Investing vs. Loans

Investing vs. Loans

Probably the first financial question I had after graduating medical school was what to do with this new windfall, the foreign concept known as a ‘paycheck’. Everyone talks about the transition from residency to independent practice as single the biggest financial event in the life of a physician, and this is true. Your (pretax) income increases by a factor of 3+ and for the first time you have a decent shot of paying off your student loans.

But entering residency can be almost as big a deal. For a lot of folks, it means going from $50,000 in new debt per year to $50,000 in income. That’s a $100,000 a year raise (my personal number came out to $93,000). Now of course it doesn’t feel like that kind of raise; loan disbursements in med school don’t really feel like new debt (I remember the phrase ‘Monopoly money’ getting thrown around a lot). And that new $50,000 paycheck is subject to income taxes, which loan money wasn’t. Nevertheless, for any traditional medical student (that is, someone who did not have a separate career before medical school), it’s the first time they have their own honest-to-goodness money to do with what they please.

So.

The obvious question is how can I best use this money to meet my financial goals?

There is almost no way the average resident is going to be able to make substantial payments on the average student loan balance. As I mentioned in my last post, interest alone is around a thousand bucks. But even if you’re losing ground by paying less than interest each month, there is still some value to paying toward your loans in residency. Every dollar you pay toward your loans is a dollar of debt that is no longer increasing by 6% a year. This in effect makes it a risk-free ‘investment’, a guaranteed return of whatever your loan interest happens to be. Considering that 10-year U.S. treasury bonds are currently earning about 3% (before inflation – after accounting for inflation they are earning nearly nothing), and considering the fact that bonds are a low-risk but not truly risk-free investment, this isn’t too shabby.

Now, the average resident probably shouldn’t be investing in bonds anyway, they should be be investing in something with much greater growth potential, namely equities/stocks. The Vanguard Total Stock Market Index Fund has had an annual return of ~9% in the past 10 years (again, this is before inflation, but it also includes the lion’s share of the losses of the Great Recession; the growth since the bottom of the recession has been insane, about 16% per year). The tradeoff of course is that stocks are risky, as every generation of investors has discovered eventually, and as my generation saw acutely in 2007-2009.

As with so many topics, my thinking on this issue was molded by the White Coat Investor, and he has an excellent, detailed piece on this topic that goes over a ton of considerations, but essentially boils down to this: take advantage of your tax-advantaged accounts while you are in residency, especially those with Roth (post-tax) contributions. Your tax liability while in residency is likely to be the lowest of your lifetime, and certainly the lowest of your working career. Every year that you don’t contribute to a Roth IRA is $5,500 that you can never invest to grow tax-free again. In addition to this, if your residency program offers a 403(b) match, you should be contributing at least enough to get you the full match. This is literally free money, a risk-free 100% return, and should not be passed up.

So what did I do?

Well I hadn’t discovered WCI in 2014 when I graduated med school. I was savvy enough on my own to get my residency’s 5% 403(b) match, but I was very skeptical of the stock market and had little conceptual understanding of Roth IRAs. But I did hate looking at my debt number, and I looked at it a lot. So I dumped as much money as I could into my highest-interest (6.8%), unsubsidized federal loans. Over the course of my intern year, I paid $17,300 toward my debt, including $10,400 toward principle.

My PGY2 year I was finally won over to Roth IRAs and contributed the full amount of $5,500, but still paid a respectable $12,800 toward those loans.

At the beginning of my PGY3 year, I refinanced my highest interest unsubsidized loans, and thereafter paid only the minimum income-driven amounts. I also contributed the full amount to my Roth IRA. This was repeated for my PGY4 year. Where did that approximately $10,000 a year go, if it was no longer going toward my loans? I think the birth of my son in January of my PGY3 year had something to do with it.

How much money would I have made if I had taken $11,000 of the money I put toward student loans my first two years, and put it toward Roth IRAs those years? Some back of the envelope math says that if I had invested that money in the Vanguard Target Retirement 2050 Fund (where all my tax-advantaged money is currently), I would have an extra $2,600 today over and above what I contributed. That represents about a 5.5% annual return on the contributions from intern year, and 7% annual return on on the contributions from PGY2. Not chump change, but nothing that makes me feel like I made a huge mistake either. And certainly if the market had taken a dive between then and now, my extra loan payments would be looking pretty smart.

A caveat to all this (and one that isn’t really covered in the WCI article, though he has talked about it a lot since) is that you shouldn’t pay your loans off aggressively if you are going for forgiveness via the Public Service Loan Forgiveness Program (PSLF). I’ll cover my thoughts on this program in a future post, but if you have any inkling that it might be for you, you’re better off paying just the minimums on your federal loans.

What am I doing now, in my fellowship (PGY5) year? My current institution doesn’t offer a 403(b) match for fellows, and even for the residents it’s a comical $40 per month (50% of contributions up to a max of $80). So no pretax investments this year. I have continued to max out my Roth IRA and have also opened one for my wife. And I’ve continued to pay the minimum amounts on student loans, but counting down the days until I can pay them back with same gusto as my first two years of residency, with a bigger pocketbook to match.

What has your strategy been during residency? Is there anything you wish you had done differently? Let me know in the comments.

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