payments are deferred. So you would have to beat the 6.8% (and much higher) interest rates that your loans are accruing, plus the original fees that you are charged to be able to make a profit by investing. Obviously the stock market is volatile, and a buy-hold strategy is best there anyway.

I don't know of any short term investment that would allow you to make money investing a student loan. Bottom line. I would decrease your student loans and lower your overall debt limit.

[STRONGside]

@Mel Technically, yes. Student loans are only limited to "education expenses". That is a really good question though, which I have gotten from talking with a lot of financially savvy parents and students over the years. My answer has always been that there is no audit or questions about where the refund money is used. The Dept. of ED, for good or bad, allows students to receive these refund and does not ever track them. As long as a student is within their allowed "Cost of Attendance" at their college, then they are eligible for these funds.

The way the Dept. of ED has set the loan certification process up, it is very possible to get large sums of money back in refund checks.

IMO, investing student loans would be a much better use of that money than spending it on beer and pizza.

[Cecilia]

If this guy wants to risk getting caught doing this, that's his choice, but those funds are supposed to be for tuition and living expenses while in school. I think given the tone of this blog and the Christian principle of being honest with what has been given to you, investing the money is a dishonest use of the funds and should not occur.

[Carol]

I would build a cash emergency fund first. You can start investing when you're out of school.

[Jenna]

Keep it in savings to pay for interest accruing on your current loans...and the loans you might be taking out for law school. Keep the rest as an emergency fund, if you don't have one already. Even if you do, keep it in savings so that you can take out less in loans for your first year of law school.

[Old Limey]

My suggestion of parking the $4000 in a rock solid bond mutual fund for 4 years would turn the $4,000 into $5,000. Building a Cash emergency fund shows no imagination whatsoever. The mutual fund that I suggested can be sold at any time the money is needed. My credit union only pays 1% for savings accounts, that equates to getting back only $4,150 after 4 years rather than $5,000.

I remember in my working days during the 80's a colleague of mine whose only daughter was attending a local university was encouraged by her father to obtain all of the student loans she possibly could. She dutifully obtained the loans, handed the money over to her father who invested the money in the stockmarket, made some money for himself, and then later on paid off the loans. I regard that as an example of "American Opportunism", which is the same principle by which Corporate America and Wall Street operates, not Christian principles - Get Real!

[R in NJ]

If you can't pay in cash, don't go to law school. The odds of getting a job that will allow you to pay off loans (the 160k Biglaw job) are very low and directly related to the rank of the school you attend. If it's not Harvard, Yale, or Stanford, the odds are less than 50-50. And it's a bimodal salary distribution at best; either you get paid 160k, 60k, or nothing. Most get 60k or nothing. That, and the practice of law is pretty miserable; the only lawyers I've met who were happy were happy in spite of their jobs, not because of it. So the odds of getting the pretty awful prize are low. Not a game you want to pay.