Physicians, especially after finishing residency, have several challenges they’ll face with their income. No longer are they limited to paying rent and covering cafeteria charges. Taxes and lifestyle creep are among two potential issues of higher levels of income, but immediacy is found in the crossroads of debt vs. investing. As income exceeds expenses and minimum debt obligations, there is a big choice to make; should you prioritize investing, or pay off your student loan debt?
Physician Strategies for Paying off Debt
Prioritizing debt payments over investing allows the physician to become debt free sooner. While being debt-free caries a justified sense of accomplishment, it also provides numerous psychological benefits as well.
According to Amy Morin of Psychology Today, “Studies show debt weighs heavily on your mental health, and paying it off may reduce your stress and improve your psychological well-being.”1 Of course, it depends on the nature of indebtedness. For example, we have more debt tolerance for a $300,000 home mortgage than for a $15,000 credit card.
There are a variety of strategies to prioritizing debt payments, however three are among the most logical:
1. Pay off loans based on the balance
This strategy focuses on paying the lowest balance debt first, then moving onto the next lowest once the first is paid. This continues until all balances are paid off. Radio host Dave Ramsey calls this the “debt snowball strategy.” The idea is to get a quick psychological win by paying off the lower debt amounts first.
The benefit of this strategy is primarily found in the psychological benefits a person experiences rather than a quantitative benefit. For example, paying off a $5,000 loan with a 4% interest can happen relatively quickly. You’ll feel accomplished and save about $200 in interest.
While this is something to celebrate, it wasn’t as financially wise as putting that same amount towards a $50,000 loan with 14%. All things equal, you would have saved $700 in interest over the next twelve months by paying the larger interest rate.
2. Pay off loans based on the interest rate
This approach makes the minimum payment on all debts, allocating larger payments on the higher interest debt first. As mentioned above, this approach mathematically works to your advantage in terms of saving interest rate costs.
The drawback is that your highest interest debt could be the largest debt amount. It could take a longer time to pay that debt down, thus delaying the psychological benefit of noticeable progress.
3. Pay off revolving credit first
This approach recognizes that having lower credit card balances improve your credit score. It’s about credit utilization, or the percentage of what you owe against the credit limit of the card. In fact, credit utilization accounts for 30% of your total credit score.2 The lower the percentage of debt over credit available, the more positive affect on the credit score.
This continued improvement of your credit score could bring benefits down the road. For example, an improvement of your credit score could land you in a position to obtain lower interest rates on future loans, thus giving you access to refinance some of your higher interest loans later.
Prioritizing Investments Over Debt: A Look at the Numbers
In the following breakdown, we’ll assume the role of three different physicians. Each physician however has some commonality:
- Each carry $200,000 in student loan debt with a 5% interest rate under the standard payment option, with a min monthly payment of $2,121
- Each makes $250,000 per year, negating tax deductibility on the student loan interest ($80,000 single filer, $165,000 married filing jointly as of 2019)3
- Each assumes a long-term growth rate of 8% in their investment accounts
- Each has $4,000 of income to dedicate to either of the following three strategies
Physician 1 – Prioritizes paying off debts first, then invests
By allocating all $4,000 to his debt, this physician was debt free in just over 5yrs. At the end of 10 years, he ended with a portfolio value of around $276,136.
Physician 2 – Prioritizes paying the minimum, invests the difference
This physician allocated $2,121 towards the student loans, while investing the remaining $1,879 in her investment account. She is also debt free, but it took the full ten years to accomplish this. Her investment portfolio however is valued at $340,631 after 10 years.
Physician 3 – Pays more than the minimum, also invests
The last physician combined her efforts, dedicating $3,000 to debt and $1,000 to investments for the first 79 months, as this is when the debt was paid off. She then invested $4,000 the remaining 41 months. After 10 years she was debt free and had $323,203 in her investment account.
So, what do you think? Is it better to invest, or is it better to pay down debt? If logic and rational was the driving force in our every action, it would be clear that paying the minimum amount each month, while investing the rest, would be the wisest financial choice.
Unfortunately, logic and rational aren’t always as present. Rather, we often find ourselves limited by intrinsic motivation and external factors. The thought of 10 years of payment may be daunting, even (financially) debilitating for some people. The concept of surety also plays a role. Paying down debt has an accurate and easily forecastable result. Investing on the other hand does not.
Similarly, if paying off smaller debt balances provides you with a psychological boost, and thus increases the chance you’ll adhere to a disciplined program, then it would be clear that this strategy would be a better fit for you. This is true even if the rates of your larger loan balances are higher. A program you stick to is infinitely better than one you do not.
When stuck at the crossroads of paying off debt vs. investing, ignore the numbers at first and take a moment of self-reflection. Are you comfortable with maintaining a larger balance for a longer period? Are you happy with where your credit score is, and does your score have a material impact on your life right now? If you choose investing over debt payoff, will you be disciplined in your investment approach? Do you have an investment philosophy? You can evaluate your investment composure below:
To make this decision even more challenging, there are alternatives to paying off your student loans. You may find forgiveness in an income-driven plan or qualify for Public Student Loan Forgiveness (PSLF), or you may find that refinancing your loans is a better option.
While the answer isn’t always easy, the best plan is always the one you’ll be disciplined to stick to.
Contact Jeffrey Stewart directly if you’d like to discuss this information in more detail or determine its application to your situation specifically. Lucid Wealth Planning offers consultation via student loan analysis, budgeting, as well as comprehensive financial planning and investment strategies. You can also schedule a virtual introductory meeting directly below.
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