ETFs as a loan repayment strategy..

[fahimaz7]

After obsessing with this for a while I wanted to see what you guys thought...

I have a little over 200k in loans at 4.8% fixed. I've decided that I like the flexibility of keeping cash on hand, in a separate savings account (1%), and to make yearly lump sum payments on my loans from this account instead of extra monthly payments (30k/year extra). In reading various investment books and sites, it seems like a better option, assuming I'm willing to take risk, would be to shuttle these extra payments into ETFs under a taxable brokerage account. Vanguard is commission free if you trade their ETFs and have expense ratios of 0.09%.

I'm maxed on 401k, IRA, and will be doing a solo401k as well this year.

So the questions are...
1. Bad idea?
2. Anyone else doing this?
3. I've even thought about doing dollar cost averaging over 4 years then one large payout...

Thanks!

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[Mman]

After obsessing with this for a while I wanted to see what you guys thought...

I have a little over 200k in loans at 4.8% fixed. I've decided that I like the flexibility of keeping cash on hand, in a separate savings account (1%), and to make yearly lump sum payments on my loans from this account instead of extra monthly payments (30k/year extra). In reading various investment books and sites, it seems like a better option, assuming I'm willing to take risk, would be to shuttle these extra payments into ETFs under a taxable brokerage account. Vanguard is commission free if you trade their ETFs and have expense ratios of 0.09%.

I'm maxed on 401k, IRA, and will be doing a solo401k as well this year.

So the questions are...
1. Bad idea?
2. Anyone else doing this?
3. I've even thought about doing dollar cost averaging over 4 years then one large payout...

Thanks!

Without getting overly analytical, a concern I have is that 4.8% is not a very low interest rate, especially when you compare it to what you might get in stock market returns that will be taxed. I don't know what your marginal income tax rate is, but @ 30% you'd need roughly 6.9% return on an ETF just to break even with the 4.8% rate after taxes. Is that possible? Sure. But given current stock market conditions I'm not sure I'd be counting on at least 7% returns over the short to medium term.

 

[sazerac]

Short answer: pay yo damn loans

Longer answer: when you analyze risk vs reward, you need to analyze both. You are focused too much on reward and not enough on risk. What are the odds of your loan suddenly being half as big next year, at least temporarily? Zero. What are the odds of your ETF being half as big next year? Higher than you are willing to admit.

As the previous poster points out, the reward only happens if your returns (after tax) are huge. But what about the risk? The risk that your investments won't grow as fast as your loan? The risk that your investments will shrink? The reward here just isn't worth the risk.

Good rule of thumb: If you need your money in less than 5 years, it doesn't belong in stocks. I know, I know, in an era of 1% savings accounts it sure is tempting, eh?

 

[cpants]

Bad idea.

Couple of issues here:
1. Interest on your loans accrues daily. Holding the cash until end of year means you will pay more interest. So your initial wait for the lump sum strategy is flawed. If you have cash earmarked for the loans, you should pay it ASAP toward the loans. If you are going to put a percentage of your income toward loans going forward, you should contribute monthly are even biweekly to minimize interest.
2. It is not a good idea to invest money in equities that you need in the short term because it is subject to loss. You can easily lose half or more of the money in a very short time period.
3. The kind of investments that are appropriate for money you need in 1 year will not have a return higher than 4.8%.
4. Short term capital gains are taxed at ordinary income rate, as noted above.
5. You need to make over 7% on your money in 1 year just to break even when you pay off the loan.

 

[fahimaz7]

If you were to invest over the course of 4-5 years and then pay out in a lump sum, wouldn't the gain be relative to the interest on the loan? For example, if after 5 years my taxable account gained an average of 5%. Yes, 5%. If my student loans are 5% and my tax on those long-term capital gains is 15%, wouldn't my effective student loan interest rate for those 5 years be something in the ballpark of 2.5%? Sure it would be nice to have a 10% return over those 5 years, but if I'm in the green at all wouldn't that be a win (effectively reducing my student loan interest)?

 

[Mman]

If you were to invest over the course of 4-5 years and then pay out in a lump sum, wouldn't the gain be relative to the interest on the loan? For example, if after 5 years my taxable account gained an average of 5%. Yes, 5%. If my student loans are 5% and my tax on those long-term capital gains is 15%, wouldn't my effective student loan interest rate for those 5 years be something in the ballpark of 2.5%? Sure it would be nice to have a 10% return over those 5 years, but if I'm in the green at all wouldn't that be a win (effectively reducing my student loan interest)?

