I have no financial or other relationship with the good doctor, and as far as I know, The Physician Philosopher has no relation to the physician known as The Happy Philosopher. They just both happen to be happy philosophizing physician bloggers.
Today, TPP is talking about how carrying student loans should change the way you approach asset allocation in your portfolio of investments. Take it away, TPP!
Growing up in a house where credit card debt was as common as a Florida rain in the summer, debt had been normalized for me. I didn’t have a healthy fear of debt. It was a necessary evil. I remember signing my first master promissory note in medical school stating that I’d be okay with paying down my debt, and thinking how awesome it was I was getting “free” money.
My future self now hates how little I did to prevent the amount of debt I accumulated back then, but I simply didn’t know better at the time. However, debt is a reality for most people graduating from medical school (or dental school or law school or any advanced degree program) these days. Today we will discuss how student loans fit into our overall diversified portfolio and how we should view this pile of money we owe to someone else.
A Diversified Portfolio
On many financial websites, you’ll often hear the term “diversified portfolio”. The idea behind this is that you are invested in a wide array of assets, which will help protect you from the turbulence of the market. This can occur in two major ways. I’ll discuss each and how student loans fit in.
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Stock / Bond Ratio
The idea here is that you should have a good mix of stocks and bonds. For example, some people propose an 80/20 model, which means you are investing in 80% stocks / 20% bonds. Many argue that as you transition closer to retirement you should have a higher proportion of bonds. The premise is that while bonds provide historically lower yields, they are also more stable (less volatile) and provide relatively guaranteed returns, unlike stocks. Stocks have the potential for greater rewards, but with that potential comes much greater volatility. Having a good mix provides diversification.
Given that I am a young attending (32 years young as of this writing) and have a long horizon prior to my retirement, my Stock/Bond Ratio is 1. I have discussed my portfolio before, but essentially I am 100% stocks via various low-cost index funds. Many financially minded people will (wrongly) tell you that being 100% stocks shows two things:
1) “You have obviously not had your first major correction yet. We will see if you are 100% stocks after that!” This is a ridiculous line of reasoning. I am actually hoping for a Bear market for the next five years so that I can buy all of my mutual fund investments while they are at a discounted price.
The market always corrects back. You simply need the mental fortitude to stick to the plan. And if it doesn’t correct, we are all up the creek. Not just me.
2) “You don’t understand how it works. Bonds provide you stability during the times when the market corrects.” I agree that bonds are a form of protection and stability in a down market. When stocks dip, bonds can sometimes rise. However, this is not the only way to protect against fluctuation as we will discuss here in a moment.
The other way to diversify is to make sure your asset allocation places your invested stocks into multiple parts of the market. For instance, I have 55% large caps in my 403B at work while I have a smaller portion in international index funds (~5-10%).
Student Loans, The New Bond
Unfortunately, debt is a necessary evil for most of us who have obtained an advanced degree. To put a positive spin on my debt, I like to think of student loans as another source of diversification for my portfolio known as Student Loan Bonds. [In case you are curious, I am not the only one who thinks of student loans as bonds].
It is a completely different (negative) asset class. As I pay down my debt, I am increasing my net worth. Therefore, Student Loan Bonds are certainly an investment that will provide more wealth. How exactly do Student Loan Bonds fit into the diversification mentioned above? Glad you asked.
The reason that I think of student loans as Student Loan Bonds is because I have an interest rate on my student loans (~3.6% most months) that is just about as “Guaranteed” as any bond you will find, no matter how high the rating. I have a 10-year variable rate with intentions to pay off my debt ($180,000 at end of fellowship) two years after graduating from fellowship.
During my first year as an attending, I am set to invest $75,000 (in all stocks) and to pay off about $80,000 in debt. So, despite looking at the TPP Portfolio, which holds 100% stocks, my stock to bond ratio is actually upside down. I have 48% in stocks and 52% in Student Loan Bonds.
