Should You Invest or Pay Down Debt?

When it comes to the age-old question of invest vs debt, many people wonder what to do. Some say invest without looking back. They tout that if the compound interest you can gain by investing is larger than the interest rate on your debt, then it's a "no-brainer." Other people say pay down debt. They mention that a life of no debt is a life of freedom and paying it down gives you a guaranteed return, free from risk. But is it really so black and white? How can two seemingly smart camps of people come to such vastly different conclusions?

When it comes to investing or paying down debt, the right answer depends on a unique set of circumstances and facts that can be ever changing in our lives. Yes, they include math. But they also vary based on our risk tolerance and individual values. Let's take a deep dive and examine this further.

Benefits of Investing

Investing has several benefits. For starters, it allows you to put your money in a position to grow and make a profit. Most people don’t build wealth or even acquire the funds needed to meet their financial goals by just saving. They are usually able to meet these goals investing, whether that’s in the stock market or in real estate or in some other lucrative business venture. The younger you are, the more likely investing will work out in your favor because you have more time for compound interest to turn your investing yield into even greater returns. Although nothing in life is guaranteed, and some investments can fluctuate in value from year-to-year, investing money allows your money to grow and can help you reach your financial goals sooner.

Benefits of paying down debt

Investing has benefits but so does paying down debt. For starters, paying down debt gives you a guaranteed return. Unlike investments that can decrease in value during market downturns, paying down provides certainty. It’s a surefire way to enhance your net worth. Not only does it decrease your liability, but it also helps to free up your cash flow. By getting rid of those monthly debt payments you will have fewer fixed expenses/bills and more money to spend on other things. In addition to more cash flow, paying down debt provides another benefit that can’t be quantified: financial freedom. There is no doubt that people, especially high-income earners, who are debt free, feel psychological freedom. They can leave jobs they don’t like without worrying about how they will repay their student loans. They can take guilt-free vacations and enjoy more of life's pleasures. People may lament certain investments that don’t pan out but very few people regret paying off debt.

So what should you do?

Should you aim for the growth and the magic of compound interest by investing? Or, should you free up your cash flow and get a guaranteed return by paying off debt?

It depends.

If you get a great investment return (like a retirement match at your job) then investing likely makes the most sense. If you have high-interest debt from a credit card or personal loan, then paying down that debt likely makes the most sense.

If you’re in between or neither scenario applies to you: Let the interest rate be your guide and if all else fails, split the difference.

If the interest rate on your debt is higher than the estimated, inflation-adjusted returns you expect from your investments then it likely makes more sense to invest. How do you make this comparison? Take the estimated return you expect to get from your investment, subtract out inflation, and compare your new inflation-adjusted return on investment to paying down debt. If the estimated return you get on your investment is still greater than what you would get on your debt then invest. If the estimated return you get on your investment is less than the interest rate on your debt then pay down the debt. If the returns are about the same or you are unsure which one is better, then do both. Use a portion of your income to pay down debt and another portion to invest. How much you allot to each category largely depends on your risk tolerance, personal goals, and overall financial plan. 50/50 is a good place to start. 

New Goals for the New Year (2022)

It’s 2022 and many of us want this year to be better than last year. Instead of just hoping this happens, let’s make some realistic goals and put steps in place to achieve them. Here are some of my 2022 goals:

1. Continue to invest at least 10% of my salary in retirement accounts. Investing money gives me the opportunity to allow my money to grow. Because of inflation (the rising cost of goods and services) money sitting in a savings account is actually losing buying power by the day. In order to prevent this, I keep a certain amount of money in an emergency fund and make a habit to invest the rest. Since I know I can’t be relied upon to actively put the money into investment accounts each month, I make it automatic by having 10% of my paycheck automatically invested into my work 403b (similar to a 401K) before the money hits my bank account. I also have a set amount automatically invested into my Roth IRA. You can do the same thing. The amount you choose to invest is up to you, but having automatic contributions into your 403b or Roth IRA will allow you to start building wealth long before you retire which will create more options for you in the future.

2. Make more money from side hustles (increase passive income). As a senior resident physician who is starting fellowship next year, I haven’t gotten the “big bucks” just yet. I make more than I did as a first-year doctor, but I still haven’t gotten that attending salary boost. Although I’m anxious to get paid more, I refuse to put my life on hold for a year and a half until that time comes. While many people choose to moonlight (work extra shifts as a physician) to supplement their income, I’ve always been concerned that doing so might cause me to burnout from medicine. So, I've tried to increase my income a different way. For me, that means monetizing my hobbies and increasing passive income. I’ve made tens of thousands of dollars doing that as a resident physician and would encourage other docs to consider passive income ideas, or monetizing some of their hobbies, to increase their monthly income as well.

