By: Chris J. Roe, CPA/PFS
As a physician, you may have loads of debt and struggling to decide if you should tackle paying debt down aggressively or investing some money for the future.
A physician can prioritize debt payments over investing to become debt free quicker. Or can make the minimum debt payments. The latter frees funds to invest in a market where opportunities are volatile, but earnings can be impressive. Then, there is an approach that takes the middle ground: pay down some of the debt quicker and have some money left over for investment.
The below illustrates the three alternatives with hypothetical examples. But first, let’s explore strategies for prioritizing debt payment.
Strategies for Paying off Debt for Physicians
Most people are happier being debt free. It provides both an emotional relief and a sense of security. Research shows a direct relationship between debt and psychological well-being.1 Of course, it depends on the nature of indebtedness. For example, individuals have more debt tolerance for a $500,000 home mortgage than for $20,000 in credit card debt.
While a variety of strategies to prioritizing debt payments exist, Trent Hamm writing for The Simple Dollar describes three approaches to consider in becoming debt-free.2
1. Pay off loans by lowest to highest balance.
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. Ramsey points out that this can be a “big deal” for some and can be a life-changing start to become debt free.
2. Pay off loans by highest to lowest interest rate
You make the minimum payment on all debts, but make a higher payment on the highest interest debt debts . This can be a better approach mathematically 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 and you will have to delay the aforementioned psychological payback.
3. Pay off credit cards first
This approach recognizes that 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: the lower the percentage, the more positive affect on the credit score.
When Physicians Should Prioritize Investment Over Debt Payment
An anesthesiologist and blogger describes three strategies for physicians using examples of three hypothetical young doctors. The author made some assumptions (and did the math accordingly):3
- Each doctor carried $100,000 student loan debt with a 4 percent interest rate (with a monthly payment of nearly $2,000)
- Their incomes were too high to deduct the loan interest from their income taxes
- Each had a stable income and could stick to their plan
- Market gains continued at an average rate of 8 percent
- Inflation and dividend taxes were negligible because of tax sheltering, etc
- Investments were not tax deferred (Note: factoring in tax benefits when investing pretax dollars could skew the outcome in favor of investing vs. debt pay down)
Doctor #1 prioritized paying off debts. She paid off the student loan in three years and began investing $3,000 every month thereafter. After 10 years, Doctor #1 is debt free and accrues an investment amount or $334,976.84.
Doctor #2 paid only the minimum toward his debt and invested the remainder. After 10 years ,Doctor #2 is likewise debt free and has an investment account worth $360,209.42.
Doctor #3 employed a combination of tactics. She paid a little more than the minimum on her student loans and invested at the same time. Her student loan was paid up in 4.5 years. After 10 years, her investment net worth is $345,529.58.
So, our anesthesiologist blogger did the math and showed how risk taker Doctor #2 came out ahead. Doctor #3 hedged her bets and saved some interest payments on her student loan, but earned slightly less. Doctor #1 settled for the lower return, but went for the positive psychological payoff of being debt free quicker.
There is no single answer to solve this the question" Should I invest or pay off debt?" Each physician's personal situation is unique and the right approach for one physician may not be right for another.
Should you want to discuss your particular situation and what approach is right for you, we are here to help.
2020 All Rights Reserved. This content is developed from sources believed to be providing accurate information, and provided by Twenty over Ten and Rx Wealth Advisors, LLC for general informational purposes only. It may not be used for the purpose of avoiding any federal tax penalties and in no way is meant to provide specific tax, legal or financial advice. Please consult legal, financial or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any financial advice or investment security.