Having any investments in bonds at this point seems redundant to me until my debt is paid off. I get the guaranteed rate and protection I desire through my Student Loan Bonds. Two years after graduation when my student loans are gone, I will likely transition to a 90/10 stock to bond ratio until I am 40.
Surely, you can appreciate that student loans are an entirely different animal. They don’t fit into any of the definitions I’ve mentioned before (large cap, mid cap, small cap, international, REITS, etc). Therefore, paying money towards my debt is actually a type of asset allocation diversification.
If you think that bonds provide a sure and steady rate of return, I promise you your student loans likely provide the same. For example, as of today, the Vanguard Total Bond Market Index Fund has ranged from 1.91% returns over the past five years to 3.84% over the past ten years. Your (refinanced) student loans are likely right in the middle of those targets, and if you haven’t refinanced and are sitting at >6% interest, then this isn’t even a conversation. You should be hammering away at your debt.
Take Home Point
If you are asking the question of whether you should invest more aggressively or pay down debt, I encourage you to do both aggressively. Student loans can serve as a form of diversification and produce the guaranteed market stabilization that you seek from bonds. Investing in bonds while you have a substantial amount of debt, particularly early in your career, could prove redundant.
What do you think? Can student loans perform similarly to bonds in your portfolio? Do you see a need/space for bonds in your portfolio if you are aggressively paying down debt?
[PoF: While I appreciate TPP’s perspective, and I would guess many young physicians with a long investing horizon would choose to approach asset allocation in a similar manner, I’ll play the devil’s advocate and offer a different perspective.
By putting $75,000 towards stocks and $80,000 towards student loans, TPP looks at that as a stock / bond ratio of 48 / 52. But, do you recall when he referred to those student loans as a negative asset? He’s right! He’s not holding bonds, he’s holding negative bonds.
By paying down those bonds, it’s fair to say he is investing, but certainly not invested at a 48 / 52 ratio. I don’t know his current portfolio or student loan balances, but let’s say he’s got $110,000 invested in stocks and $100,000 remaining on his student loans. Leaving out other assets for the sake of simplicity, he’s got a net worth of $10,000 and $100,000 is invested in stocks. That’s like a 1,000% stock allocation. A 10% drop in the value of the stock market (like we had last month) would wipe out his entire net worth!
Now, I’m not arguing that he should invest in 100% bonds until his loans are eliminated, but it’s best to differentiate between the current asset allocation of your portfolio versus how you’re allocating your ongoing investments.
The same could be said for holding a mortgage. Jonathan Clements makes this very point in How to Think About Money. Someone with a paid off house and 100% stock allocation is actually invested less aggressively than someone with an equal stock and bond mix and a mortgage balance that exceeds the bond balance.
Food for thought.
This thought exercise, though, only further validates TPP’s aggressive loan payoff strategy. Eliminating a negative bond (student loan, mortgage, or other personal debt) gives you a lower-risk portfolio as a whole.
To learn more than you care to know about student loan repayment, refinancing, forgiveness, and more, take a look at my student loan resource page. For those of you not pursuing Public Service Loan Forgiveness, I’ve negotiated excellent cash back bonuses through eight top refinancing companies; their current rates are listed here, as well.]
Finally, be sure to check out The Physician Philosopher if you were intrigued by what you read today.
I’m 100% debt-free now, but I’ll be honest – I never adjusted my asset allocation based on my debts. I might think about it a little differently if I was carrying significant debt today, though. Based on what you’ve read today, how do you view your asset allocation?
47 thoughts on “Got Student Loans? Alter Your Asset Allocation.”
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Interesting post, TPP! I have to disagree with your classification of your loans as bonds but agree that paying down the loans gives you a guaranteed return of whatever the interest rates on the loans are.