3. Avoid accumulating consumer debt. When I first started residency, I had lots of credit card debt. Most of it I accumulated before I went to med school. I was unable to pay it off while getting my degree so when I graduated and started residency, I still had it. My credit card interest rate was 10% which means that each day I had the debt I was being charged extra money in interest. It didn’t take me long to realize that the sooner I paid off the debt the more money I’d save in interest fees. When I got my first job as a doctor, I prioritized making large credit card payments and paid off the debt in less than a year a half. I’m still credit card debt free, so my goal for this new year is to avoid accumulating more. It can be so tempting to use my credit card to book flights, pay for vacations, and purchase other items on sale but resisting that urge has served me well. In 2022 I hope to continue this practice.

4. Save money for future vacays. In order for me to avoid accumulating credit card debt one of the things I do is plan ahead. I save money in advance for large expenses like vacations, travel, holiday gifts, and friends' weddings so that I don’t end up charging these expenses on a credit card. I also have a percentage of money from each paycheck deposited into an entirely different bank account. I use the money in this bank account to save for future large expenses. Having these automatic deductions into a separate bank account prevents me from having to rely on my memory or self-control. I plan to continue this same practice in 2022.

5. Carve out time for self-care. As a senior resident physician who will be starting fellowship next year, life is busy and occasionally stressful. One of the ways I plan to decrease stress and improve my own wellbeing is by investing in self-care. For me, that means reading more books, finding time for rest and relaxation, having periodic therapy sessions, and maintaining healthy eating & exercise habits. Life can be hectic, but making the time for my own self-care and happiness is better for my overall mental health and longevity.

Tell me, do you plan to do some of these things this year? What are some of your goals for the new year?

5 Things I learned After Paying Off My Credit Card Debt

1. It is much easier to get into debt than it is to get out of it. I racked up a significant amount of credit card debt during my years as a graduate student. I moved to a city I couldn’t afford, accepted a job that didn’t pay well, and used credit cards to make up the difference. Needless to say, I accumulated debt pretty quickly. It’s not like I was “balling out of control” taking fancy vacations or living some lavish lifestyle but the cost of basic expenses in a high-cost-of-living area took its toll. Although it was fairly easy to rack up this debt, I had to make some hard sacrifices to pay it back.

2. Paying off debt takes a lot of sacrifice and behavior change. I delayed paying off credit card debt when I got into medical school simply because I couldn’t work during that time and was already living on student loans. Once I graduated and started working as a physician, paying down that debt was one of my top priorities. The interest rate on my credit card was about 12% and although that’s great for a credit card, the longer I kept this debt the longer I was going to be paying at least 12% more for the things I purchased years ago. In order to pay it off as soon as possible, I literally threw money at this debt. Each month for the first 6 months I was a physician I had a chuck of money automatically sent to the credit union that issued my credit card. Every month I saw money that I could have spent on a nicer apartment or a fancy vacation go to pay back debt I had accumulated well over 6 years ago. I was jealous of my classmates who ate at restaurants all the time or were always traveling to nice places when I was essentially living like a broke college student trying to back this debt. Trust me, it was tough.

3. The temptation to avoid paying it off can be hard to resist. There were so many times where I’d want something (like a nice lamp for my apartment, a fancier bed spread, or a newer cellphone) and I realized that I could probably purchase those things easily if I didn’t have so much money going toward paying off my credit card. I contemplated delaying paying off the card by a few months in order to experience some gratification now. While doing so may not have totally derailed my financial goals, it would have created a dangerous habit that could cost me even more down the line: delaying debt repayment to purchase material things. I’m a firm believer that the habits, mindset, and discipline needed to pay down debt are the exact same traits needed to save, invest, and build your net worth. Delaying gratification is never easy, but learning to do so had such a positive impact on my finances and ability to build wealth.