The only way you are in the green at all is if your after tax investment return (even 15 0r 20% if all LT cap gains) exceeds your student loan interest rate.

I think of it this way. Every dollar you pay towards your student loans earns an effective annual return of whatever your interest rate is on the loan. For you, that's a guaranteed 4.8% return. It's hard to find an investment with such an iron clad guaranteed return of that amount. I mean you might find a CD for like 2%. You can get a treasury yielding around 2%. But 4.8%??? Guaranteed!

Personally I'd pay off the loans and consider that as a bond like substitute in your asset allocation for your retirement accounts and just up the equity percentage in those. But that's just me.

 

[sazerac]

If you were to invest over the course of 4-5 years and then pay out in a lump sum, wouldn't the gain be relative to the interest on the loan? For example, if after 5 years my taxable account gained an average of 5%. Yes, 5%. If my student loans are 5% and my tax on those long-term capital gains is 15%, wouldn't my effective student loan interest rate for those 5 years be something in the ballpark of 2.5%? Sure it would be nice to have a 10% return over those 5 years, but if I'm in the green at all wouldn't that be a win (effectively reducing my student loan interest)?

Using that logic, you'd reduce your student loan to 0% by paying off the loan instead. 0% is better than 2.5% interest on a loan.

 

[Plastikos]

While this may or may not be a great idea, the math and trade offs presented in these responses are just not the correct or a real way of looking at the problem. There is really only one thing that matters the cost of your loan. You have many things in your favor, mainly you get to choose the term for the loan and know the exact cost of it as well. Its not 4.8% leading to some unknowable final amount, you know the amount already as shown on your documents. Your investments only have to ever beat that over the lifetime, nothing more. Its very simple.

While many will talk it down and using terms like "guaranteed return", it is not so. Its savings from less exposure to interest. Its a nominal known amount that can only be saved as a percent of what was agreed upon. Pay it all today, 100% interest saved, pay on schedule its 0. Also remember the kicker, loans are simple interest and investing is compound. Rates really are not the issue, compound interest will always, always win out over a long enough time frame. Now back here in reality you have to deal with more reasonable times, but the basic premise still holds true that simple interest is no match for compound. You should at some point have enough accumulated investments that a single average year in the market returns you a nominal amount larger than your loans were, and we all should have those days ahead of us.

For example, if a 100k loan was on a level repayment 10 year plan at 4.8% the maximum avoidable interest would be $26,108.75. Thats all the savings you could get, and the whole hurdle your investment would have to beat over its lifetime to turn out to be a better idea. Even if over your 30 year career before draw down you only gained 2% compound on that investment ever, it would be a gain of $81, 136.16. Almost 3 times as much, and its likely you'll do better than that. Such is the power of compound interest. When people talk about risk/reward they often totally neglect the greatest likelihood that you are leaving a lot of money on the table. You need to have a long term out look though, 5 years doesnt make a lot of sense, 15-30 years does.

Now, you have to make sure you're thinking long term for this to work, one of the biggest advantages of this idea is that the investing time frame is hopefully much longer than the loan one. Loan payback has its place but it has very very little to do with return and best use of money.

First off I'd try to refinance the loans to an even better rate. Then think of something without a dividend as thats a major drag, or use a muni bond fund that is tax free. How you use your money in a taxable account can be much more important than a deferred one as taxables have consequences when you switch instruments, etc...

I have chosen to invest everything and give only a small nominal extra payment to one of my loans as it will result in higher terminal wealth/net worth and just makes sense. Time value of money, learn about it and use it to make better decisions. Everyone is very much on board with paying down loans and thats a great sentiment, but it is often not the best use of the money, but it is whats repeated ad nauseam on personal finance blogs without mentioning the draw backs.

Not that you shouldnt pay off your loans in a timely fashion, but its certainly not the obvious and easily best move it is purported to be so often. You can never go back and recoup lost compounding or make your dollars worth what they were 5 years ago, those opportunities are just lost.

 

[Mman]

For example, if a 100k loan was on a level repayment 10 year plan at 4.8% the maximum avoidable interest would be $26,108.75. Thats all the savings you could get, and the whole hurdle your investment would have to beat over its lifetime to turn out to be a better idea. Even if over your 30 year career before draw down you only gained 2% compound on that investment ever, it would be a gain of $81, 136.16. Almost 3 times as much, and its likely you'll do better than that. Such is the power of compound interest.

