Background: My wife and I make a comfortable living, we have a mortgage, no car payment, no credit card debt, but substantial student loans, about $1,000/month. (about $100K total)

We both have government jobs that offer decent pensions (in retirement about 70% of our final paycheck until we die). In addittion, I contribute 10% to a 401(k). (my job matches the first 5% as well)

So I feel confident in our retirement planning. We also have about $10,000 for an emergency fund (something happens to house/car, we don't have to use a credit card)

After expenses, we have about $500/month to save/invest. I kinda tried the snowball thing, ( i would put half into savings/ half onto debt) but our student loans are large, and I did not get lots of reward of putting an extra $200 onto a $20,000 loan.

I'm looking for suggestions. Logically, student loans are 3.5-5% APR. I have potential to make more in investments. So I should open a mutual fund (vanguard) and just save $500/month?

*Side note: I feel i won't have $500/month for long. Soon we'll have kids, and/or one of our cars will finally die and we'll have to take a loan for a new (used car).

overall goal: I feel safe about retirement planning, we have an emergency fund. Due to student loans/mortgage, I have a fear that everything could still go bad. (lose our jobs or something) What is smartest thing to do with my extra $500/month?

With interest rates of 3.5-5% and tax deductibility it might not make the most sense mathematically to pay off the student loans. And it sounds like your personal concern is more about being defensive and insulating yourself from risk.

Taking those two things together I would suggest you simply save the $500 a month in something reasonably safe. But don't just put it in a savings account because you will not get enough return. I'd put it in a relatively safe bond fund.

On the other hand, if your average interest rate is 4%, you are paying $4000 a year, $333 a month in interest. That's a big fraction of your $500 extra. It might make some sense to pay down the highest interest rate loans to reduce your debt service expense. I am not a fan of the snowball method because it is essentially a costly gimmick. And it sounds like you don't really "fall" for it anyway. If you can get rid of a 5% loan or two in a reasonable time then you'll be better off.

You also mention planning kids. Does that mean your wife will be ceasing to work? Will you have high day care expenses? Because either way, it does not sound like you can afford it. $500/month ($12000) a year does not pay for day care if you both continue to work. If one of you quits then it sounds like your income and retirement income will be slashed significantly. I strongly suggest you put off the kids until you've paid off the student loans. That's probably not what you want to hear but your finances don't seem to support any other decision.

What's wrong with saving cash?

There is nothing wrong with saving cash. But NOT paying off the loans only makes sense if the money is earning a return greater than the after-tax return of paying off the SLs after adjusting for risk. That can be done right now in high quality bond funds.

If you put the money in cash then there is lower risk but also a cost associated with the extra interest paid on the loans. That is essentially the cost of avoiding risk.

If you put the money in stocks you will likely earn a higher return but you'll be exposed to higher risk.

The fair comparison is with a high quality (risk-free) bond of similar maturity to the SL. If the SL term is 10 years the compare it to a 10 year treasury. Cash has a 0 or 1 day term so it is not a fair comparison.

I wouldn't get too complacent regarding the pension. Pension returns are terrible. Calpers earned ~1% last year while projecting 8%. That's not gonna work. With everyone being squeezed, I think you will find the taxpayers become more and more resistant to continue to fund pensions.

I would....not have kids yet and focus on paying down debt.

That's a serious concern and should not be dismissed. At the same time, we still have the Constitution. No matter what the voters say, public pensions will have to be paid. The more likely scenario, which is already happening, would be to change rules to make them less generous for new employees. It also makes a big difference which government we are talking about. Feds and some states are better than others.

I agree with you that we have an unsustainable system. But we also have a framework of law that makes it impossible to just take away earned government pensions.

Laws can be changed. Many private employers have tried to make changes only to new employees, and it's not always enough. Sooner or later, if your prior obligations are too much, then something has to give. Maybe it won't be something overt like changing the law. Maybe instead, our government will inflate their way out of it, along with the rest of their obligations (debt). Just because something is guaranteed, even by law, does not mean you will get it if the guarantor has no way to provide it. You can't squeeze blood out of a stone.

You can squeeze tax money out of taxpayers. Government pension obligations are often backed by the ability, and requirement, to use the full taxing power of the government to meet the pension obligations if necessary, in preference to bondholders. Pensions could block payments to bondholders and that would eliminate a state's ability to function.