4. The debt was costing me more than I realized. I decided to prioritize paying down my debt because I realized I was paying drastically more for things that I purchased years ago. In other words, the credit card company was charging me monthly interest of over 12% per year on the total balance of the card. The longer I delayed paying it off, the longer I would be paying interest. When I started learning more about personal finance, I realized the debt was costing me even more than extra interest payments. It was also delaying my ability to build wealth. Every dollar I was spending on this credit card debt, was a dollar that wasn’t going into retirement accounts to be invested in a way that actually earned me more money. Instead of EARNING 8% per year on money invested in retirement accounts, I was actually PAYING 12% more on debt. The sooner I paid off this credit card, the sooner I could get more money invested and start earning interest instead of paying it.

5. Paying down the debt improved my quality of life. Now that I’m credit card debt free, I’m so much happier. I no longer have a large chunk of money going toward a bill I accumulated years ago. Instead, I’m investing more money into retirement accounts and saving more money in my emergency fund. I’m also planning a couple international vacations that will be paid for in cash. To be able to live my life without relying on credit cards is such a freeing feeling. Plus, it took so much sacrifice to get it paid off that I literally never want to go back.  

Are Student Loans Good Debt or Bad Debt?

As many of us are well aware, the cost of a college education has rapidly increased. In fact, many college graduates finish school with tens of thousands of dollars in student loans to repay. While some people feel as though the price of their degree was worth it, many others aren’t so convinced. Truth is, student loans can be “good debt” for some people and “bad debt” for others. Let’s determine where it falls for you:  

1. Did you actually earn a degree? Many people finish high school and enroll in a college with good intentions to get their degree. Unfortunately, life doesn’t always work out as planned. Due to the rising cost of tuition, work obligations, competing expenses, or family responsibilities, some people may have to post-pone their college dreams. Accumulating student loan debt, without a tangible degree to increase your potential job opportunities and salary can be detrimental to your finances. If you obtained a degree then the student loans may be "good debt." If you didn't then they may be "bad debt." 

2. How much debt do you have? While getting a college degree is a notable accomplishment, it’s important to examine if you did so at a fair price. Some people get scholarships to pay for the entire cost, others have to maximize federal and private loans to cover their basic needs. Where do you fall on this spectrum? The more debt you have, the more you may have to consider whether the debt was worth the added benefit of the degree.

3. Were you able to get a job after graduating? Not all colleges are created equal. Some schools may be better at helping their graduates get jobs than others. Unfortunately, not all degrees are created equal either. Some degrees such as those in engineering or science may be more marketable or have better job prospects than others in language arts or history. If you earned a degree but are struggling to find a job with that degree, then it may be time to question if the loans you took out to get the degree was money well spent. 

4. Does the job you got earn you a decent salary? “Decent” can vary from person to person. The general rule of thumb is to make sure your student loans don’t exceed your [projected] income. For example, if you get a degree in education and the average salary for teachers is $45,000 then your student loans should not exceed $45,000. Some people extend this rule to 1.5x their salary, but usually anything more than can be challenging to pay back. Although these rules may not apply to everyone, having a general guideline can help us ensure that we aren’t borrowing more money than we’ll be able to repay. If you borrowed less than 1.5x your salary then perhaps the student loans were a good investment. 

5. Does the degree you earned lead to other opportunities? Taking out student loans can be about more than getting a degree to increase your pay. Aside from the job opportunities and salary the degree may or may not have afforded you, think about other opportunities. Did the skills you learned with the degree allow you to accomplish a lifelong goal? Did the people you met while getting the degree give you access to lucrative networks and people that can help you going forward? Did it provide you with invaluable life lessons, maturity, or the self-confidence needed to help you gather the courage to go after your goals with reckless abandon?

My point: Obtaining student loans to attend college is something that is commonplace. While the worth of a degree shouldn’t be judged purely on how much money it cost you or the job you obtained afterwards, one must be realistic. If student loans are going to be considered “good debt” then we must ensure they meet a few criteria. We should refrain from taking out much more than our projected salary, use the degree to advance in our careers, and leverage our time in college to obtain access to other invaluable opportunities.

How To Tackle Student Loan Debt

If you’re like me, or one of the millions of Americans who have student loan debt, I understand your plight. Learning about the different servicers, figuring out the repayment plans, and familiarizing yourself with terms like “refinance” and “consolidation” can be a bit daunting. Although many young professionals may have already come up with a plan to tackle their student loans, there can be a bit of a learning curve for new graduates. Here are some simple steps to help you tackle your student loan debt:

Step 1 = Figure out how much student loan debt you have. If you filled out a FAFSA form and received student loans from the federal government, then you can go to https://studentaid.ed.gov/sa/ to see your total student loan debt balance. You will need to input your FSA username and password in order to login (this is the same username and password you used to fill out your FAFSA form). Keep in mind, the total amount of student loan debt you have will include the principal (how much you actually borrowed) and the interest (the amount the government charges you each year until you pay the money back). If you took out private loans from outside banks, foundations, or corporations you will need to contact them directly (if they haven’t already started contacting you first) to determine how much you owe.