I think it would be mathematically incorrect to take a 30 year return on something and compare it to what you could pay on a loan with 10 year repayment. After all, the extra dollar you could pay today would be something you didn't have to pay back in later years and could invest instead. So if you paid $100K today and invested that $26,108.75 over the next 10 years it would continue to compound in interest for that same additional 20-30 year time period and you'd have far more than just $26,108.75 after 30 years. If you are investing something instead of paying off a loan, sequence of returns matters a lot in terms of how profitable that decision might be in comparison to just investing during your accumulation phase. And if you are looking at a longer time line, the difference between nominal returns and real returns starts to matter more.

That's not to say I am not aware of the benefits of leverage and compounding, but that's a little bit of a separate (although related) issue in terms of risk tolerance to one's overall financial portfolio.

 

[Plastikos]

I think it would be mathematically incorrect to take a 30 year return on something and compare it to what you could pay on a loan with 10 year repayment. After all, the extra dollar you could pay today would be something you didn't have to pay back in later years and could invest instead. So if you paid $100K today and invested that $26,108.75 over the next 10 years it would continue to compound in interest for that same additional 20-30 year time period and you'd have far more than just $26,108.75 after 30 years. If you are investing something instead of paying off a loan, sequence of returns matters a lot in terms of how profitable that decision might be in comparison to just investing during your accumulation phase. And if you are looking at a longer time line, the difference between nominal returns and real returns starts to matter more.

That's not to say I am not aware of the benefits of leverage and compounding, but that's a little bit of a separate (although related) issue in terms of risk tolerance to one's overall financial portfolio.

Why? Thats exactly part of the greatness of it, you control the term and the differential is highly in your favor. Also, that extra dollar 5 years later once you started investing it wouldnt be worth as much due to inflation, and the lost opportunity cost of missing the compounding of the previous 5 years. The risks are far over blown in almost all circumstances. We are talking about discretionary monies here, either going to faster loan pay down or instead investing. You're still paying that loan off, and I do not suggest someone should stretch it out super long, 10y is about as long as you would want. They should also refi to nearer to 3%, make it even better.

Its a question of priority, best use of money, and options/liquidity. You prioritize paying off loans that money is gone forever along with the opportunity cost, and you gain zero in liquidity until its fully paid off. If instead you invest, not only do you still have the option of paying off that loan with the taxable (or anything else you can pay down) and therefore liquidity and choices. You may decide to pay the loan off with this money, let it continue compounding, or since money is fungible just move some around.

Mathematically it will never matter as paying down the loan will not be the best use of money no matter how you slice it. Net worth is agnostic, and it will increase more with investing over paying down, nominal and real. I am assuming that anyone with loans is still just starting their career, as the choice makes a lot less sense later on as compounding time decreases and loans dont make any sense at retirement. Best moves definitely are stage dependent.

 

[Mman]

Why? Thats exactly part of the greatness of it, you control the term and the differential is highly in your favor. Also, that extra dollar 5 years later once you started investing it wouldnt be worth as much due to inflation, and the lost opportunity cost of missing the compounding of the previous 5 years. The risks are far over blown in almost all circumstances. We are talking about discretionary monies here, either going to faster loan pay down or instead investing. You're still paying that loan off, and I do not suggest someone should stretch it out super long, 10y is about as long as you would want. They should also refi to nearer to 3%, make it even better.

Its a question of priority, best use of money, and options/liquidity. You prioritize paying off loans that money is gone forever along with the opportunity cost, and you gain zero in liquidity until its fully paid off. If instead you invest, not only do you still have the option of paying off that loan with the taxable (or anything else you can pay down) and therefore liquidity and choices. You may decide to pay the loan off with this money, let it continue compounding, or since money is fungible just move some around.

Mathematically it will never matter as paying down the loan will not be the best use of money no matter how you slice it. Net worth is agnostic, and it will increase more with investing over paying down, nominal and real. I am assuming that anyone with loans is still just starting their career, as the choice makes a lot less sense later on as compounding time decreases and loans dont make any sense at retirement. Best moves definitely are stage dependent.

I think you are ignoring the risk of the investment losing money in the near term. I mean nobody knows what the stock market will do this year or next or even the next 5 years. Sure over 30 years it will make plenty of money, but when comparing to the repayment of a loan those super long term returns aren't nearly as relevant as the short term which is far more hit or miss and at today's valuations I wouldn't bet on short term returns exceeding 5% per year. While they might, it's not nearly as likely as it would've been after a crash.