We are invested primarily in stocks in our 401(k), 403(b), and brokerage account. We significantly slowed down on investing last year to focus on aggressively paying off our debt. Up until that point, we had been maxing our retirement accounts, so we’re okay with pulling back for a little while. The interest on my husband’s med school loans is killing us, so we’d prefer to attack the debt first.
Thanks for the comment!
And I hear you, they are certainly not identical to bonds. I suppose I really am focusing on the guaranteed return aspect of it.
I think maxing out your retirement accounts before hammering away at debt is a good idea. If the income isn’t quite high enough to do that, then it makes it tough choosing between the two.
As I have said before, so much of this behavioral finance. However you need to think about it to make it okay to destroy your debt and invest aggressively. The biggest determinant of your success early in investing has little to do with how much gained interest you experience. It’s all about your savings rate. But we need to detest, abhor, and loathe our debt.
Thanks, TPP! Our income is high enough to do both, but then we wouldn’t be paying off the debt as aggressively as we’d like. To be clear, we’re still investing, just not nearly as aggressively as before.
We maxed our retirement accounts and topped that up with investments in our brokerage account for 2 years before we decided to focus on our debt. We should be able to pay all of our student loans off within 2 years or so of my husband finishing his residency this June. We’re also planning to aggressively tackle our mortgage, but we’ll likely bump our investing back up before we do that.
Once we’re done, we’ll have this ridiculous income to pour into investing without anyone else taking from it. We’re only 28, so we figure hardcore investing starting at 30 is still a pretty good plan.
Personal finance is personal, so I don’t think either of us is wrong here…although I, of course, think one of us is more right than the other. 😉 Lots of our colleagues feel the same way you do about investing and paying down debt at the same time, though, so you’re definitely in good company.
Interesting post. I agree with you. At your age, 100% in stock is fine because you have a long future of earning ahead of you, so you can earn your way out of any downturn.
I disagree that stocks are on sale after a correction or that they always come back. This vastly understates the risk of investing in equities. Staying the course means investing the same way when stock prices run up as when they crash.
Student loans are not bonds to borrowers. I have seen this line of thinking on several finance sites. I assume the link in the article is for investors in student loans, not borrowers. If you have $100k in bonds and $100k in loans, your net worth is zero, but your net bond position in $100k. Investors leverage bonds all the time. You can too with a margin account. Having debt on your personal balance sheet increases your investment return (assuming the interest on your loan is lower than the expected return on your investment) and increases your risk. That’s it. No need to overthink things.
I didn’t mean to imply that I time the market. I am definitely against doing that. I just meant to say that I’ll continue to invest regardless of what the market is doing. That way, if the market comes back up (which it always has) then I will be buying stocks at a price less than what it will be in the future. As opposed to simply looking at my accounts dwindling by the day.
I recognize that we could pull a Japan and crumble to nothing and stay there for 10 or 20 years. If that happens, most of us are in trouble even if only half of your accounts are in American stocks.
I completely agree with what you are saying. I think my post is more behavioral finance in nature than anything. It’s a way to encourage you to both invest and pay down debt aggressively. And, hey, 100% for a few years at the beginning of your career probably isn’t going to hurt you. But it could help.
I’ll speak from personal experience, as Dr Shirts (my better half) was fifteen months into practice when we took a market shalacking starting in September of 2008. Instead of going heavy in stocks, we were aggressively paying down debt. There’s a psychological barrier that shows up, everyone is telling you how bad things are so we attacked the loans creating fixed costs instead of being more aggressive with our investments.
Food for thought…as one of my favorite modern philosophers (Mike Tyson) said: “Everyone had a plan until they get punched in the face”
I think that’s spot on (your plan to pay off debt). I am pouring money into my debt (about $90K per year if you include the bonus money I am putting into it). The only thing I am doing prior to putting that money in is to max out my retirement accounts (403B, governmental 457, and backdoor Roths for my wife and me).
I am VERY much of the philosophy to “set and forget” things when it comes to investments. I think this is crucial because of the behavioral finance behind it. There are studies that show the more often you check your investments, the more likely you are to change something, and the less money you’ll make.
