You worked hard to put yourself through medical school. You pursued a dream that was big and daunting. Now you are finally getting settled in your first practice, but that means the time has come to assess your debt situation.
Which is more important: paying down debt or investing towards retirement and future goals?
A doctor can prioritize debt payment over investing and become debt free faster. Alternatively, you can make the minimum debt payments. The latter frees up your funds to invest in a market where opportunities are potentially lucrative. But there is an approach that takes the middle ground: pay down some of the debt quicker and have some left over for investment.
Strategies for Paying off Debt for Physicians
People of any career are generally happier being debt free. Freedom from a debt provides both an emotional relief and a sense of security. There is a well documented link between debt levels and psychological well-being.1 Important to realize, however, is that we tend to have more debt tolerance for a $200,000 home mortgage than for a $10,000 credit card.
How should you prioritize debt payments? Trent Hamm writing for The Simple Dollar describes three approaches to becoming debt-free.2
A. Pay off loans by their current balance — lowest to highest.
Dave Ramsey fans will recognize that as the “debt snowball strategy.” The idea is to get a quick psychological win by paying off the lower debt amounts. Ramsey regularly preaches that this tactic can be a life-changing start towards become debt free.
B. Pay off loans by interest rate — highest to lowest
Make the minimum payment on all debts, but make a higher payment on the debts with highest interest. This approach mathematically saves on interest rate costs. A downside is that your highest interest debt could be the largest debt amount. It could take a longer time to pay that debt down, which means you have to wait a lot longer for the psychological win.
C. Pay off the 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 paydown)
Witness these results
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.
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.
No two situations are alike, and it is only natural to need some guidance. Seek out a professional financial planner to crunch the numbers on your situation. Educate yourself on the risks involved with investments, and discuss your options with your planner.
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The information given herein is taken from sources that IFP Advisors, LLC, dba Independent Financial Partners (IFP), IFP Securities LLC, dba Independent Financial Partners (IFP), and it advisors believe to be reliable, but it is not guaranteed by us as to accuracy or completeness. This is for informational purposes only and in no event should be construed as an offer to sell or solicitation of an offer to buy any securities or products. Please consult your tax and/or legal advisor before implementing any tax and/or legal related strategies mentioned in this publication as IFP does not provide tax and/or legal advice. Opinions expressed are subject to change without notice and do not take into account the particular investment objectives, financial situation, or needs of individual investors.