Step 2 = Find out the interest rates and the servicers of each loan you have. When you took out a student loan from the government, it was issued by the Federal Department of Education. However, there are different sub-departments within the Department of Education that handle your loan repayment. These “sub-departments” are called loan servicers and they are who you actually contact when you repay your student loans.

For example, I took out loans through the Federal Department of Education, but my loan servicer is Nelnet. Thus, Nelnet is who I pay when my loan is due. You might have taken out a loan through the Department of Education just like me, but have a different servicer (such as Great Lakes, Mohela which took over for Fedloans, Navient formerly known as Sallie Mae, etc). You must pay back your particular loan servicer directly. Once you login into the website and find out the servicer each of your student loans, you need to look at the interest rates on these loans. Chances are that you have different interest rates on each loan since the interest rate may have fluctuated as you took out loans from year to year. Your goal is to determine the range of interest rates you have on your student loans.

I know this may sound complicated, but it’s quite easy. I’ll walk you through what it was like for me. As soon as I logged into the website I had to accept a waiver. Then, I was able to see the total amount of student debt I owed (which was pretty high given my status as a medical student, but I digress). Anyway, I could also see the number of loans I had taken out and the fact that all of my loans had the same servicer (Nelnet). You may have different servicers for different loans, so be careful. Once I saw this listing of my student loans, I could then expand the tab (by clicking an arrow) and see the amount of each loan, the interest rate on each loan, and the date on which my next payment on that loan was due. If I click “view details” I can see the date on which I took out the loan and the interest that has accrued on it up to this point, among other things.

Step 3 = Understand the pros and cons of student loan debt consolidation. Debt consolidation is when you combine all of your loans into one giant loan with one interest rate. Consolidating your loans has advantages and disadvantages. The advantages of consolidating your loans (through the federal government) is that you combine all of your loans into one giant loan. Your new interest rate will be the weighted average of the interest rate on all of your loans. If you do not consolidate then you will have a different loan for each semester in which you took out money, each with different interest rates and potentially different loan servicers. This can get confusing.

By consolidating (through the federal government) you are able to combine all of these loans into one loan and focus on paying that one loan only. Having one giant loan, instead of many different smaller loans, tends to look better on your credit report. Another advantage of federal consolidation is that any loan that may not have counted towards loan forgiveness programs can now count towards those programs after you consolidate your loans (through the federal government).

The disadvantage of consolidating your loans is that any interest that has accrued on your loans will be added to the principal amount. Let me explain. If you took out unsubsidized loans, then interest accrued on those loans while you were still in school. Once you consolidate your loans, all of the interest that has accrued on your loans to that point will be added to the principal amount of the loan. For example, if you have taken out a total of $50,000 in student loans and $3,000 in interest has accumulated on the loans during that time, then if you consolidate your loans you will have a new loan with a new principal amount of $53,000 (that includes the $50,000 you borrowed plus the $3,000 that had already accumulated in interest).

I should mention that you have the option to consolidate your loans through the federal government or through a private company or bank. Although a private company may be able to offer incentives to get you to consolidate through them, I would advise you to consider consolidating through the federal government instead, if you choose to consolidate in the first place. The advantage of consolidating your student loans through the federal government is that you are still eligible for many of the benefits that come with federal student loans.

The federal government is much more understanding when you go through life changing situations. If you lose your job, become disabled, or have some life altering event that prevents you from making your student loan payment you can ask the government to put your loans into deferment or forbearance. Although they are slightly different, both of these options will grant you temporary relief from having to pay back your loans for a few months up to a few years. Most private companies will not give you this option.

Plus, many federal loans can usually be “forgiven” after a certain length of time. In fact, many federal income-driven repayment plans and programs will forgive your loans after 10-25 years. So unless you are secure in your job and are making a lot of money, I’d suggest consolidating your loans into one giant loan with the federal government if you feel you need to consolidate at all. Doing so, allows you to keep the protections that come with federal loans and makes your student loans easier to manage in the process.  

