This series of posts is sparked by an ongoing conversation with my fellow radiology resident Bo Liu (no relation to me) of whitecoatmoney.com Re: student debt management and net worth accumulation.
Our discussions cover many bases, so I will address individual key points in separate posts.
This post focuses on the prevalent dilemma of the highly educated (& indebted):
INVEST VS. PAY DOWN DEBT.
Bo (pgy2) chooses to invest instead of paying down his student debt (with 6.8+% interest, he selected income-based-repayment plan, with potential public service loan forgiveness in 8 years.) He offers great information on investment and retirement savings in his blog.
We both believe in time value and debt leverage,
but we approach our student debt/ net worth differently.
Bo makes minimal student debt repayment (~$400/mo is half of the interest accrued each month from student loan debt.) He channels his residual cash flow towards investment/ retirement savings @ potential 8-10% return.
Here’s Bo’s rationale for investing instead of paying down student loan:
- There are daily fluctuations in the market but over the long run, it gains ~10% a year (http://www.moneychimp.com/
features/market_cagr.htm). Since I’m investing for the long term, the downs won’t affect me. - Since I’m buying and holding, the only income tax I will have to pay will be on dividends – most of which will be taxed at a lower rate under long term capital gains as compared to interest you earn from say a savings account which is taxed as ordinary income.
- Student loan interest is deductible – $2500 deduction at 25% tax bracket translates into $625 in your pocket each year. As long as your modified adjusted gross income (MAGI) is less than $80,000 ($160,000 if married filing jointly).
- I am interested in an academic position, which will qualify for PLSF. After 6 years of training, working for 4 more years in academic/non-profit will lead to student loan forgiveness.
Here’s my take:
- I like the fluctuation-free, tax-free savings I get with paying off student loan. It’s solid 6.8% tax-free return for every dollar I put towards student loan principle.
- I use 0% credit card (which will later be converted into 1-2% interest debt with balance transfers) to invest @ 8-10% return for the long run.
- I leverage debt with a large differential between interest paid and return earned. Specifically, I like to leverage 0-2% debt for potential 8-10% return; but I will not leverage guaranteed 6.8% debt for potential 8-10% gain.
- I will moonlight to boost my income starting this July. ( So student loan interest tax deduction won’t really help me.)
- While I may want to stay in academics, statistically majority of radiology grads get private jobs (not PLSF qualified) simply because there are 4x more private jobs than academic ones.
- Do you invest or pay down student loan?
- Are you going for PLSF (public loan service forgiveness) and why?
- Are you paying down your student debt aggressively? what are your opportunity costs in doing so?
Comment below!
Just to expand on the discussion a little.
1. How is student loan payment tax-free? If you’re paying those payments from your income, your income is still taxed (except for the deduction for student loan interest)
2. I do the exact same.
3. There is no such thing as a zero risk investment – even your student loans can be discharged under certain circumstances. So while I agree that investment returns are “potential”, I disagree that the interest on student loans are “guaranteed”. When DFD mentioned that she would have no problem leveraging a 0-2% interest debt against the market return but she would not leverage a 6.5-6.8% debt against the same level of market return, it’s basically a exercise in comparing risk tolerances. What it boils down to is I have a higher tolerance of investment risk than DFD. And that’s completely fine, because we are different people. I believe I have a long runway ahead and I believe past performances will dictate future performance. For example, if I had a tumor, I would prefer a surgeon who’s performed 1000 successful resections than one that’s performed 10. That’s why I’m comfortable with the choices I’ve made. Who knows what will actually happen?! If only I had a crystal ball…
4. If your moonlighting income bumps you over the income cap for claiming student loan interest deduction – more power to you! You’re a great earner and I’m sure you’ll be able to spare Uncle Sam’s share at that point.
5. I don’t think this is relevant to the discussion. Regardless of the job market situation, you always have to go for what your heart desires, and I don’t believe income should rank as a top concern in choosing a career. I believe I’m better suited for an academic career because I love teaching and learning. So it makes no difference to me whether PSLF exists. Of course, because it does, I would gladly take advantage. 🙂
5. can’t agree with this more! definitely following your heart is #1 priority. that’s the same decision i made when deciding to enter into radiology. Rads is my passion and no one can pay me more to do something else in medicine, but i definitely had to face the realities (described by practicing radiologists) of diminishing job security and decreasing reimbursement in radiology. it’s fantastic that your heart is in teaching and would go for academic jobs anyways… i just know for a fact that some of my peers are NOT into teaching or public service, and that they are going for PSLF only for the forgiveness of their giant student loan. They bite their tongue while doing the 4-7 years of public service with reduced pay (compared to private practice). my only concern for my friend who genuinely desires to pursue public service is just the fact that there are NOT many teaching/non profit jobs in radiology… i learned that even at many radiology residency programs, teaching faculty/attending radiologists belong to a private group, which is not PLSF qualified entity.
2. awesome! have you ever considered paying down student loan with 0% credit card money? that’s a guaranteed savings too 🙂 even if you have to balance transfer later after 12-21 months, you still enjoy more than 4% savings (2% balance transfer fee for 12-18 months vs. 6.8% on student loan interest).
also, if you have ANY student loan that WILL not be forgiven under PSLF (ie. private bank loans, etc.), it would be wise to pay it down ASAP, right?
No, I would rather borrow at 0% to gain 10% than borrow at 0% to gain 6.8%. I do not currently have any non-federal student debt.
agreed, your point indeed is the risk tolerance deal
I would rather borrow at 0% to gain 10% AFTER i’m certain that my student loan does not snowball at 6.8% 🙂
Love it!
One recommendation Amanda, you may want to integrate Disqus into your comment systems as it’ll allow more universal comments.
Very interesting discussion!