Speaker 0 00:00:08 What's up.
Speaker 1 00:00:09 Welcome to the finance for physicians podcast. I'm your host, Daniel Raimi. Join me as we dig into what it looks like for physicians to begin using their finances as a tool to live better lives. You can learn more about our
[email protected] let's. Jump into today's episode today. Jeff and I are going to be getting into an extremely common question. We see coming up with folks, we work with question is, should I pay off debt or invest? It seems like a straightforward question. And in some cases it is, but other times it's very complicated and tends to entertain goal itself and to other areas of your life. Listen in to learn more about how we help people address this question and find out why our answers differ considerably from person to person. Jeff. What's up, buddy? Hey Daniel, it's good to be back with you again today. Yeah, man, always, always good to be with you. I know it's a rainy day outside, but you're uh, you got your happy face on, I can tell. So that's right.
Speaker 2 00:01:03 Always happy inside the office
Speaker 1 00:01:06 Today. So we're talking about, uh, the question of whether or not you pay off debt or invest. It seems like probably one of the more common questions we hear from people. And it sounds really simple. I guess it's a straightforward question at a minimum, and it can seem like a simple question, but in our experience, you know, most of the time it's, it's much more complicated. There's a lot of it tends to entertain goal in all other areas of life. And so we're going to kind of talk through, you know, how we approach that question and ideally help you kind of be in a better position to start thinking about that yourself. So I think the first thought I have is, is how come this question is so much more complicated than it seems on the surface.
Speaker 2 00:01:53 I think it's more complicated than it seems just because it's comparing something that we can give a real number to, to, to another alternative that we really don't know the outcome of. You know, it's just almost comparing apples to oranges a little bit. It's hard to, to give an objective number unless you know exactly what we're comparing for an objective response,
Speaker 1 00:02:16 Right? Like a debt has a fixed interest rate.
Speaker 2 00:02:18 Yeah. Yeah. So my mortgage, I always know what I'm going to pay every month until it's gone, but I don't know what the market's going to do tomorrow and it could be up, it could be down and there's no guarantee there. So it's, it's tough to compare the two, just from a, a guaranteed standpoint, you know, we can't just run an equation and say, this is how it will be.
Speaker 1 00:02:37 Yeah. And I think on top of that, there's the whole values aspect in life balance aspect. And I have found that a lot of times, people that are asking that question haven't really assessed whether or not their lifestyle is imbalanced with, with what their savings is. And so it can be kind of a getting the cart ahead of the horse situation. Um, you know, maybe, maybe you, your, your question you should be asking is, am I saving enough or do I have enough to work with, to start to pay off debt and past? Um, but you know, for today, we'll assume the answer to that is yes. But once you get to that point, like if, you know, you have X dollars to work with, um, I think there's a few different factors in play as far as how we sort of start to assess this, uh, this sort of question, Jeff, you want to throw out some of those factors that we kinda end to think through when we're looking at this,
Speaker 2 00:03:32 I'd say probably a big factor. There is number one, I guess what's more important to you right now is the, is your priority, is it to get to financial independence as fast as possible? Or is it to have flexibility in your life today? And you know, which one do you prioritize a little bit more than the other, or at least to have flexibility sooner? One of the things I think about often one of the myths, I guess, of, of paying off things early or making additional payments is that, you know, when you think about some of the mortgage payment strategies that are out there to get things down, that mortgage payment doesn't actually go away until you pay off the mortgage. So let's say you hit it hard and pre-pay things somewhat, but you know, there's, there's no, you didn't pay off the mortgage and then you lose your job. That's, that's even more of a problem because now you don't have additional savings to cover anything lost flexibility there. Right? And so I guess looking at the risks appropriately is a big deal too, because we don't want to have a myth for the risk that we're getting rid of.
Speaker 1 00:04:35 So your priorities, your goals are huge. The risks that are in play are important. We can, we can circle back to these a little bit more. I think also rates of return and interest rate. Like, I guess we would call that like the numbers are important as well. Another one I would throw out there it's cashflow, you kind of hit on that, but how's it going to affect your, you know, monthly obligation is a big deal. Any others you can think of Jeff, that kind of the big factors
Speaker 2 00:05:01 That pretty much hits the nail on the head with, with those different factors there. And just even assuming just, there's just a lot of assumptions that go into it. And so, you know, if we're comparing a fixed number or a fixed equation to something, we don't know, that's where it gets wishy.
