Let me start by saying that I am a huge Dave Ramsey fan. When I completed residency and began my current position, The Total Money Makeover was the first personal finance book I read, and pardon the cliché, but it changed my life. It instilled in me a strong foundation in money management and offered me a road map to handle the situation I was in: hundreds of thousands of dollar in student loan debt, starting my first real job at age 31, thinking about buying a home with a wife, three kids and no significant assets.
My first instinct was to, “put a little toward student loans, put a little toward a down payment and put a little toward investments.” Dave Ramsey convinced me that this was not a good idea just starting out and I agreed.
I used Ramsey’s “debt snowball” plan to get control over the many different types of student loans I had including some from my undergraduate days. After quickly taking care of some of the low balance loans, I was able to put more toward the larger balances as each smaller one was paid off. Is wasn’t long before my initial debt was cut in half. This is where I strayed from the Dave Ramsey path.
Earmuffs Dave: Invest while still in Debt?
Once my student loan debt was manageable to me, meaning I felt my income was high enough and consistent enough that I could easily pay off my loans in less than five years, I started to put a little more money(I was already maxing out my 401k) toward investments and a little less toward my loans. These investments were in the form of a defined benefit plan, three 529 plans and a taxable investment account.
The reason I decided to take this route was my loan interest rates were 3-4%, but over the previous 3 years I was averaging >10% in returns from investments. So naturally these numbers led me to explore this other option, because 10 is more than 4, just ask my friend Shel Silverstein. Is this always the right move? No, there aren’t guarantees with investing. Should you at least consider another option? Absolutely!
This is about opportunity cost, the cost of choosing one route versus an alternative. If you are putting all of your time, energy and money into paying off your student loans and mortgage, that leaves very little if anything to invest. You’ll have given away precious years of compound interest growth at an average rate around double the rate of the loans you are paying off.
Side note: this does not apply to high interest debt like credit card balances, that debt needs to be paid off ASAP, Dave Ramsey style.
Other side note: I also respectfully disagree with Ramsey that credit cards are bad, I contend they are excellent for rewards as long as you pay off the balance each month. But that’s another topic for another day.
I’m definitely not presenting the right way to do things or suggesting that you shouldn’t put 100% of extra money toward debt payoff. Each situation is different-loan size, term, interest rate, income, investment risk comfort, age, job security.
I am merely offering another view, another opinion, or even another second opinion. Did you see what I did there? Because of the name of this site…Another Sec..whatever, let’s get going:
Three young doctors
Let’s say there are three young doctors, fresh out of training with $100,000 in student loan debt. To pay the student loans off in 10 years, the minimum monthly payment is $1,012.45. Let’s now pretend that each young doctor has an additional $1987.55 to either put toward loans or invest ($1,012.45 + $1,987.55 = $3,000). Once their loans are paid off, each will put the all of the money toward investing, $3,000/month. Finally, let’s pretend that we follow their journey for 10 years.
Before we get started though, we need to make some assumptions:
-$100,000 student loan with a 4% fixed interest rate
-No tax deduction for the student loan interest because their income is too high
-Stable income so they don’t need to deviate from the plan
-8% annual market gains
-Investments aren’t sold during the 10 years so no capital gains tax
-Dividend tax is also negligible (either small dividends or tax sheltered account)
Young Doctor #1
Just read The Total Money Makeover coming out of residency and wants to stick with the plan. She will put all of the $3,000 toward student loan payoff each month. Her loan will be paid off in about 3 years, after which she will invest all of the $3,000 each month.
After 10 years, she will be debt free and have an investment account worth: $334,976.84
Young Doctor #2
Just read Rich Dad, Poor Dad and is determined to build assets which will lead to passive income. He wants to just pay the minimum toward student loans and invest the remainder, $1,987.55. By just paying the minimum, it will take him the entire 10 years to pay off his loan.
After 10 years, he will be debt free and have an investment account worth: $360,309.42
Young Doctor #3
Just read both books and decided to hedge her bets a little by paying more than the minimum on her student loans, but also investing at the same time. Of the $1,987.55 left over after the minimum payment, she splits it in half and directs $993.78 toward student loan payoff and $993.78 toward investments each month. Her loan will be paid off in 4.5 years, after which she will invest all of the $3,000 each month.
After 10 years, she will be debt free and have an investment account worth: $345,529.58
Conservative vs Aggressive vs Moderate
These three young doctors will all be debt free in 10 years, but will have different amounts in their investment account because of their difference in risk tolerance.
- Physician #1 (loan payoff priority): $334,976.84
- Physician #2 (invest first priority): $360,309.42
- Physician #3 (contribute to both): $345,529.58
If you want to be as conservative as possible, then you’ll make it your primary goal to eliminate debt. If you are a risk taker, you’ll accept being in debt longer with the tradeoff of probably having more money when it’s all said and done. If you’re like me, you’ll probably try to find a good middle ground: more aggressive than conservative, but more conservative than aggressive, or conservatively-aggressive?? Some may also call this being a moderate risk taker. Of course this is a spectrum and you can adjust your risk however you’d like.
So let’s pretend I did just grab the microphone from Dave Ramsey at a personal finance video awards and gave my spiel. After I dropped the mic(camera cut to Beyonce giving a standing ovation), I would pick it up, hand it back to him and chances are, he’d say something like this:
“We buy things we don’t need with money we don’t have to impress people we don’t like.” -Dave Ramsey
Chances are he’d also slap me.