Invest or Pay down debt!A while back, one of the residents I interact with at the hospital mentioned that they had some extra discretionary spending money. So, they decided to open up an IRA for the “tax break.” Unfortunately, this resident makes a little too much to get a tax credit, and if they chose to invest in an IRA it should be post-tax Roth money. During the conversation this resident revealed that they had about $50,000 in student loans remaining to be paid off and that they were accruing around 7%. They were also enrolled in REPAYE, which pays 50% of any remaining unpaid interest each month for people enrolled in the program. Given their low student loan debt ($50,000), this resident was unlikely to benefit from REPAYE, because their monthly payment would cover all the interest. Thus, they would receive no subsidy from the government towards any unpaid interest (because they already paid it all).
Socratic Teaching Methods:So – as is my style – I asked a question instead of telling them what to do. I asked, “Do you think you are more likely to get a better “return” paying off your student loans that are at 7% or by putting money into the market where it can go up 10% or down 10%? Which one do you think provides the more likely benefit?” Of course, they knew the answer. They just hadn’t thought about it framed in this way. Naturally, they decided to get a sweet cashback deal by refinancing their student loans down to ~ 5% and put their extra money towards their student loans instead. For the record, I don’t think putting money into an IRA is the worst idea. In residency, it’s actually a great idea if your employer doesn’t match your 401K/403B. Certainly there are worse things to spending your money on – like payments on a new car that you don’t need or a year’s worth of cigarettes. That said, I think many people feel the guaranteed 5-7% in loans is better than putting money in the market. If the debt is <5%, investing would certainly be a reasonable option.
Invest more money!With the previous conversation in mind, it might surprise you that I gave the exact opposite advice – if you can call asking questions that lead to answers “advice” – to someone else two weeks later. Why? Because personal finances are personal and their situation was slightly different. This second resident was in the same marriage/child situation as the previous resident. Except, this one had about $200,000 in loans at around 7% in interest. In this situation, the resident was enrolled in REPAYE and was receiving a little more than $400 in interest paid for by the governmental subsidy each month. This makes their effective interest rate (following the subsidy) approximately 3.5%, which is better than they could get through even if they utilized a student loan refinance ladder! What happens, then, if this resident with a higher debt burden puts extra money towards their loans? Well, for every extra dollar they put towards their debt, 50% of it will go towards paying down their interest and 50% will go towards the money the government was going to pay for them. Essentially, every extra dollar raises their effective interest rate and reduces the amount of subsidy they get from the government. If they paid an extra $200 per month, only $100 would go towards the interest and the other $100 gets sucked up by the subsidy the government was planning on giving them.
Here’s the question for this resident:Again, I asked the resident a question. “Do you think you would be better served getting 50 cents of every dollar you put towards your 3.5% debt? Or do you think it would be better to put money into an IRA where you get to use the full power of every dollar compounding in the market hopefully at 6-8%?” The answer, of course, is that it probably makes more sense to put money into the market in this situation. Now, if the resident was in another repayment program that didn’t provide this kind of subsidy (i.e. IBR or PAYE), money spent towards the loans might be the better option.
Take Home: Personal Finances are PersonalJust like the advice I gave my oldest kid is different than what I’d say to my two youngest, personal finance advice should be different for everyone, too. We all have different goals and risk tolerance levels. The point of the above examples is that you need to understand your entire situation. Once you have all of the information you need, what you do with your money might be different than what others should do. This serves as an important reminder to avoid comparing your situation to others. Personal finance is a single player game. Oh, and for the record, my little girl fell off her scooter five minutes later. A band-aid was all that was required. Bad advice? Nope. The ends don’t justify the means.
Do you have examples where the right thing is not the same for different people? Have you ever made a bad decision because you didn’t have all of the information?