You could consider a Roth IRA for the investment. Yes, it could go up or down (though you could choose to invest in just savings accounts / CDs which eliminates that concern), and there are no taxes on the proceeds.
Plus, the principal can be withdrawn as needed without penalty (not the earnings). There may be some restrictions - I seem to recall that you can’t take out money that hasn’t been in there for 5 years (meaning you can’t put it away now and take it out next summer) but I may be misremembering that part. I have read articles about people using their Roth IRAs as an emergency savings fund for just that reason.
You have to consider income levels. I happen to be living at the poverty line, so even a 2.9% car loan would represent a very significant debt load to me whereas to someone with a 6 digit income it would be insignificant.
On the other hand, the amount of money that represents 2-3 months of living costs for me (a suggested emergency fund) is also significantly smaller than that of someone making a 6 digit income.
Which just drives home the point everyone else is making, you have to look at your overall situation.
Another quirk of my circumstance is that income taxes are nearly non-existent for me simply because I don’t make much money. On top of that, if I suddenly had an extra $350/month I’d actually be spending it on maintaining our health (both my spouse and I need to see a dentist and get new glasses) and replacing some damaged things (deferred car maintenance, new microwave, etc.) around the home for about six months before even thinking about the question of whether to save for the rainy day fund or invest in something. But that is very much our situation and probably not the OP’s (I hope it’s not the OP’s, because being poor sucks). That is because I’m in a situation where today’s needs are so immediate that “IRA or mutual fund?” doesn’t even exist. (Yes, I am working on improving the situation.)
This is all very different from the time in my life when I was making sufficient money that I had no debt, a 6-month emergency fund, and could afford to fly airplanes as a hobby. While I probably could have done a better job of retirement planning/saving during those years I still do have retirement money waiting for me when that time comes.
Yes, I do understand the uses of credit and debt, however, at my income level the problem with that is two-fold. First, people and corporations are reluctant to loan me money at all, much less at low rates despite a good credit score, and there is the issue of whether or not I will be able to continue to meet monthly debt payments. It does me no good to take out a loan I can’t pay back, much less having something like a car repossessed and then losing my job because I can’t get to work. Or getting evicted because I can’t pay the rent. This is why any extra goes to the emergency fund, in case there’s an interruption in income. Failure to meet debt obligation will also keep a poor person poor.
acquiring transportation (fortunately, my vehicles are paid off but occasionally I’ve had to finance repairs to keep them reliable)
family emergencies
durable purchases that will far outlive the lifetime of the debt
Our main credit card for such purposes has a 5% interest rate, and we make sure to make more than just the minimum payments when we do use it. I am also going to join the credit union where I work, because they’re another way to borrow at low rates (usually) and I’ve had good experience with that.
There are lots of psychological factors too. If someone has some level of debt they are comfortable with, paying off debt A might encourage getting into debt B, so using the money to save might be best. (And having easy to access savings is important. Just not in a mattress, please.
If some is incredibly debt averse, pay it off. It will make you feel better.
But putting money in an IRA is good because it encourages steady savings, which I can tell you sitting at age 63 feels real good when you are near retirement age.
I personally hate car loans, and pay cash. I have no problems with my mortgage, though.
The advantage is that, if you lose your job for whatever reason, you then don’t have a car loan to pay off. Plus, if you had significant assets in the form of savings that would usually also affect your ability to access benefits/welfare that you would otherwise be entitled to having paid in during your working life. So another thing to consider is exactly how secure your employment is. Even if your employment is pretty secure, illness or an accident could cause it to cease, so do you have private unemployment insurance that would be enough to cover the car loan?
If the difference between investing the extra money vs paying off the loan is very small, then not having those extra payments going out should something bad happen would be a plus point in favour of paying off the loan.
OP, have you checked whether you can actually pay the car loan off early without penalties?
Some great points about your income level and cash-flow situation being very important. I guess I took the comment about “maxing my 401(k)” and “extra $350 a month” to mean that things were fine on the cash-flow front. Job security is also an issue - you never want to be in a situation where you don’t have the cash on hand to cover your fixed expenses while you look for a new job. But reducing fixed expenses vs. saving more to cover them if you lose your job are really two sides of the same coin. The difference is that your debt service costs you money (2.9% annually in this case) while saving earns you money (variable depending on what you invest it in and how markets perform - low-risk is very low-return right now).
I also definitely agree with the psychological aspects of forced savings. A Roth IRA is a great benefit for people that have room in their budget for it. Forcing yourself to start funding it now makes you more likely to keep doing it going forward. I’d probably even put it above non-matched 401(k) contributions depending on your current tax rate.
So, OP, hopefully you have some tools to do the math now, but make sure you don’t get stuck in “paralysis by analysis” - doing something productive with that money (even one month’s worth) will far outweigh the relative benefits between the two options you’re considering.
Thanks for the advice and analysis everyone. I’m going to go with building a 2 month safety cushion first, and then re-evaluate after that. That will probably take me past paying the car off anyway, so it’s sort of win-win. I was just thinking there would be some sort of rule of thumb out there that was pretty much easy to follow like 1) invest in blah 2) pay off debt 3) invest new money in blah or 1) pay off debt first then 2) invest in blah, not plans that depend on how I “feel” about debt, or other emotional triggers.
But I really do appreciate everybody’s input, and it’s given me some things to think about.
As an aside, this is what I usually read about when it comes to 401K, IRA, Roth, and whatnot - “depending on your current tax rate” That’s the part that I can’t get more detail on, and I assume if I paid a financial advisor, I would (hopefully). My question always comes back to “what IS the tax rate that makes Roth IRA better than non-matched 401(k) contributions?” Assuming debt free existance, and maxed matching funds from my employer, what tax rate should I be at before contributing to a Roth IRA instead of non-matched 401K or vice versa. Like I said above, if this is a thing that people get paid money to figure out (fiancial advisor), that’s an okay answer too.
One aspect we haven’t even talked about is that a Roth you can open anywhere to get high-quality low-cost investment options. A 401(k) you are generally limited to whatever your employer offers (which are often, but not always, high-cost actively-managed plans).
Another thing to consider (aside from tax rate) on Roth versus non-matched 401(k) would be protection from creditors out lawsuits. The protection varies by state, but there is the theoretical risk that if you’re sued or go bankrupt, assets in an IRA could be partly at risk. Money in a 401(k) is fully protected.
If you don’t need the tax break from pretax contributions, I’d personally go for Roth. Some retirement plans even offer a Roth option in their 401(k) plans (mine does). We need the tax break now, unfortunately, so we are not taKing advantage at the moment.
One article said that if you can be disciplined and invest the tax savings each year, Roth and pretax are a wash in the long run.