 

[fahimaz7]

I think you are ignoring the risk of the investment losing money in the near term. I mean nobody knows what the stock market will do this year or next or even the next 5 years. Sure over 30 years it will make plenty of money, but when comparing to the repayment of a loan those super long term returns aren't nearly as relevant as the short term which is far more hit or miss and at today's valuations I wouldn't bet on short term returns exceeding 5% per year. While they might, it's not nearly as likely as it would've been after a crash.

Have you read the Intelligent Investor? Very interesting book that chronicles the bear and bull markets of the past 100+ years. While I completely agree that the S&P500 can drop 40% in a calendar year, the likelihood of it staying down over any 5-10 year period is very low.

http://www.macrotrends.net/2526/sp-500-historical-annual-returns

What's interesting about using a taxable account to accumulate wealth is that it's still a liquid asset. You can sell it at anytime and even tax loss harvest to offset gains in other categories. For the purposes of this post, the question was whether or not using an ETF or the like in a taxable account, to hold onto cash that you would otherwise be putting in a 1% savings account is a viable strategy. I have no interest in making biweekly or an extra monthly payment to pay off my loans quicker, only to have very little cash on hand (minus emergency fund). I would rather have the luxury of having cash on hand, throughout the year(s), followed by a large sum payment if that's what I choose to do with the money at that time.

Having cash on hand is a very good luxury to have and shouldn't be forgotten early in ones career.

 

[sazerac]

...Having cash on hand is a very good luxury to have and shouldn't be forgotten early in ones career.

That's why we all recommend an emergency fund of 3-6 months of spending, as the first luxury item to have when you finally make more than you spend.

 

[Plastikos]

I think you are ignoring the risk of the investment losing money in the near term. I mean nobody knows what the stock market will do this year or next or even the next 5 years. Sure over 30 years it will make plenty of money, but when comparing to the repayment of a loan those super long term returns aren't nearly as relevant as the short term which is far more hit or miss and at today's valuations I wouldn't bet on short term returns exceeding 5% per year. While they might, it's not nearly as likely as it would've been after a crash.

Im not, I just dont care as it doesnt matter. This is a long term plan. Why would we compare based on the short term. Youre anchoring yourself to the loan term for no other reason other than its there and makes sense superficially. It makes zero sense in reality. It should be based on the time frame for when you plan to draw down assets and no earlier. It will be different for everyone, but acting as if it has to be five years makes no sense whatsoever other than its simple and anchoring. Again, the returns dont have to be the same.

Part of the prerequisites for doing something like this is having a 100% realistic time frames and expectations. If you're shocked that your 100% stock investment can lose 50-80% in a single year and not reach positve values until 17+ years (historically, and uniquely to US, longer elsewhere) than you have no business partaking in such a plan and arent mentally prepared for it. However, you dont have to do 100% stocks either, a mix of stocks and muni bond funds will be less volatile and taxing for most people. Im not worried about what my money does this year, the next 5-10, but around 20 I'll be more interested to see how it went.

I think its been especially foolish since the financial crisis with rates near zero and lots of refi opportunities available, with of course outsized gains available in the market due to lower starting point and improving economy for people to have been on the debt crush path. Thats a psychological issue and very common after a great depression like crash, same reason people have doubted the whole way up. Now we are no longer in the obvious section of returns stage, but I will not be surprised if returns go well for years to come. This has been a much slower recovery than those prior and the trajectory has not been crazy (until lately). That can all change of course, but you have to take a view of things on a probabilistic level and then decide.

Likelihood you lose your earning power and cant service your loans, very low. The probability that paying down your loan will result in an opportunity loss compared to investing instead? Very, very high. Most everything else can be insured against or controlled (like spending). If it comes to the behavioral argument I never buy that as if they cant be trusted to invest you cant trust them to make extra payments either. People are notoriously terrible at risk assessment and when it comes to finance doctors are terrible as well, ascribing high risk to unlikely things and low risk to the opposite, and use improper time frames to justify those decisions.

 

[Plastikos]

That's why we all recommend an emergency fund of 3-6 months of spending, as the first luxury item to have when you finally make more than you spend.

Saw some Sazerac Rye bourbon tonight in Bevmo as I was looking for some bourbon myself, had a little laugh at your username, but still purchased the four roses as intended.

 

[Mman]

Im not, I just dont care as it doesnt matter. This is a long term plan. Why would we compare based on the short term. Youre anchoring yourself to the loan term for no other reason other than its there and makes sense superficially. It makes zero sense in reality. It should be based on the time frame for when you plan to draw down assets and no earlier. It will be different for everyone, but acting as if it has to be five years makes no sense whatsoever other than its simple and anchoring. Again, the returns dont have to be the same.