Speaker 1 00:05:16 Yeah. Right, right. So the first one we hit on values, goals, priorities that, that sort of thing, you know, once you know those, what those look like for you, the key there is to incorporate it into this decisions. So for instance, like Jeff, you were saying is financial independence is a big deal for you. Maybe you are going to invest up to the level where you're on track for that, and then make sure you're paying debts off at the level that they're going to get all paid off by that point in time at the latest, right.
Speaker 2 00:05:46 Yeah, that's right. And I think a good point that you have even just in that little statement is that it doesn't have to be all or nothing
Speaker 1 00:05:52 On the options. So
Speaker 2 00:05:54 If you have your priorities set, that's probably first step so that you can make sure that you're on track for whatever your financial dependence goal is and then decide what, how to get there, what to do with it.
Speaker 1 00:06:05 Yeah. And then other people maybe you value not having debt or debt keeps you up at night causes tons of stress. And so maybe in that case, it's like crush the debt as fast as possible. And so that's, you know, it's your, if it's gonna reduce stress and allow you to live more happily than, you know, maybe that's the straightforward game plan for you and that's kind of an independent of the numbers.
Speaker 2 00:06:30 Absolutely. Yeah. Yeah. If you, you know, if you have debt that you have to pay, right, then you are obligated to have income to pay that somehow. And so once you can start eliminating that, that obligation all of a sudden, it frees up so many other options in your life, right. So it can free up what you choose to do with your, with your living, what you choose to do with your occupation. So you don't have to go pedal to the metal if you don't have as many obligations to pay.
Speaker 1 00:06:57 Yeah. So really I think I would say that's the most important thing is there it's in alignment with your values and your goals and what's most important to you. And then the second thing we had mentioned was risks. So risks in there that can be pretty broad as well. So for example, let's say one risk is job loss or, you know, income loss. You need to be thinking about that first, I think before you kind of answered this question. So for example, let's say you have credit card debt and no cash reserves. You really should be taking care of that big risk first, before you even start to address this type of question, you know, so the you're not, you're not, and also, you know, on top of that, the fact that credit card debt has typically high interest rates. Um, but what are some other risks? I know that's, that's kind of a, you know, your life risk type thing, but what are some other risks that come to mind? Yes. Yeah.
Speaker 2 00:07:48 So some other risks of the debt itself would be, I guess so far, we've been assuming that you can do both, right. You can save as, but let's say you could only do one all of a sudden if, you know, if you are choosing to pay off debt completely versus any sort of backup investing, um, like I said, the, the risk that you're going to still have to continue making payments with no reserve that that job loss is huge in that case, the other risk, right. Let's talk more about the, some other risks too in that is that we don't know what returns are going to be if our investing and we make, I think we make good assumptions and hopefully we make conservative assumptions based on what history has shown us. Um, but the truth is we don't know. And so, you know, if, if it turns out that, you know, investment returns do turn out flat for the next 10 years, and you're paying off between that and paying off your mortgage in 10 years, all of a sudden that advantage that you think that would be there for investing at least breaks even rather than being a wealth advisor.
Speaker 1 00:08:51 Yeah. So for that, I think you have to look at your own tolerance for investing risks or just overall risks with your assets and liabilities. So for example, paying off a debt is a very low risk move from the standpoint of investing because you're, you know, you know, for sure you're going to avoid paying interest, it's a set rate. And, you know, you know, what the cost benefit is, it's easy to quantify on the other hand or the other extreme investing in, you know, high risk investments, that's high risk and you short term, especially, you're not, you don't know exactly what it's going to do. You have to be able to hold it for a really long time to realize that return. And so you have to be able to incorporate your tolerance for the risk. And then also the time that you have to take, you know, the time available to do what we're talking about.
Speaker 2 00:09:43 So I'd say that's definitely true that that kind of sums up the, a number of the risks and how to evaluate them, I guess. So how do we look at then? I mean, when we look at these risks, how do we look at, how do we mitigate some of these? It seems like sometimes in our, in our planning, we, we have some boring parts of the plan that I guess nobody maybe really gets excited about like just having cash on hand, like, but that plays into the equation too. How much could you fund, you know, in the event of an emergency to even be comfortable to build on these things?
