NerdWallet's Smart Money Podcast - Should I invest or pay off my student loans?

Episode Date: February 10, 2020

Should you invest or pay off debt? This question can get especially tricky when you’re talking about investing in your company’s stock versus paying down your student loans. Sean and Liz help a listener who wants to know if she should exercise her stock options or focus on paying her $90,000 student loan debt. As always, send us your money questions! Email [e-mail] or call or text the NerdHotline at 901-730-6373.

Hello, welcome to the NerdWallet Smart Money Podcast, where we answer your money questions in 15 minutes or less. I'm your host, Liz Weston. And I'm your other host, Sean Piles. As always, be sure to send us your money questions. You can call or text the Nerd Hotline at 901-730-6373. That's 901-730-NERD. Or you can email us at podcast at nerdwallet.com. This episode, we've got a really interesting question that'll be familiar to anyone who's worked at a startup. It comes from Kelly in Sacramento. She asks, my tech company offers stock options and there's so much hoopla over them in the Bay Area. I don't know if I should even exercise given my $90,000 student loan debt, but at the same time have FOMO. That's fear of missing out for any of you who

don't know. Most of the people I work with in tech are lucky to have no debt as their parents paid for all of their college. Lucky people. It is a private company, so I can't just sell my options on the open market. What's your advice? Oh boy, Kelly. So you're dealing with student loans, but you also want to try your hand at investing. It sounds like we have some similar financial journeys here. And I also have that FOMO. And I don't think that we're alone with that. And Kelly, I really like your question because it's about balancing financial priorities. Should you pay off your student loan debt or should you spend some of that money on your company's stock options? And how should you even think about handling your stock option?

It's a pretty tricky question all around. Fortunately, at NerdWallet, we love tricky questions. We also have some guidance for how to balance those competing priorities. So in this episode of the Nerd Wallet Smart Money Podcast, we're going to talk with investing nerd Ariel O'Shea to help us understand stock options and how to think through competing financial priorities. Okay, let's get on with the show. Hey, Ariel, thanks for joining us. Thank you for having me back. Okay, Ariel, can you please start by giving us a brief explainer of what employee stock options are? Yes. So stock options are just one part of a compensation package that an employer might offer you. And like Kelly said, they're very common at startups, but they can be offered by

other companies as well. So what they do is they give you the right to buy the company's stock at a specific price during a specific period of time. So let me make sure this is understood because it's really important. And I was actually confused by this at first too, when I first was offered stock options. It's the option to buy the stock, but the company isn't giving you the stock. You have to actually pay for it, which means you need money to exercise the options. What they're giving you is the right to buy the stock at what is hopefully going to be a discounted share price and a price that's going to remain a discount. So if you buy the stock, you're exercising your options. And then the hope is that that stock will

then rise in price even further. So then you can turn around and sell the shares that you purchased at that lower price and pocket the difference. Employee stock options come as a grant. They're called a stock grant. And the grant is going to limit or set how much stock you are being offered to buy. And there is going to be a vesting schedule that's going to limit when you can buy that stock. So grants and vesting and exercise, oh my, those are a lot of terms that people might not be familiar with. So can you give us an example? Sure. So let's pretend Kelly got a grant of 2000 stock options, and the company says it's on a four year vesting schedule. So that means that she has the right to exercise and exercise just means buy the stock over a four year period of time. So a really

common vesting arrangement is 25% per year over that four years, which would mean Kelly could buy 500 options after her one-year work anniversary. And then she can buy 500 more each year after those four years. And then she will be fully vested in the stock and she will have purchased all of her options. But that's just one way stock options can be structured. There are a lot of other ways. It varies a lot by company. so that eventually after you buy the stock, you can then later on sell it and buy yourself a yacht and sail off into the sunset just to simplify this whole process. Yeah, that's definitely the hope. I would say that might be a slight oversimplification because it doesn't always work out that way. So we all want to sail off on a yacht, but there are some

important things that people should know. So if the company is already public, it's a little bit easier to understand. Public means, you know, the shares are already traded on a stock exchange. So you know how much those shares are trading for. And you could theoretically exercise your options and then sell them the same day. And, you know, you would do that if you were going to make a profit. But if the company is not already public or there aren't ready buyers for that stock, then you can buy the stock and hold on to it, or you can wait to buy until there's an opportunity to sell. You can buy the shares as your options vest, but some companies actually will let you buy them before you're vested. This is called early exercise, and there are some tax advantages to that. So find out if your company offers that.

And if you do want to buy the stock, that's something that you should look into. Yeah. And one thing I want to touch on is that there's actually no guarantee that the stock will actually become more valuable than the price that you bought it at, right? Right. There is no guarantee. You could make a lot of money by purchasing the stock, or you could make a little, or the options could end up worthless. And in fact, really the only guarantee is that there are serious tax implications to all of this. So if you have stock options, you should also have a CPA to give you advice about them. That's really important. So Ariel, what's the best way to approach this for most people?

