By Chris J. Roe, CPA, PFS
It’s not uncommon for physicians to carry loads of debt. From student loans to business startup costs, it’s expensive to become a doctor and run your own practice. Realizing the full return on your investment often takes time. So if you are struggling to decide whether to focus on paying debt down aggressively or investing more money for the future, you’re not alone.
You can choose one of two divergent paths, both of which have their merits. Prioritizing debt payments over investing allows you to become debt-free quicker. On the other hand, making minimum debt payments frees funds to invest in a market where opportunities are volatile, but earnings may exceed the cost of your debt. Alternatively, there is an approach that takes the middle ground: pay down some of the debt quicker and have some money left over for investing.
The below illustrates three alternatives with hypothetical examples. 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 emotional relief and a sense of security. Research shows a direct relationship between debt and psychological well-being. (1) However, it’s important to note a person’s attitude toward debt also 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. The mortgage is on an asset that should be growing in value and is held at a lower interest rate, while the credit card debt is generally held at a relatively high interest rate and the funds are less likely to be leveraged.
While various strategies for 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.
Author and radio show 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 these wins can create motivation that becomes life-changing start to becoming debt-free.
2. Pay off loans by highest to lowest interest rate
For this strategy, you make the minimum payment on all debts, but make a higher payment on the highest interest debt. 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 win.
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 impact on the credit score.
When Physicians Should Prioritize Investment Over Debt Payment
An anesthesiologist and blogger at Another Second Opinion offer an interesting perspective on investing by describing three strategies specifically 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 pre-tax 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 of $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.
Because physicians are high earners, you can avoid falling into the trap of ballooning student debt, which lower earners find themselves in when they choose income-based reduced payment plans. When you hear stories about student loan borrowers owing more than they started with a decade after graduation, this is why. Your investment in education is paying off at a better pace.
There is no single answer to solve the riddle of investing versus paying 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.
Copyright 2021 All Rights Reserved. This content is developed from sources believed to be providing accurate information, and provided by 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 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 security.