- Minimize debt while in medical school and residency!
- A little lifestyle creep after training is fine. Just don’t go overboard.
- Don’t ignore your debt. Make a solid plan to destroy your debt!
- Compounding interest is powerful! Use it EARLY for your good (and don’t let people use it against you!).
- Recognize that you can BOTH aggressively invest AND destroy debt! Moderation is key.
Compound interest? What’s that?
When I was growing up, debt was just a normal part of life. My parents and grandparents used credit cards daily, and usually not because of the crazy good reward systems provided by the CC company. It was simply what they did. Debt was normalized.
As I started accumulating financial knowledge through reading books or visiting financial blogs aimed at high-income professionals, I started to learn that debt was something to be destroyed. It delays building wealth.
Wealth = Assets – debts
Assets includes a lot of things. Cash in your checking/savings account is the simplest expression of this. Retirement accounts (401k, 403b, 457, etc) also count. Cars and houses (if paid off). Even pure silver is an asset (Hint: check out the photo). The list goes on. Essentially, anything that is worth something and can be used for buying power is considered an asset.
Debt is something that most of us can understand a little better: undergrad debt, advanced degree (medical school) debt, cars, houses, credit cards.
Fact: The less assets you have and the MORE debt you have, the less wealthy you are.
So, the question becomes… how do I become wealthy (and even financially independent!)? Let me give you five steps that will help you take substantial steps towards this goal by increasing your assets and destroying your debt.
Step 1: Live like a medical student/resident while you ARE a medical student or resident.
I know this sounds simple, but trust me when I say that I know a lot of people who took out every dime that they could during medical school, and not because they had to, but because they wanted to look “the part.”
Driving a BMW and buying a house isn’t probably a good idea until you’ve paid off most of your debts and accumulated wealth. That doesn’t usually happen until several years out from training, much less while you are in training. Driving a beater or renting a house is perfectly acceptable.
Credit card debt is also NOT normal. Yes, many people have it. No, it is not a good thing, nor is it normal.
Number 1. Minimize debt while in medical school and residency!
Step 2: Live like a trainee for a few years after you finish training.
You may consider this step 1B, but the point is so valid that I want to drive it home (unlike that new BMW). The biggest financial mistake most people make after finishing training is saying, “Hey, I earned it…I am gonna buy everything I held off on NOW!” Nothing will set you further behind than this mentality. Period. All this accomplishes is to increase your DEBT, exactly the opposite of what we need to accomplish!
Nothing eats at the money you could be putting into destroying debt or investing more than increasing your lifestyle drastically upon finishing training.
If you want to allow some lifestyle creep, that is fine. I am a little more moderate on this issue than a lot of people out there. You lived on $4,000 per month in residency and now your take home pay is $10,000 per month? By all means, do something nice. You deserve to enjoy some of it. Live on $5,000. That’s an extra $12,000 per year. That’s a really nice cruise, trip to Europe, or even both if you find a good deal!
THEN, take that additional $6000 you get each month ($72,000 per year) and put it straight into investments and debt. You’ll feel a great lift in your lifestyle, and will be accomplishing substantial progress towards becoming wealthy and well!
Number 2. A little lifestyle creep after training is fine. Just don’t go overboard.
Step 3: Choose to do PSLF or refinance your loans
You can read more about this in-depth topic in my post on refinancing (coming soon!). The point I want to make here is that compounding interest should be working FOR you (see thought experiment below), and not against you. $200,000 in medical school loans compounds VERY quickly at 7%. So, it is prudent to consider refinancing your loans as quickly as you can! I refinanced after finishing training and got a rate around 3% or less than half of what I had owed. Again, see the refinancing post for more details.
If you plan on working for a non-profit academic hospital for ten years the other alternative is PSLF (Public Service Loan Forgiveness). After ten years, whatever isn’t paid is forgiven. If you are smart, and paying back debt during residency, this time counts towards that first ten years! Interestingly, as of this writing, this is the first year that people are able to receive PSLF, but I haven’t heard of anyone actually utilizing it yet! I do have friends that plan to do PSLF, though.
Step 3. Don’t ignore your debt. Make a solid plan to destroy your debt!
Step 4: Maximize your earnings (and compound interest) early in your career.
It is a question as old as time. Should you be investing or putting money towards debt? I answer this question in more detail here. I think that this is tough to answer, but not until a certain branching point. One thing is for certain, compounding interest works towards your favor at a young age, and you cannot get back that time on compounding interest once you’ve passed it up!
Thought experiment: Two different physicians.
Physician A finishes training at 32 years of age and saves $50,000 per year for 20 years directly out of residency. At age 52 Physician A will have (assuming 8% interest growth) will have $1.95 million. Physician A invested a total of $1,000,000.
Physician B waits 5 years to invest because they took the step up in lifestyle they felt they earned, and at age 37 invests $75,000 per year ($25,000 more per year each year) until the same age. At 52 years old, Physician B will have (assuming the same 8% interest earnings) $1.85 million. Physician B invested $1,125,000.
Physician B invested $125,000 MORE than Physician A yet has $100,000 LESS at age 52. Physician B lost $225,000 because they waited. Compounding interest is powerful!
Number 4. Compounding interest is powerful! Use it EARLY for your good (and don’t let people use it against you!).
Step 5. Destroy debt and aggressively invest
You should be BOTH investing AND destroying debt. As a good target, you should be investing 20-30% of your base salary.
For those inclined towards step-by-step processes:
- Determine how much being debt-free matters to you.
- If debt shakes you to the core (like it does for me since I cannot get disability insurance) = Throw every extra penny at your debt after maxing out 401k/403b at work for you and spouse.
- If debt isn’t a big deal because you understand the thought experiment above and are a cold-hearted logician, pay off your debt at the required (refinanced!) rate and proceed to the next step.
- INVEST: Maximize your employer match and vesting options (401k, 403B) into low-cost index funds. If you earn enough, max out your 18,000 ($18500 starting in 2018). Whether to go pre-tax versus Roth (coming soon!) is a different conversation.
- INVEST: If married, maximize your spouse’s employer matching and vesting options through their 401k/403b also into low-cost index funds.
- If your spouse has a governmental 457, then max this out as well.
- INVEST: The next step is a backdoor ROTH. This is highly publicized, and should be done in January to, again, let compound interest be your friend.
- INVEST: Taxable options
So, what do I do?
I, of course, take the route of moderation.
Aggressively investing: I decided to max out my 403(b) account and my wife’s 457 (she is a part time teacher, its a governmental 457). With matching/vesting money, this lands us squarely at $65,000 per year in investments ($36,000 contribution on our part). This is >20% of my base salary. I plan to increase this number to $90,000 per year once debt is paid off. (As an aside, I also invest $1100 per month for my kids 529 plan, but this doesn’t count towards my wealth, though it does count towards my wellness).
Destroying Debt: I also put $4,000 into debt each month = $48,000 per year. Any additional windfalls I receive (such as quarterly bonuses), I put at least half of that into debt as well. I started with $180,000 and plan to have my debt paid off in a few months over two years.
Once I finish destroying my debt, half of that money will go into investing, and the other half will pay for a monthly payment on a house where I live.
Number 5. Recognize that you can BOTH aggressively invest AND destroy debt! Moderation is key.
Are you aggressively investing or are you a destroyer of debt? A little bit of both? What do think? Leave a comment below!