In general, the buy and hold method makes sense when the share value of the stock is really cheap and you have faith in the company's long-term growth prospects. So if you're paying very little per share, you're not risking all that much money and you can get favorable tax treatment if you buy and hold the right way. So again, talk to that CPA. Otherwise, you might want to wait for some sort of liquidity event exercise. That's really important. You can always wait and buy the stock when the liquidity event happens. When there's an IPO, for example, you don't have to tie your money up for months or years waiting for something that might not happen.

Okay, I just want to take a step back. I will say that is a lot to digest. If anyone is feeling a little overwhelmed by all that information, just go back and rewind. We won't even know that you did it. Or you can also check out our show notes post at nerdwallet.com slash podcast for more info. Did we mention you should also talk to a CPA? Seriously, stock options are one of those areas where you really need the help of somebody who lives and breathes taxes. This is just not DIY territory.

Right. And that's a really good disclaimer as well. Talk to that CPA because they are the experts in this. And now let's turn to the second part of Kelly's question, how to balance the competing financial goals of paying off student loan debt and wanting to invest. Liz, what are your thoughts on this? Basically, you don't want to put off investing until you're completely debt free. That's because it just takes too long for most of us to get out of our debt. It could take decades and you could be passing up great opportunities in the meantime. So here's how we break it down at NerdWallet.

We suggest people start with a starter emergency fund. That's like $500. You don't have to save up the three months worth of expenses or whatever you've heard. You just need something to get started. Next, we want you to take full advantage of any 401k match you have at work. That's free money. Don't leave that on the table. Number three, now you focus on paying off toxic debt. That's credit card debt, payday loans, anything with a high or variable interest rate is something that you should focus on paying off. After that's taken care of, then you kick up your retirement savings and your emergency savings. You notice that paying off your mortgage early, paying off your student loans early, that's not on the list until we get to this point, until you have all your other financial ducks in a row. Don't worry about

making extra payments on the mortgage or the student loans. Now, again, this is general advice for most people. Your situation could be different. So keep that in mind. And one thing I would love to add on to that is that paying off toxic debt with a high interest rate is in a way a form of investment because once you have that debt paid off, you won't be spending as much money monthly on the interest rate to whatever company you owe money to. And that is really valuable. Yeah, exactly. And Ariel, one thing I want to ask you about, I've also heard the argument that by spending most of your waking hours working at a company, that in itself is a form of investment. And it's

not paying dividends per se, but at least it's paying your rent this month. Right. And it kind of is paying dividends in a way because you're getting those regular paychecks, right, which are what dividends are. But this is a really important point. And I'm glad you brought it up. It is so important to limit the part of your investment portfolio that's invested in your employer for that very reason. If your company goes belly up, you could lose your job, which means that paycheck dries up. And you could lose the money you invested in the company's stock. So you really hit both ways and that can be really damaging. Yeah, that's a really good point there. And I do want to touch on student loans here because 90K is a lot of student loans. I have

a fraction of that and it does hurt me every month to pay it. So totally sympathize with you, Kelly. But if you want to make your payments a little more manageable and you have private student loans, maybe look into refinancing. And if your loans are federal, I'm going to guess that you're probably best on the standard payment plan, but also income-driven plans can help if you are struggling to afford your student loan payments. We have more details on student loan tips on our show notes post at nerdwallet.com slash podcast. All right, Kelly. Well, I hope that helped answer your question. And with that, Liz, let's get to our takeaway tips. Absolutely. The first most important thing

is with stock options. Make sure you understand the terms of your company's arrangement because they're all a little bit different and get a tax pros help. Again, this is not something you should be doing on your own. Number two, the financial priorities part, paying off debt versus investing. You want to take full advantage of any company matching a 401k and pay off toxic debt like credit cards before you make any extra payments on student loans or mortgages. So you do want to do some investing while you're paying off debt. You should not just do one goal at a time because it just takes too long to get that debt paid off in most cases. All right. And that is all we have for this episode. Again, if you have a money question of your own, turn to the nerds and call us or text us your questions at 901-730-6373.

That's 901-730-NERD. You can also email us at podcast at nerdwild.com and visit nerdwild.com slash podcast for more info on this episode. And remember to subscribe, rate, and review us wherever you're getting this podcast. And here's our brief disclaimer, thoughtfully crafted by NerdWallet's legal team. Your questions are answered by knowledgeable and talented finance writers, but we are not financial or investment advisors. This nerdy info is provided for general education and entertainment purposes and may not apply to your specific circumstances. And with that said, until next time, turn to the nerds.