Speaker 1 00:10:12 Yes. A mitigation having cash reserves or even having insurances like having disability insurance, it's like income insurance, having those sorts of things in place, kinda like help you be in a position to be able to actually execute on this, this sort of thing. The problem is, you know, investing or paying off debt typically for most people requires income. So if the income stops, you have a problem. And so there is mitigation strategies that are, you know, fairly straight forward. So that's kind of behind the scenes that, you know, or I guess, uh, should be considered even before you're addressing this question, let's say you've gotten, you've kinda squared away all the risks, or at least you feel comfortable about it. And, um, I think the next big thing is returns or interest rates or that sort of thing. I know interest rates are a little bit more straightforward and I think there's some obvious situations where, you know, it makes sense to pay off debt first over investing, but what's, what's kinda the con the big considerations here when we're starting to look at, uh, you know, your ROI and return on investment or interest rate type stuff.
Speaker 2 00:11:17 Oh yeah. You know, a big one right now is, is what is your interest rate, right? Because there's such an opportunity with refinancing or new mortgages who have a very low interest rate historically. And so, I mean, it's almost hard to make a mathematical case based on historical returns, not to pay or invest instead of, um, you know, paying off a mortgage earlier, because if you're at 2.5% there in a mortgage, it's almost almost impossible to not, not beat that by doing some kind of investing for long-term investing. For sure. I mean, yeah, if you look at it, if you invest today and, you know, next week we have another, uh, amazing, you know, COVID news story or, or the election happens in another week or two, right. Or, um, you know, that the returns could be up or down either way but long term. I mean, if you lock in at 2.5% interest rate, uh, if we, if we're not beating that with investment returns over 30 years, we might have more financial problems than just the interest rates.
Speaker 1 00:12:19 Yeah. And that's one of the advantages of debts is you can kind of like, I guess, refinance it. So you can, there's nothing really comparable to that with investing with, with debts, when interest rates overall go down, you can consider refinancing and like mortgage rates. You're saying, you're saying, you know, two and a half percent is kind of a norm right now. And so that's an extremely low rate. Student loans are kind of funky right now, too. They're the federal loans like the stated rate is, you know, six to 7%, but the government is waving all interest at this point. So really their act actually like a 0% interest rate. So if you can get any interest in the alternative investment, then that's going to be better than 0%, but is it, so if we're looking at the interest rate of the debt and comparing it to the return of the investment, you know, a question that might come up is, is it as simple as just comparing those two numbers to decide kind of, which is the higher priority and so that it can be, but that's not exactly apples to apples though.
Speaker 1 00:13:22 We had already hit on the fact of the risk and, you know, values and that sort of thing, but there's also, um, taxation is a factor. And so when you invest, in some cases, you can filter the investment from taxation. And so that's, you know, effectively like a better returning investment than an alternative that is not sheltered from tax. That's a great point. And then on debts, sometimes mortgage interest, for example, is sometimes deductible or student loan. Sometimes you can take a little deduction. And so, um, taxes are a factor in the whole equation. That's one that comes to mind. The second thing is, as far as with debts, it's, it's not a permanent, it's not, you can't just leave it there, like an investment, you set it in, you know, the return expectations should be indefinite versus what the debt like, there's an end date. Like you can't avoid, you know, it's not like a long, unlimited time Verizon type thing for as long as you have the money in there though. They're definitely not apples to apples, but I think it is, you know, that's how we look at it as we start to kind of look at the percentages of, of each of them. So I'll give you some easy examples, like credit card debt has 10% interest rate and an investment I'm thinking about maybe investing, even though I have no credit card debt, like
Speaker 2 00:14:35 Gotcha. Yeah. So, you know, what, what would you say historical, you know, investment returns have been on a, on a portfolio that's, you know, heavily into stocks, 80, 20, 90, 10, uh, percentage of stuff,
Speaker 1 00:14:48 Less than 10%, less than 10, right.
Speaker 2 00:14:52 If you're being conservative on it, you know, I mean, you might hear numbers all over the place.
Speaker 1 00:14:56 That's what I would say for the purposes of this conversation. I would say probably less than 10%, but that's a risky investment too. So paying off a 10% credit card debt is a good, you know, you're guaranteed to avoid the interest, okay.
Speaker 2 00:15:10 With credit card debt, there's no tax benefit to it at all. And I mean, I'm not a big fan of, of getting debt just for a tax benefit anyway. But if there's not a benefit at all, then that's a guaranteed 10%. And by the way, what credit card do you know? That's 10%, if you don't even know that was a bad example. Yeah. You're probably talking to probably credit card at 29%, but even if it is 10% compared to a 10% variable return, let's say the market's returning 10% and the credit card is 10%.
Speaker 1 00:15:40 The tie goes to the credit card, right?