Either way, the two thoughts that will make keep me content if/when the next market correction or bear happens:
1) The market should come back up. If/when it does and when I have continued to dollar cost average throughout the down market, I’ll be better off. Jonathan Clements in his book (How to Think About Money) gives a thought experiment to his class that shows that a down market early in your career, such as the two years I’ll be 100% stocks, followed by an up market later is the best way to grow money. POF has benefited from this greatly and calls it the “nike swoosh” market.
2) I am putting a bunch of money into loans with guaranteed returns that didn’t go into the market. This protects me some.
Minor point. TPP says “my Stock/Bond Ratio is 1.”
100% stock portfolio means that ratio is infinite (or mathematically undefined.)
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This is a really interesting take on student loan repayment. If I had realized I could have refinanced my student loans, I think I may have done something similar. Mine were at 8.5% though (!!!!!) so the daily interest accrual was enough to light my hair on fire. The low rate you’re talking about is similar to my mortgage though, and I’m not paying that off early.
8.5%? ???? That’s highway robbery!
Man, there is a reason that most personal finance websites have Student Loan Refinancing Pages (including my own). First, they provide a service to our readers. And, second, they provide a kick-back bonus for both sides. Truth in advertising.
Seriously, though, refinancing student loans is huge now. I had a resident tell me the other day that they have $500,000 in debt. It’ll probably accrue to $600,000 by the time he finishes. Oh, and he isn’t doing PSLF 🙁 Yikes.
Yeah, I cringe to think about how much extra I paid in interest even with paying them off quickly. But they’re gone now, so there’s that.
Well you are better off than me! That’s strong work. Congrats!
I can relate to that. I’m a dentist with about $550k in just dental school loans and they are consolidated at 7% interest. Doing the Pay As You Earn (PAYE) income based repayment so I’m stuck with them for 20 years (only 17 more to go!). Even with refinancing the monthly payments would have been too much to handle from the get go.
Physicians seem to be a little better off than dentists when it comes to student loans vs income ratio but it’s pretty ridiculous what an education costs these days.
I actually did a post on some of the most common causes of burnout and one of them that I included was on how debilitating the debt is for many graduated students. I was blown away by how much debt the average dental student incurs. So much so that I included the number in my post.
When your debt to income ratio gets > 2… PSLF really should be a top consideration. It sounds like you are doing PAYE already. I imagine you must work for a private group, which is why you cannot take part in the PSLF. Many of the private refinancing companies actually won’t refinance debt as high as 550K. Some will, but I bet it’s at a premium.
Thanks for the article. We just finished paying of 300K student loan debt in 2.5 years. I didn’t consider it a negative asset class per se. I saw it as a pain in my asset 🙂
I am glad it is gone, and by aggressively paying it off, I was able to forge behaviors for our family that will help build wealth in the near future. I think this is lost in the invest vs pay off debt debate. It was way easier to get my wife on board with a tangible goal. It was very fun to see that number dwindle away and to celebrate when we paid it off. Now we can keep the same habits and aggressively invest. The behavioral side of personal finance is so important, and for most people it is easier to mold that behavior with aggressive debt pay down.
There is certainly much of this that is psychological. Whatever helps you fight the urge to hurt yourself (poor word choice?) in the market is crucial. That could be paying down debt so it is more “in your face” or it could be having someone hold your hand through a bear market.
Behavioral finance is not to be underestimated in how important it is to financial success.
I did similarly and it worked out, but now that I see it on paper I’m not sure I didn’t just get lucky with my timing.
Also, I used to wish for the big beat market, but saw a study recently about it that showed most investors do better long term without it for various reasons. One being fearing the market and staying out too long.
Also, love that there is an edit button. Writing from the WCI conference hotel and still a little groggy…
I think that study is true for exactly the reason you said, down markets usually prevent people from putting money into it. If you understand the basic mechanics of it all, you won’t pull your money or stop putting new money in during a down market.
