[This post on minimizing debt may contain affiliate links to products at no additional cost to you that accomplish the charitable mission of this website.]
[The next few posts will be part of a “Resident Series” that discusses topics particularly relelvant for those in training. That said, I think a lot of it will be applicable concepts to those who have already finished as well. And I plan on doing a “Practicing Provider Series,” too. Let me know what you think in the comments!].
On a recent forum that I visit, a poster questioned everyone on whether it was worth taking a big trip to Europe after finishing his first licensure exam (USMLE Step 1). What the person was really asking is…. “Is it worth it to minimize debt?” This is difficult to answer, but I think we can wrap our minds around the question if we take certain things into consideration. So, let’s get into it.
As many of you know, finishing Step 1 of the USMLE is a big big deal as this score determines (way too much) what specialties will be available to you for training. In fact, I myself took a trip (to New York) after Step 1 to celebrate it being over with my wife.
The question of whether this sort of trip is “worth it” is always tough to answer because really they are asking two separate questions: (1) Is it a financially wise decision to go on a trip with loaned money from medical school debt that someday you’ll have to pay back (also sometimes phrased “how much will it really cost me in the end?”) and (2) will the happiness the trip brings me be worth the lost money? The second question is tougher to answer.
I, unfortunately, do no have a crystal ball for your happiness and future perspective. For that reason, on this “Wellness Wednesday” we are going to discuss some ways of answering the first question and focus on why minimizing debt is so important in training. After all, I firmly believe that wealth and wellness are connected, particularly with this sort of question.
Is it really just a “drop in the bucket”?
I used this phrase (“It’s just a drop in the bucket of my debt”) so many times during medical school and residency that I should have been paid by whoever coined the phrase. It’s a common thought when you are deep in debt. It somehow makes you feel better about the insurmountable mountain that you haven’t even started to climb. But is it really just a drop in the bucket? Let’s see.
As I previously, mentioned, my wife and I took a trip to New York after Step 1. [In full disclosure, please remember that I didn’t have my personal finance “enlightenment” until the end of residency in 2016. After all, I used to invest money in stocks when I was accruing debt at 6.8% interest]. This trip cost us around $3,000. The emotional side of me looks back at that trip very fondly. We saw Wicked live on Broadway (I’d recommend it to anyone to this day; what an incredible show!). We ate at some nice restaurants. Walked the city. Went to some famous spots and Dylan’s Candy Bar. We slept in a really cozy bed in a hotel right in the middle of time square. It was great.
You’re probably thinking, “wait… I thought he was going to tell me why it’s not just a drop in the bucket.” You are right. I am going to tell you that, but I also want to be fair and recognize that our trip to New York was great and one of our favorites today. It made the heart happy.
However, we cannot forget about the head (financial aspect of things). So, let’s look at the math. We took that trip back in 2010, or 8 years ago. There are two different ways to look at this. How much would I have made if I invested this money and how much more debt did I accrue because I spent this instead of giving it back?
Opportunity Cost 1: Money lost if invested
Given my passive index fund view on investing, let’s take that $3000 and put it into Vanguard’s Total Stock Market Index Fund (VTSMX). We took this trip in April of 2010, but would have paid for it likely in February or March of 2010. On February 19, 2010 the VTSMX was valued at $27.50. Today (2/15/2018) the value is $67.32, which is approximately 2.448 x the original value in February 2010. Therefore, my $3000 would be worth $7,334 today (as of this writing).
I don’t think this is really the best way to look at this opportunity cost, though. This is because I wouldn’t recommend to any student in debt to put money into the market when their debt is accruing at 6.8% interest. That’s just bad advice no matter how you look at it. So, let’s look at how much more debt I accrued because of this decision.
Opportunity Cost 2: Incurred Debt
Student Loan Refinancing Programs during residency did not exist when I was in training. For this reason, I didn’t refinance my loans until fellowship in 2017. Therefore, my debt was accruing at 6.8% interest from February 2010 til I refinanced my loans in July of 2016 to 3.6%. I refinanced at a variable rate, but to make these calculations a little simpler I am going to use a fixed 3.6% rate for my fellowship year.
[By the way, I highly recommend a variable rate as a fixed rate is really just a variable rate with a built in insurance policy cost from your refinancing company. I think White Coat Investor’s advice is spot on here: Your rate would have to go up dramatically AND fast in order to save money with a fixed rate].
So, where does that leave me? That $3000 as of today (2/15/2018) has compounded to a little less than $5,000 ($4,840). Another way to look at this is that it added one extra month of loan payments, because I am paying $5,000 per month into my loans.
A Hybrid Theory
The problem with considering opportunity cost 1 or opportunity cost 2 alone is that it doesn’t take into account that your accumulated debt would have decreased your total payment by that same amount. Presumably (if you are wise) you would be taking that current monthly student loan payment and putting it into an investment account once your student loans are paid off.
Let’s make a conservative estimate. Let’s say that we took 50% of that total accumulated debt ($4,840/2 = $2420) and invested that instead because we wanted to buy a house after paying off our student loans. So, half of that next (now missing) student loan payment is going to mortgage, and half to a taxable account.
If we invested $2420 one time and it grew over a typical 30 year career and earned 6% real interest, it would be worth $13,899. Combine that number with the $3000 it originally cost us to go on the trip and that total opportunity cost comes out to $16,899. Now THAT is one expensive trip to New York.
What does the retrospectiscope show?
Hindsight is 20/20. Despite not saving anything during residency (not what I recommend!) I am still going to be able to achieve my financial goals and be financially independent and be able to retire by my early to mid 40s. I could have done it much faster if I had been saving during residency, but at the time I was just trying to make it through. [However, I must also point out that I only came out of training with $105,000 in debt (accrued to $145,000 by fellowship + my wife’s $40,000 from graduate school = $185,000 at my first attending pay check)].
We had a great trip to New York, but that trip was only $3000. If that trip had cost $10,000 instead (like the original poster’s Europe trip) that money would have compounded to $16,133. With the same hybrid model above (investing 50% of what we would have already paid off), that number comes out to $56,330.
Essentially for every $1 I spent back then, it was going to cost my future self more than 150% ($1.50). However, that $1.50 would have been invested and would have grown over a 30 year career. That is where it really gets expensive (1$ turns into $5) because it takes you that little bit longer to pay off your student loan debt and prevent you from investing in your next step (for us a taxable account).
The take home is that your decisions while under significant debt need to be properly weighed. Any substantial costs you incur (car payments, fancy vacations to New York or Europe, bigger houses than you need, etc) are going to cost you big in the end. Make sure that it is truly worth it to you. I cannot tell you what that means, but as in everything else, please be intentional in your spending!
What do you think? Did I over estimate the cost? Underestimate it? What am I missing? Would you tell the student to take the trip to Europe if it would cost $10,000?