Speaker 2 00:15:43 High goes with the credit card. Cause that's guaranteed. No that it's 10% savings on every dollar you put towards it. Um, you know, with the market, it could be, you know, negative 3% this year. It could be 20% the next year. It might average 10% in the long run, but I'd take a steady climb instead of a roller coaster if I have the choice.
Speaker 1 00:16:02 So let's get into a little bit harder, uh, examples. So let's say you have a 7% student loan interest rate, and you're comparing that versus let's start with the work 401k. So do you pay off your student loan at 7% or do you start to invest in your new work, your new four Oh three B
Speaker 2 00:16:24 Oh buddy. So that's a, that's a really good question because, um, you know, let's even PR um, so many people we work with are dealing with public service loan forgiveness, but let's not even think about that in this park that for now, because that gets, yeah, that's a whole nother conversation, but even that let's look at the tax savings you're going to have, especially, it's going to look at, we want to look at what are your taxable earnings basically. So yes, if you have a high income and let's just ballpark that if that 35% federal tax rate, so, you know, for every a hundred dollars that you're putting into a tax sheltered, a pre-tax account, like your four Oh three B that's, you know, that's 35%, uh, tax savings. Whereas you've got to factor that in to the equation. Add into that. Let's I mean, I know there are break points on student loan, interest deductions too, but if there's any interest deduction that you get on your student loan as well, I mean, it starts to make that rate smaller effectively and the, you know, the tax savings you'd have on the pretax account would be an exponential benefit.
Speaker 2 00:17:29 So if I was going for those two, I would absolutely lean towards maxing my pre-tax accounts. Assuming, assuming that cashflow is, is comfortable and all that other stuff.
Speaker 1 00:17:39 Yeah. And they were, there might be a match on the work plan to that. That makes it a no brainer. The, if there's a match on your retirement plan through work, you pretty much do that before anything. But, um, I'm talking, we're, we're kind of talking about money above and beyond that. And so the, the, what I would say all kinds of cheat and throw out a different variable, what I would say is, you know, refinance your student loans, get them down to get them down to 3% and then put it in the work retirement plan because it's too hard to design. 7% is kind of, I would lean more towards that's a harder guaranteed avoiding 7% is pretty enticing to me, the market, even, I mean, it is the tax benefits are very, uh, enticing. I would probably, I think if I was push came to shove, I would lean towards the same opinion.
Speaker 1 00:18:25 If what you're saying, Jeff is I would lean towards the work retirement plan, but it's definitely a difficult decision right there. And you have to incorporate your values and goals and your personal preference, that sort of thing. And so that's it for the sake of today, we probably call that a toss up. But, um, you know, if you can refinance your student loans and pull them down to 3%, that becomes a much easier decision, you know, cause 3% versus your expected return on your investment, plus the tax benefits of the work retirement plan, kind of a no brainer, right?
Speaker 2 00:18:53 Yeah, absolutely. If you can, if you can get that type of a discrepancy in the interest rate and what your, especially the tax savings are just huge at that point. And like you said, too, it doesn't have to, you really don't have to be all or nothing. You can make sure you can prioritize, get your match first and make sure that you take advantage of the super awesome portion of, of saving in a free tax account. And then you can then weigh the decision. Do I do more to the pre-tax account to the four Oh three B or do I pay down student loans? So it doesn't have to be all or nothing, but there's a priority system there you can work on.
Speaker 1 00:19:27 Yeah. So I ideally that's, that's going back to the kind of where we started is ideally the, the biggest thing is that you're taking into consideration your own priorities and what's most important to you and where you want to go and tailoring that to the deciding which direction you go. You're also thinking about some of the uncertainty and addressing the risks, kind of making sure they're covered first and then also taking into consideration how much risk tolerance you have for investing in the first place. And then at that point, you're in kind of a good position to do the numbers, you know, compare the rates or whatever, but you have to remember to be strategic too. So, you know, going back to the student loan example, um, you know, if you can refinance debts, that's kind of a strategic way to, to help make that more efficient right off the bat.
Speaker 1 00:20:11 And then ideally if you can kind of balance all that together, that's really what it comes down to is kind of balancing all of that for your specific situation. And, and, um, you know, that that's where we're going, right? And that's, that's where we get the happy life. That's how we get to be. That's how we get to be like John always happy. Awesome. Well, Jeff, uh, good chatting with you as always. It's been a pleasure Daniel as always. Thank you so much for joining us today. If you found this valuable, please give us a review on iTunes and share with a friend. Also check out our
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