What am I doing? Consolidating. Even though my loans are already with the same loan servicer (Nelnet) with fixed interest rates, I need to consolidate in order to waive my grace period and start making payments under Public Service Loan Forgiveness as soon as I can. Graduates have a 6 month grace period before they have to start paying back their loans. While most graduates appreciate this grace period, I plan to opt for Public Service Loan Forgiveness (PSLF). Under PSLF, I'll be enrolled in an income-driven repayment plan that caps my repayment at 10% of my income until my loans are forgiven. However, PSLF doesn't kick in until after the grace periods ends. If I wait 6 months for the grace period to end, I will miss out on 6 months of low payments that could count towards PSLF. In order to waive the grace period, I must consolidate.

My point? If you have multiple loan servicers, variable rate loans, loans that don’t automatically qualify you for a loan forgiveness programs, or plans to pursue PSLF specifically, then consolidating through the federal government may be beneficial for you as well. 

Step 4 = Think twice before you refinance your loans. Although refinancing can be similar to consolidating, the terms are different. Consolidating your loans is when you combine all of your loans into one giant loan and the interest rate you pay is the average of the interest rate you had on each individual loan. Refinancing is different. Refinancing is when you combine all of your loans into one giant loan and pay a LOWER interest rate than what would have been the average on all the loans. Refinancing can only be done outside of the federal government through a commercial bank, credit union, or some outside company.

The advantage of refinancing is that you pay a lower interest rate than you would have otherwise which can save you thousands of dollars. The disadvantage of refinancing is that you lose the protections and benefits that come with having federal loans. After you refinance, you are no longer eligible for federal deferment or forbearance if life takes a turn. Most importantly, you are no longer eligible for federal student loan forgiveness programs. Unless you are certain that you will not be pursuing any student loan forgiveness programs and have enough job security that needing deferment or forbearance is unlikely, then you may want to wait to refinance.

What am I doing? Choosing not to refinance right now and revisiting the subject in a few years. As a graduating medical student who will start residency training as a physician, I am in a unique situation. My plan is to enroll into an income driven repayment plan through the federal government. I will pay my student loans on time each month until I finish residency training and fellowship. Afterwards, I will decide to work in academics or private practice. If I choose academics I will keep my loans with the federal government and opt for public service loan forgiveness (which forgives my loans within 10 years). If I do not choose to work in academics, I will refinance my loans with a private company and plan to pay them off in 5 years.

Step 5 = Enroll into a repayment plan that is best for you. There are many different repayment plans. You need to check with your loan servicer to see which repayment plan options you qualify for or use the repayment estimator to get a general idea. If you don’t choose a plan, you will be automatically enrolled in the standard repayment plan which puts you on track to pay off your loans within 10 years. Although this plan will save you money in interest payments, the monthly payment required may be higher than you can afford.

If this is the case, enroll in one of the income-driven repayment plans. These plans only require you to pay 5% to 15% of your income in students loan payments and will automatically forgive your loans after 20-25 years, if you haven’t already paid them off. (If you opt for public service loan forgiveness, then your loans will be forgiven in 10 years).  Income driven repayment plans are ideal for anyone who plans to get their loans forgiven via public service loan forgiveness or some other type of loan forgiveness program.

Step 6 = Look into loan forgiveness programs and submit the necessary paperwork. I alluded to this above, but as you think about your student loans it’s important to consider whether or not you are considering some sort of loan forgiveness program, most notably public service loan forgiveness. Although this program will forgive your loans after making 10 years of payments, you need to ensure that you have properly enrolled into it.

You can refer to the student loan website but essentially you need to have direct loans through the federal government, work at some sort of academic institution or non profit organization, and make 10 years of on-time qualifying payments. If you know you want to enroll in this program, then you can fill out the form on the student loan website.

To summarize: there are 6 steps you need to take to start tackling your student loans. First, go to the student loan website and figure out how much money you owe. Then, determine your loan servicer and the interest rate on each of your loans so you can figure out who to contact to start repaying them. Next, you need to understand the pros and cons of federal debt consolidation so you can figure out if you should combine your loans into one giant loan or not. Remember to think twice before you refinance your loans since doing so will make you ineligible for federal loan forgiveness programs. After that, enroll into an income-driven repayment plan, if your monthly payments under the standard plan are higher than you can afford. Lastly, look into government loan forgiveness programs and submit the necessary paperwork to enroll.

Tell me, was this helpful? Do you feel more like you have a game plan on how to tackle your student loans?