Currently it is not possible for states to declare bankruptcy to escape pension obligations. There are attempts to change that but there are so many issues that I do not see it happening. Such a change would effectively make muni bonds much more risky and that would drive up borrowing costs for ALL municipalities and states. That would be a true calamity, though not necessarily a bad thing...

Federal government pensions are similar.

In reference to the comment about Calpers, I am not specifically familiar with that system though I do know what it is and what has happened to it recently. But the 8% expected return is a long term rate. There is no reason to expect that return every year. We are in the midst of a recession, or at least a downturn. I would not be worried at all about getting only 1% last year. In fact, that's a pretty phenomenal return given that the S&P 500 closed up 0% last year.

I think it is pretty naive to think that the laws won't be changed. Taxpayers aren't going to sit back and fund lavish pensions for govt workers when the taxpayers have seen their own retirements decimated.

You wouldn't be worried about Calpers posting a 1% return when they are projecting 8% compounded returns out into the future? Bernanke has basically said the economy sucks and he is going to keep rates low for 3 more years. Where is Calpers going to get the return? Where are they going to make it up? Calpers earning 1% is a pretty big deal.

Only 4% of CalPERS' assets are liquid. You might have a look at their asset allocation to get an answer to your question. With a fund worth $219.4B, it's not like they're putting their money into CDs and passbook savings accounts.

I'm not sure what you're trying to say here? Their asset allocation is what it is and to be frank is on the risky side for what a pension fund should be investing in. The point is that they are heavily in risk assets and even with that they are significantly underperforming their projections.

What I'm trying to say is that their asset allocation indicates a potential gain fair in excess of what Bernanke sets as interests rates. Your question was, if I recall, how CalPERS was going to get 8%/

Your statement that the fund takes on far more risk than a pension fund should have is unfounded. Were it a fund for an individual, yes, it would have too much risk. But it's not a fund for an individual. It is, in fact, a tax supported fund, with a sizable source of income. Using my own case as an example, my asset allocation is far more weighted in equities than conventional wisdom would suggest because my income allows me to take on more risk.

So in short, what I'm saying is that CalPERS' asset allocation suggests that over the long term, 8% is not out of the question. As for them having to much risk in having that allocation, without knowing more about their current and future obligations, and without knowing how much they are taking in, it's pretty difficult to make a credible assessment that they have too much, too little, or just the right amount of risk. Or do you have some facts and figures to back your assertion?

How does that reconcile with what you say about their returns being only 1% for the past year?

I don't have any issue with what seems to be your general premise that pensions might be in trouble. But I'd want to see more facts before getting too concerned about any particular fund. And I would not be worried about underperformance over a short period either.

I don't naively think that laws won't be changed. I think laws probably will be changed because they have to.

When a private company promise a pension to someone then renegs on it, that is illegal. But it is a civil issue. The retirees can sue the company. The company can declare bankruptcy. Then a bankruptcy judge can "adjust" the pension obligations. Usually though it doesn't come to that. There is a settlement.

In the case of a government pension though things are different. If the government tries to reneg on the pension, that would be a "taking" which is unconstitutional. The government can be forced to raise taxes to pay the pension obligations.

In spite of all the political jabber, a state cannot declare bankruptcy. If laws were changed to make that possible, it would simply mean that a bankruptcy judge raises taxes or auctions off the state's assets rather than the legislature.

For the Federal government, there are some other constitutional issues that would need to be overcome. Again, in spite of what the politicians say, it is not legal for Congress to put the country's debt in doubt. Any action by Congress to default would not be legal. And entitlement obligations would have to be paid before bond interest.

There is no doubt that we are in bad shape and some serious changes are needed. But there is an awful lot of fearmongering going on. When you look at the numbers you find that, in the case of the Federal obligations, it would take only a 2% tax increase to make it all better.

I think with the extra money you have each month you should consider building your emergency fund a little bit more, especially if you are planning on having kids soon. Once the kids come, you may find it more difficult to save. $10,000 is a great start to an emergency fund, but if money becomes tight it won't take long for that to dry up.

As far as your question whether to invest or payoff your loan, I don't think it's necessarily just a financial decision. I think you have to also consider what you are the most comfortable with. Personally, once my emergency fund was built up, I would want to first tackle my debts before investing outside of my retirement accounts. But I place a lot of value on owning rather than borrowing and look forward to the day when I have zero debt.