I guess my point is that you look at how much interest you'd save on the loan over X years and look at your investing return over significantly longer Y years. The thing is, those savings over X years from the loan could then be invested over Y-X years and earn further return that you seem to ignore. So if the sequence of returns in the first X years wasn't nearly as good as the subsequent ones, paying off the loan earlier would lead to an outsized return compared to investing the difference for the duration.

 

[Mman]

Have you read the Intelligent Investor? Very interesting book that chronicles the bear and bull markets of the past 100+ years. While I completely agree that the S&P500 can drop 40% in a calendar year, the likelihood of it staying down over any 5-10 year period is very low.

http://www.macrotrends.net/2526/sp-500-historical-annual-returns

What's interesting about using a taxable account to accumulate wealth is that it's still a liquid asset. You can sell it at anytime and even tax loss harvest to offset gains in other categories. For the purposes of this post, the question was whether or not using an ETF or the like in a taxable account, to hold onto cash that you would otherwise be putting in a 1% savings account is a viable strategy. I have no interest in making biweekly or an extra monthly payment to pay off my loans quicker, only to have very little cash on hand (minus emergency fund). I would rather have the luxury of having cash on hand, throughout the year(s), followed by a large sum payment if that's what I choose to do with the money at that time.

Having cash on hand is a very good luxury to have and shouldn't be forgotten early in ones career.

I think I've read the Intelligent Investor 5 or 6 times, or at least certain chapters that often. Not sure I'd say the odds are very low of the S&P staying down over any 5-10 year period since we've just had 2000-2007 when it did that and 2007-2013. Having cash on hand is a good idea, that's why I personally maintain a 12 month emergency fund. Not everyone can afford that sort of allocation, but it provides me piece of mind to stay the course on my investments.

 

[Plastikos]

I guess my point is that you look at how much interest you'd save on the loan over X years and look at your investing return over significantly longer Y years. The thing is, those savings over X years from the loan could then be invested over Y-X years and earn further return that you seem to ignore. So if the sequence of returns in the first X years wasn't nearly as good as the subsequent ones, paying off the loan earlier would lead to an outsized return compared to investing the difference for the duration.

I guess Im having trouble completely getting what you're saying. Maybe it will help if we define our assumptions since that may be part of the problem. After that, maybe you can clarify a bit so it gets through my skull, because I dont seem to be fully grasping it. I am discounting the market and sequence risk due to knowing I cant predict that correctly, and just using inflation/history as reasonable way points for the decision.

1. There exists a student loan with X term at Y rate.
2. Your retirement/draw down date is X+10 or 20 years.
3. It can be paid as scheduled, or more aggressively.
4. If paid as scheduled, the rest is invested. Cost to this is all loan interest, market risk.
4a. This cost is known and nominal, bounded, as is the term.
5. If paid off aggressively, say 1/2 X, risk is opportunity cost from whatever those sums would have grown to in the market at X+20 years vs. X(early payoff fraction) in remaining time in market.

I think that is more realistic since we dont really have lump sums, though it makes for easier comparisons.

 

[Mman]

I guess Im having trouble completely getting what you're saying. Maybe it will help if we define our assumptions since that may be part of the problem. After that, maybe you can clarify a bit so it gets through my skull, because I dont seem to be fully grasping it. I am discounting the market and sequence risk due to knowing I cant predict that correctly, and just using inflation/history as reasonable way points for the decision.

1. There exists a student loan with X term at Y rate.
2. Your retirement/draw down date is X+10 or 20 years.
3. It can be paid as scheduled, or more aggressively.
4. If paid as scheduled, the rest is invested. Cost to this is all loan interest, market risk.
4a. This cost is known and nominal, bounded, as is the term.
5. If paid off aggressively, say 1/2 X, risk is opportunity cost from whatever those sums would have grown to in the market at X+20 years vs. X(early payoff fraction) in remaining time in market.

I think that is more realistic since we dont really have lump sums, though it makes for easier comparisons.

I guess I was approaching this from a lump sum POV. If all we are talking about is paying an extra amount of money per period to pay off the loan slightly faster, then that usually doesn't make a lot of sense. But if you are talking about investing a lump sum of cash right now or paying it to a near 5% loan, that's different math, especially if the term of the loan is much shorter than your retirement horizon.

 

[cpants]

Of course it may make more sense to invest in the market rather than pay a loan up front depending on your personal situation and interest rates. This is typically the case with keeping a mortgage. If the OP can refinance at a lower rate, it may make sense for him to keep the debt for now. However, that is not the question the OP proposed.

