There are a lot of competing goals when you first get out of residency.
You have hundreds of thousands of student loans to pay off.
You need to build up your investment accounts, which lag far behind your college classmates who have been working for the past decade.
You need to save up for a down payment for your dream home.
If you have kids, you need to begin saving for their college educations.
And of course, you’ve been living like a student and resident for the entirety of your 20s, and there are a few hobbies or splurges you’d like to enjoy now that you’ve finally crossed the finish line and finished residency.
It can be overwhelming to balance all of these competing priorities for your money.
For this post, let’s look at the most common question about how to use your money right after residency: should you pay down student loans or invest in the stock market?
Considerations in the Pay Student Loans versus Invest Debate
Current student loan interest rate
The decision between paying down student loans and investing in the stock market is a balance between how much you are paying in interest compared to what you could earn in the stock market.
Many medical students took out loans in the 6-7% interest rate range. If you are not going for public service loan forgiveness (PSLF), then you should strongly consider whether refinancing your student loans could lower your interest rate.
Expected Investment Returns
On the other side of the ledger, what can you expect in investment returns from the stock market? Historically, the market has returned 10.9% from 1950-2017, according to data from NYU. Of course, your expected return may be a little lower if you include, as I recommend, some bonds in our portfolio.
And investing in the stock market is not without risk. Even though the stock market has had an incredible run since 2009, the stock market can, and does, experience significant declines.
Don’t forget the benefits of retirement accounts
When you invest, you can put the money in retirement accounts such as a 401(k) or a backdoor IRA, or in a regular taxable account. Remember that retirement accounts offer tax benefits that need to be accounted for in the student loans versus investing debate.
From a mathematical perspective, it’s better to invest than pay off student loans
Because the expected return of the stock market typically exceeds that of the interest rate on your student loans, from a strictly mathematical perspective, it makes sense to put your money in the stock market.
Tack on the benefits of contributing money to a tax-advantaged account, and the difference between investing and paying off student loans widens.
From a mathematical perspective, it's better to invest than pay off student loans. Click To TweetWhy not hold your student loans indefinitely then?
So if the math says that you will end up with more money if you invest rather than pay off student loans, does it ever make sense to pay off your student loans early?
Absolutely! There are many good reasons to pay down your student loans.
By holding student loans you are leveraging your portfolio
Remember that investing money in the stock market while holding student loans introduces a leverage into your portfolio.
Most people would not use margin to borrow money to purchase stocks. While some people have suggested owning 100% stocks, especially with the current bull market, few people would use leverage to be 110% or 120% stocks.
But think about what you are doing when you start putting money into the stock market while still holding student loans. Let’s say you’ve paid down your student loans to $100,000 while building your investment portfolio to $150,000. Your net worth is $50,000, but you hold $150,000 in investments. If you do this, you must have a high risk tolerance, because you are $150,000/$50,000, or 300% stocks!
Remember that you are able to borrow money from some brokerages at interest rates lower than typical student loan interest rates. Few people recommend using margin to invest in the stock market with leverage, but it is routine for physicians to continue to hold student loans while investing in the stock market.
The Value of Being Debt-Free
While there is a strong mathematical case for holding student loans while investing in the stock market, there is also a strong psychological incentive to pay off student loans.
You aren’t a company to maximize profits for your shareholders. You don’t need to ring out every cent of profit in your portfolio. The relief of being free from the student loans that have hung over your head for a decade or longer is a good reason to pay off your student loans before investing.
Conclusion
The decision to pay down student loans versus investing in the stock market is, like all personal finance decisions, a personal decision.
Mathematically, it is better to invest in the stock market, because the stock market has a higher expected return than the student loan interest.
But investing instead of paying off student loans introduces leverage to your portfolio, and there are strong psychological incentives to pay off your student loans quickly.
In general, because of the benefits of retirement accounts, I recommend that the typical new attending physician maximize their tax-advantaged accounts before paying down student loans. After they have maximized their tax-advantaged accounts, I’d recommend paying down student loans before investing in a taxable account, unless they are going for PSLF.
For most physicians, my general recommendation is to max out your tax-advantaged accounts first, then pay down your student loans. Click To TweetWhat do you think? How did you balance paying down student loans and investing after residency?
Agree with your conclusion.
We follow your recommendation and maximize our tax-advantaged investing accounts, then use our extra money to pay down the loans.
We do also invest in a Backdoor Roth IRA, which gives us no tax advantage now but will hopefully make up for it when we get to withdraw the money tax free. We’ve considered holding off on further Roth investments until the loans are gone but it was our first investment account and it still feels right to contribute to it.
Good article on an age-old question!
-DoD
I think what you said at the very end is spot on. I think this becomes a personal decision, but there is certainly a method to the madness before that point:
1) Fully max out your work retirement accounts. Don’t leave money on the table.
2) Fully max out your spouse’s retirement accounts, if married.
3) Consider a backdoor Roth given that this is money you “lose” each year you don’t do it.
4) Pay off your debt or invest.
I do both things aggressively. I put about 76K per year into investments via retirement accounts and 60K into loans via monthly payments with an additional 30K in bonuses towards debt. I should have my 180K in loans paid off in two years after graduating, while investing about 150K.
Good post! Always a valid topic to consider.
I agree. Emergency fund. Then tax-deferred accounts. Then attack the debt.
I gave myself 2-3 years to pay off all debt. We rented a small apartment and ate a lot of cheap meals at home but boy was it worth it. Once you have no payments it is easy to invest and live well long-term. The emotional aspect cannot be overstated. Being completely debt-free feels wonderful!
I went all in on investing. My student loans were much lower than what current graduates face. All my money went into investments and I never paid extra on student loans. I know you will hate me when I tell you that my total loan burden was $29k. In todays world I don’t think I would do it that way. I think you split the difference. I would fund all tax protected space then 1/2 of the available money would go to loans and the other half to investments. Of course starting salaries are enormous now compared to when i finished. My first job started at $90k.
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