Should Young Physicians Invest While Still in Debt?
SEPTEMBER 22, 2017
Another Second Opinion, MD
When I completed residency and began my current position, Dave Ramsey's The Total Money Makeover was the first personal finance book I read. Pardon the cliché, but it changed my life.
It instilled in me a strong foundation in money management and offered me a roadmap to handle the situation I was in: hundreds of thousands of dollars in student loan debt, starting my first real job at age 31, and thinking about buying a home with a wife, three kids and no significant assets.
My first instinct was to try to do all three at the same time — save up for a down payment, pay off loans and invest in the stock market. Dave Ramsey convinced me that this was not a good idea just starting out.
I used Ramsey’s “debt snowball” plan to get control over the many different types of student loans I had, including some from my undergraduate days. After quickly taking care of some of the low balance loans, I was able to put more toward the larger balances as each smaller one was paid off. It wasn’t long before my initial debt was cut in half. This is where I strayed from the Dave Ramsey path.
Investing while still in debt
Once my student loan debt was manageable to me, meaning I felt my income was high enough and consistent enough that I could easily pay off my loans in less than five years, I started to put a little more money (I was already maxing out my 401k) toward investments and a little less toward my loans. These investments were in the form of a defined benefit plan, three 529 plans and a taxable investment account.
The reason I decided to take this route was that my loan interest rates were 3 to 4 percent, but over the previous three years, I was averaging more than 10 percent in returns from investments. Is this always the right move? No, there aren’t guarantees with investing. Should you at least consider another option? Absolutely!
This is about opportunity cost, the cost of choosing one route versus an alternative. If you are putting all of your time, energy and money into paying off your student loans and mortgage, that leaves very little, if anything, to invest. You’ll have given away precious years of compound interest growth at double the rate of the loans you are paying off.
Side note: This does not apply to high-interest debt like credit card balances; that debt needs to be paid off ASAP, Dave Ramsey style.
Three young doctors
Let’s say there are three young doctors, fresh out of training with $100,000 in student loan debt. To pay the student loans off in 10 years, the minimum monthly payment is $1,012.45. Let’s now pretend that each young doctor has an additional $1,987.55 to either put toward loans or invest ($1,012.45 + $1,987.55 = $3,000). Once their loans are paid off, each will put the all the money toward investing, $3,000 per month. Finally, let’s pretend that we follow their journey for 10 years.
Before we get started though, we need to make some assumptions:
- $100,000 student loan with a 4 percent fixed interest rate
- No tax deduction for the student loan interest because their income is too high
- Stable income so they don’t need to deviate from the plan
- 8 percent annual market gains
- Investments aren’t sold during the 10 years, so no capital gains tax
- Negligible inflation
- Dividend tax is also negligible (either small dividends or tax-sheltered account)
- Investments are not tax deferred (the argument is even more lopsided when you factor in the tax benefits of investing pretax dollars while you’re in a top tax bracket)
Just read The Total Money Makeover coming out of residency and wants to stick with the plan. She will put all the $3,000 toward student loan payoff each month. Her loan will be paid off in about 3 years, after which she will invest all the $3,000 each month.
After 10 years, she will be debt free and have an investment account worth $334,976.84
Young doctor #2
Just read Rich Dad, Poor Dad and is determined to build assets that will lead to passive income. He wants to just pay the minimum toward student loans and invest the remaining $1,987.55. By just paying the minimum, it will take him the entire 10 years to pay off his loan.
After 10 years, he will be debt free and have an investment account worth $360,309.42
Young doctor #3
Just read both books and decided to hedge her bets a little by paying more than the minimum on her student loans, but also invest at the same time. Of the $1,987.55 left over after the minimum payment, she splits it in half and directs $993.78 toward student loan payoff and $993.78 toward investments each month. Her loan will be paid off in 4.5 years, after which she will invest all the $3,000 each month.
After 10 years, she will be debt free and have an investment account worth $345,529.58
Figure out your risk tolerance
These three young doctors will all be debt free in 10 years but will have different amounts in their investment account because of their difference in risk tolerance.
Physician #1 (loan payoff priority): $334,976.84
Physician #2 (invest first priority): $360,309.42
Physician #3 (contribute to both): $345,529.58
If you want to be as conservative as possible, then you’ll make it your primary goal to eliminate debt. If you are a risk taker, you’ll accept being in debt longer with the tradeoff of probably having more money when it’s all said and done. If you’re like me, you’ll probably try to find a good middle ground: more aggressive than conservative, but more conservative than aggressive, or conservatively aggressive? Some may also call this being a moderate risk taker. In fact, most would call it that.
Of course, this is a spectrum, and you can titrate your risk however you’d like. As a young physician, you may want to consider taking a little more risk as you have many years for these investments to grow. Make sure you don’t miss the opportunity.