He is planning on drawing yearly payments of 30k toward his loans from an account. Currently, he is using a 1% savings account to hold the money until he makes payments. He was asking if it would make more sense to invest this money in ETF's rather than keep it in a savings account. The answer to that is no, not if he is planning on making yearly payments to his loans from the account. Money needed in the short term should not be invested in the market. Otherwise, it might not be there when needed. On that time frame he would also be subject to short term capital gains taxes on any returns.

Whether or not he should use the 30k to repay loans at all is a totally different question.

 

[fahimaz7]

Of course it may make more sense to invest in the market rather than pay a loan up front depending on your personal situation and interest rates. This is typically the case with keeping a mortgage. If the OP can refinance at a lower rate, it may make sense for him to keep the debt for now. However, that is not the question the OP proposed.

He is planning on drawing yearly payments of 30k toward his loans from an account. Currently, he is using a 1% savings account to hold the money until he makes payments. He was asking if it would make more sense to invest this money in ETF's rather than keep it in a savings account. The answer to that is no, not if he is planning on making yearly payments to his loans from the account. Money needed in the short term should not be invested in the market. Otherwise, it might not be there when needed. On that time frame he would also be subject to short term capital gains taxes on any returns.

Whether or not he should use the 30k to repay loans at all is a totally different question.

So the option(s) that I was asking about was whether or not holding these extra payments in a taxable account would be better than doing so in a high-yield savings account. While it would be nice to add an extra 30k/year to my loan payments, I am fresh out of residency and the idea of not having the flexibility and security of extra funds is an uncomfortable proposition. My original plan when I finished residency was to hold that money in a separate account and make a yearly lump sum extra payment. When I worked out the math this resulted in me having 2-3 extra months of payments on the back end with an estimated loan completion being 60 months (230k+ interest). The alternative was to hold the funds in a taxable account and to withdrawal them (or not) at a later date if they mature with any reasonable amount of yield. The worse case scenario is mentioned by one of the other posters, which is that after 10 years I am sitting on 200k in a taxable account (30% loss with 300k put in over 10 years) and I paid ~55k in total interest on a 230k loan. The best case scenario is that my investments yield an average of 7% growth and I'm sitting on 450k in the taxable account and my loans are paid off.

 

[cpants]

So the option(s) that I was asking about was whether or not holding these extra payments in a taxable account would be better than doing so in a high-yield savings account. While it would be nice to add an extra 30k/year to my loan payments, I am fresh out of residency and the idea of not having the flexibility and security of extra funds is an uncomfortable proposition. My original plan when I finished residency was to hold that money in a separate account and make a yearly lump sum extra payment. When I worked out the math this resulted in me having 2-3 extra months of payments on the back end with an estimated loan completion being 60 months (230k+ interest). The alternative was to hold the funds in a taxable account and to withdrawal them (or not) at a later date if they mature with any reasonable amount of yield. The worse case scenario is mentioned by one of the other posters, which is that after 10 years I am sitting on 200k in a taxable account (30% loss with 300k put in over 10 years) and I paid ~55k in total interest on a 230k loan. The best case scenario is that my investments yield an average of 7% growth and I'm sitting on 450k in the taxable account and my loans are paid off.

A little confused by your post. If you are planning on putting aside 30k during the course of the year and then make yearly payments toward loans you should not hold the money in ETF's or stocks. The savings account you are currently using, CD's, or a money market account would all be appropriate. If you are planning to use the money to pay off the loans with a lump sum in the medium term (5-10 years)-- stock investments are also probably too risky.

If you want to save the money long-term instead of applying to your loans, that may or may not be the right choice. You would have to give more info about your current holdings, salary, family/goals, etc to give an opinion. Taxable account would probably be the only option in that case, as you have maxed tax-deferred accounts. The worst case scenario is not losing 30%.

Regardless, of what you are going to do with the 30k you should probably try to refinance your loans. You can easily knock the interest down to 2.5-3% which is a big savings on a loan that size.

 

[Plastikos]

So the option(s) that I was asking about was whether or not holding these extra payments in a taxable account would be better than doing so in a high-yield savings account. While it would be nice to add an extra 30k/year to my loan payments, I am fresh out of residency and the idea of not having the flexibility and security of extra funds is an uncomfortable proposition. My original plan when I finished residency was to hold that money in a separate account and make a yearly lump sum extra payment. When I worked out the math this resulted in me having 2-3 extra months of payments on the back end with an estimated loan completion being 60 months (230k+ interest). The alternative was to hold the funds in a taxable account and to withdrawal them (or not) at a later date if they mature with any reasonable amount of yield. The worse case scenario is mentioned by one of the other posters, which is that after 10 years I am sitting on 200k in a taxable account (30% loss with 300k put in over 10 years) and I paid ~55k in total interest on a 230k loan. The best case scenario is that my investments yield an average of 7% growth and I'm sitting on 450k in the taxable account and my loans are paid off.

