Investments vs. Student Loan Payments

[FlowRate]

I feel like common wisdom/advice is to pay off student loans before working on investments. But the math seems to indicate that, within certain confines, maximizing early-career investments pays far greater returns than paying off all of your student loans immediately.

We can take my own case as one example:
~150k in capitalized loans after finishing residency
~200-300k gross income starting (150-235 net)
~60k lifestyle, expenses, etc.
~90k remainder

~60% of my loans are not federal and are subject to a 10-year repayment and, psychologically, I don't like the idea of taking longer than 10 years to pay off my loans. I'll earn too much to benefit from PSLF. To make this first run of the numbers conservative, we'll say my average interest rate is 6.8% (it's not, but that's my modal federal rate.)

To pay off my loans in 10 years, I'd have to contribute about $1750 per month, with leaves $5750 to direct either to paying off the loans more quickly or getting started with investments.

According to this calculator, paying off the loan more quickly will save 46k in interest and pay off the loans in 1.8 years instead of 10 years, whereas investing that amount over the 1.8 years will result in 590k of estimated compound interest over 30 years.

In practical terms for me right now, this has me thinking that I should invest some of my excess income in a tax-deferred account, now that my Roth is fully funded for the year.

Running these calculations with various other extreme cases:
300k loans @ 7% paid off in 10 years (original plan) giving ~2300 to use toward loans vs investments @ 5% x 30 years of interest = investments pay off more in the long run.

300k loans @ 7% initially planned for 20 year repayment with ~4750 to use toward loans vs investments @ 5% x 20 years of interest = investments STILL pay off more in the long run.

Obviously this has to be titrated to actual loan interest rate and risk tolerance for actual expected investment returns, but seems pretty convincing with these conservative estimates that it's more important for early-career physicians to max their investment contributions (especially tax-deferred) prior to increasing their loan prepayment amount, at least with regard to long-term financial benefit.

Am I missing something? Any disagreement?

TL;DR: Investments compounded for 20+ years are more powerful than (appropriately repaid) student loan interest.

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[Tigerhawk77]

Doesn’t factor in risk.

 

[TMP-SMX]

Once your credit score is high, refinance your loans for a better rate and pay them off as per the repayment terms. You should max out your 401k/403b match. So depending on your match don't give up free money. I agree with the Roth contributions since your first 6 months out of residency you will still be in a lower tax bracket than any other time in your life (you can also put in 5500 for a spouse if you are married). What repayment plan are you in for the federal portion? If under REPAYE you get an interest subsidy (at least during residency) though it sounds like you are paying more than the interest or you've used up your subsidy years.

 

[mvenus929]

It depends on a lot of things, some of which you have control over and others you don’t, but in the end, it’ll come down to your comfort level with debt.

I came from a family that declared bankruptcy when I was in middle school. We lived on WIC for the first 2 years of my sisters’ life. Probably would have been on food stamps had it not been for cheaper food at military installations we had access to. I can’t stand debt. So, I put in some money into retirement accounts and toss the excess at my debt. I paid off nearly 20K in student loans my first year out of residency (making about 90K, plus bought a car outright and applied for fellowship... likely could have paid off 40K had it not been for the latter two things and moving for fellowship). But, I also maxed out my Roth IRA throughout residency, when I could’ve used that money to pay off my debt (the balance is now on the order of 26K, so not chump change).

So yeah, you might make more long term investing and paying the minimum in student loans. But you might get a psychological benefit from being out of debt faster, and then being able to snowball all that money into investments.

Most people do some hybrid model—invest some, but also pay more than the minimum payment in loans.

 

[Dahresto]

Emergency fund, then pay off all debt first before you look into investments.

 

[FlowRate]

Doesn’t factor in risk.

I think I mentioned it but I understand that the post was a bit long.

Once your credit score is high, refinance your loans for a better rate and pay them off as per the repayment terms. You should max out your 401k/403b match. So depending on your match don't give up free money. I agree with the Roth contributions since your first 6 months out of residency you will still be in a lower tax bracket than any other time in your life (you can also put in 5500 for a spouse if you are married). What repayment plan are you in for the federal portion? If under REPAYE you get an interest subsidy (at least during residency) though it sounds like you are paying more than the interest or you've used up your subsidy years.

Yeah I'm planning for post-residency phase. I'm currently doing REPAYE for my direct loans and deferred my perkins and institutional loans, because they have less flexible payback plans that would have made it impossible to build an emergency fund or have money to enjoy life (although it turns out I'm even more frugal than I thought and might have been able to start paying off the Perkins.)

Emergency fund, then pay off all debt first before you look into investments.

I mean, this seems to neglect the point that 30 years of compounding interest is way more powerful than a fixed interest rate on a loan with steadily falling principal, risk factors aside.

 

[ifailedmcat]

FlowRate, from what I understand, you are correct. I don't think the consensus is to pay off your student loans before maxing out tax deferred accounts. As you have pointed out it is exactly the opposite. Strictly from a numbers standpoint, this will net you more money in the long term.

What I find is that most physician finance forums and blogs (including this one) are home to strong FIRE advocates who are highly debt adverse. If you can stomach keeping and leveraging your debt, it is generally better to invest the difference before paying down any student loans. A better argument is whether one should should pay down student loans or invest in a taxable account..

 

[Retire Early MD]

Hi Flowrate. Very nice calculations. I can relate to your situation. For me, what I did was:

• Pay off high interest rate debts over 6% including student loans.
• Refinance my student loans to get better rates.
• Split the rest between low interest loan and investment.

Why 6%? Because I was able to make about 8% investing on my own over the past years and even when taking in account the recession.

If your student loan is at 7%, I would just tackle it and pay it all off as early as possible. Think of it as an easy guaranteed return of 7% on an investment. Which is not bad especially during the transition period of bull to bear market (which is coming soon 2020).

 

[Angus Avagadro]

Hi Flowrate. Very nice calculations. I can relate to your situation. For me, what I did was:

• Pay off high interest rate debts over 6% including student loans.
• Refinance my student loans to get better rates.
• Split the rest between low interest loan and investment.

Why 6%? Because I was able to make about 8% investing on my own over the past years and even when taking in account the recession.

If your student loan is at 7%, I would just tackle it and pay it all off as early as possible. Think of it as an easy guaranteed return of 7% on an investment. Which is not bad especially during the transition period of bull to bear market (which is coming soon 2020).

I agree. 6-8% school debt should be paid first, refinance to lower rate if possible. Risk is important. Not many people made 6-8% per year from 2008 to 2017 due to crappy economy and slow growth. Get rid of the debt. As Dave Ramsey says, debt is tyranny. You get up every day to work for someone else.

 

[Entadus]

The debtor is slave to the lender. You would get rich investing so much quicker if you didn't have that loan payment every month like a dead elephant on your back. Pay that ish off in 2 years, live like a resident, get out of debt first. Imagine the freedom and peace of mind it would bring (plus you'd avoid that pesky uncalculated risk of investing 'on margin') Then you'll be able to build wealth with a full attending income at your back