If youre going to do this your taxable needs to have a longer term plan. You can build it up instead of the extra payments, which I 100% agree is very valuable to have liquidity at this early stage, which is something all the debt first crowd always dismisses. Since you cant predict exactly what would happen with the market anything less than a 10y time frame is not a reasonable comparison. Just build up the account and when they are equal, you can decide whether or not you want to pay it off. Remember inflation is also working for you in loan pay back and against you if you dont invest as early as possible.

With a long enough time frame, closer to 20 years the most likely scenario is you made quite a bit of money by prioritizing investing over debt pay down. However, refi to an even lower rate to make it even a better deal. Over 20 years inflation (at todays rates) will cut a $1 to 0.65c. The worst rolling 20 year total return S/P return was 7%, and this just happened ending in 2009. People commonly forgot we just left one of the worst 10-20 year investing periods (2 50% drops). So I always view aggressive early debt payoff as a choice between growing my money long term, or getting some fringe benefit from debt reduction (they definitely exist). In reality most of the time paying aggressively early is just making sure you pay with the most valuable dollars you'll ever have.

 

[fahimaz7]

Regardless, of what you are going to do with the 30k you should probably try to refinance your loans. You can easily knock the interest down to 2.5-3% which is a big savings on a loan that size.

I don't know anyone who has refinanced in the past year or two to a 2.5% loan. Fixed rates are around 3.75 for a 5 year loan with great incomeebt ratio. With a >800 credit score I was looking in the upper 4's for 10 year fixed rate. These things have changed drastically in the past few years.

Variable is tied to the Libor +1.8% and adjusted on a monthly basis (top tier candidates). Scary stuff imo.

 

[cpants]

I was offered 3.2 fixed/2.3 variable for a 5 year note a couple of months ago, but I know things are tightening up.

 

[Plastikos]

I don't know anyone who has refinanced in the past year or two to a 2.5% loan. Fixed rates are around 3.75 for a 5 year loan with great incomeebt ratio. With a >800 credit score I was looking in the upper 4's for 10 year fixed rate. These things have changed drastically in the past few years.

Variable is tied to the Libor +1.8% and adjusted on a monthly basis (top tier candidates). Scary stuff imo.

Whats to be afraid of? Its very simple to model out what would happen. There will not be merciless rate hikes as we would end up in a recession. However, all one has to do is see how much interest is saved in a variable rate that goes above the fixed at different intervals, in fact I think there is a post here or at WCI. However, TL;DR, unless rates go up aggressively and fast all the saved interest and lower principal exposed to the higher rate later 2/2 the first fact, ends up being lower than fixed. No reason to have any fears with this kind of thing, do the math, gauge the probabilities and then choose the best path.

I took a 2.9% 10 year variable a while back, I think its crept up to 3.5%, which is still below the fixed rate offer. Rates will have to keep climbing much faster for it not to have been the better choice. Also, dont forget as I know you know, a simple extra payment here and there will decrease your effective rate anyway.

 

[sum dude]

There's a difference of $130,ooo for paying off your debt in 10 yrs vs 30 yrs. Including taxes, tax write offs (depends on your salary, you'd need returns 7.0% to justify what you want to pull off. Add to that we are currently in an overheated market with PE's >22 w/ still continued near record low interest rates, and this is a recipe to make a bad mistake.

Don't overthink it--pay off your loans in 10 years. Max out your 401k. Save 20-25% of your salary, w/ 5% dollar cost averaged in an S&P 500 fund w/ low fees (<.1%) . You'll beat your model.

 

[Plastikos]

There's a difference of $130,ooo for paying off your debt in 10 yrs vs 30 yrs. Including taxes, tax write offs (depends on your salary, you'd need returns 7.0% to justify what you want to pull off. Add to that we are currently in an overheated market with PE's >22 w/ still continued near record low interest rates, and this is a recipe to make a bad mistake.

Don't overthink it--pay off your loans in 10 years. Max out your 401k. Save 20-25% of your salary, w/ 5% dollar cost averaged in an S&P 500 fund w/ low fees (<.1%) . You'll beat your model.

While I agree a ten year payoff is best, did you even read any of the posts? A 7% return is not needed, and is ridiculous. Loans are not compound interest. The sooner doctors learn this, and internalize the time value of money, the sooner they start making better decisions or at least have proper comparisons from which to base them.

 

[sum dude]

Lots of assumptions on tax bracket, but

While I agree a ten year payoff is best, did you even read any of the posts? A 7% return is not needed, and is ridiculous. Loans are not compound interest. The sooner doctors learn this, and internalize the time value of money, the sooner they start making better decisions or at least have proper comparisons from which to base them.

You can easily calculate this online
https://www.learnvest.com/knowledge-center/to-pay-down-debt-or-invest/

Assuming 33% tax rate, and that you cannot write off loans b/c you outearn write off, you need a return of 7.5% to equal 5% debt loans. But please, tell me more about compound interest...

A better idea would be going online and using a calculator to figure out the scenario based scenario rather than listen to a bunch of doctors arguing on a physician wall

 

[Plastikos]

No, you dont. What are your base assumptions? That calculator is terrible and does not consider compound interest whatsoever. I have done the math, its the whole basis of the argument as quite clearly explained in this and other threads. People focus on the wrong things. I encourage everyone to do the math since that will lead to better decisions or at least a better understanding of your reasoning. The interest rate doesnt matter so much as the overall cost of a loan which is a fixed nominal amount. The loan is eventually paid off and the investment continues to grow until draw down, which can and usually is 20-40 years later which will obviously be a substantial amount.

Compound interest at any positive nonzero rate will always beat out simple interest given enough time. With the rates and time frames we have today, for someone starting out now, they have rates/time far far to their advantage.

To each their own, the math is and always has been very clear, to say anything otherwise is just plain wrong. You can argue based on all kinds of other reasoned merits, which are valid, but math just isnt one of them.

 

[ldiot]

This idea is stupid.

 

[bcallister]

I personally like this idea, though I would not recommend putting all your eggs in the basket (investments). I would recommend finding a balance of paying some of the debt down slowly and investing another percentage. Then if the investment is a flop then you are not left with a larger student loan balance then when you started. I would recommend AT A MINIMUM to pay at least the interest on the student loan each month so your balance stays the same.

I would choose safer, more conservative investments like index funds that are steady and aren't as volatile as individual stocks, especially if you are in them more short term. Many index funds have averaged 10% over the last 90 years so they are safer than individual stocks. I don't like individual stocks as much because there is so much that can happen that is out of your control. The company could have a scandal, a bad earnings quarter, go bankrupt, or just have a bad news story plaque its value. Individual stocks jump up and down so much for funny reasons. Index funds are collections of individual stocks and are less volatile and more steady and consistent. I would do mostly index funds and choose a few stocks you want to "bet" on. 70% index and 30% stocks seems to me to be a pretty safe investment strategy.

I am a recent dental grad and have my loans in REPAYE where they are subsidized by 50%. Instead of 6% interest I am at a effective 3% interest rate for 3 years. My understanding is that once the 3 years of subsidy is up my loans will be at 6% again. So for the next 3 years I am investing more than paying down my loans because I know I can beat 3%. Once the 3 years is up I plan on refinancing my loans to get lower than 6% then I will adjust my strategy depending on what interest rates I can get then.

Check out my webasite I just created to learn more!
recentdentalgrad (plug in like any other website because it wont let me put direct link on here)

 

[NITRAS]

I’d argue to pay off your loans aggressively, (1-2 years). The debt, takes away your income in the form of payments. With no payments, you have margin to invest aggressively.

You ultimately build wealth with your income, not with games of debt.
#Dave Ramsey

 

[Siggy]

I’d argue to pay off your loans aggressively, (1-2 years). The debt, takes away your income in the form of payments. With no payments, you have margin to invest aggressively.

You ultimately build wealth with your income, not with games of debt.
#Dave Ramsey

Quoting Dave Ramsey in a serious money discussion is like quoting Jenny McCarthy during a serious discussion of the risks/benefits of vaccines. His actual investing advice and view on ETFs completely misunderstands how ETFs work. He's a scam artist with how he pushes his overpriced endorsed local providers. He thinks that anyone who can actually manage a credit card in a responsible manner is simply paying with fire (meanwhile I'll be more than happy to pocket the 2% cash back I get every month while paying my credit card bill off in full).

Edit: I'm also wrong because I use Vanguard's low ER ETFs and funds on my own instead of paying 5% to someone else to throw my money into the same funds.