You are right, though, a down market is not good for anyone who is does not have the mental fortitude to stay in the market and keep dollar cost averaging along the way.
I love the edit button, too! And the follow up to replies to your specific comments. I don’t follow many comments on other blogs because I don’t want to see the other 99 comments that don’t relate to mine a lot of the time. Though sometimes I do.
I treat my mortgage as my bond allocation for new money. I still have bonds I just don’t currently buy new ones instead paying off debt.
Liquidity ultimately matters to some degree.
What do you think your percentage split is between stocks/bonds/cash? Sounds like may have a pretty high allocation in stocks based on your comments. Are you going to stay at that allocation until the mortgage is paid off?
The major difference between a mortgage and student loan debt is that I have a choice to pay the first (I could move if something major happened) as opposed to have to pay back my student loans eventually whether I want to or not. I would be less aggressive viewing a mortgage in the same way because of its optional nature and the fact that it is usually paid off on a much longer time line.
I never adjusted my asset allocation of cation either, but I did count school debt as a bond like investment. Every dollar in was a guaranteed return. I still paid it off as quick as I could and now I still remain 100 percent I. Stocks.
How long do you plan on staying at 100%?
When we were paying off our much more modest $50k In student loan debt we were investing at the same time. However, we did focus on paying off our debt very aggressively, and that’s worked out well for us.
I didn’t adjust our stock allocation, plus it was a pretty short period of time.
Thanks for the comment, Mrs. Kiwi!
I’ll be in the same situation. I am only taking this approach for the two years following my start as an attending physician. After that, I’ll switch to 80/20 most likely.
The key to this approach, is that it must be fast. I don’t think its smart to stay in 100% stocks forever. And, many would argue, you should never be 100% stocks 🙂
I always eliminate any personal debt. It is a guarantee win and straightforward to do. We aggressively saved our way to FI. It happened quickly enough that I don’t believe my investments had much to do with it. It is only now that I need to start investing since I will be using equities as an inflation hedge.
Early on your savings rate matters dramatically more than the type of investment or the amount compounding interest. That said, if you lost 80% of it on speculation that’s not good. It needs to be a solid plan (such as the low-cost index funds that I invest in).
I can’t tell, though, if you are saying you need to pay off your debt BEFORE you invest. In that case, I disagree. I think you need to be doing both. Otherwise, you are likely leaving money on the table. I fully support filling up all of your retirement vehicles first and then use any remaining cash to pay down debt as quickly as possible (while avoiding lifestyle inflation).
I plan to keep about 30-33% of investable assets in the public equities market even when I am fully invested. Otherwise I use GIC/ CD’s and real estate. The GIC’s are insured/ risk free and real estate is a more controllable and tangible asset. I am a great believer that after a while, why take risks if you do not need to. Medicine is already such a mammoth wealth generator. And you are correct, I am happy to leave money on the table at this stage.
It’s been said more than once, “If you’ve won the game, stop playing.”
I know some aren’t big fans of this motto… but I cannot say that I am. I’ll be stepping back when I become FI, though I may not quit completely.
I think the concept of thinking about student loans in this way is interesting. However, how do you think about it if you on say the public service loan forgiveness plan as a doctor. Now I am a Dr. (Ph.D.) not an M.D. (I have stayed at the Holiday Inn a time or two) but I am on PSLF, primarily because of my wife’s student loans and mine combined. How does the logic work with say PSLF for doctors, lawyers, etc in different kinds of jobs.
I guess I should have included that in my preface. This sort of mentality only applies to privately refinanced student loans.
I have some posts coming up in the next week or two on PSLF and private refinancing options.
If you are doing PSLF, your goals should be the following:
1) Keep your monthly payments as low as possible.
2) While in residency, you should try and take part in any program (for example, REPAYE) that will reduce your interest rate just in case the government goes back on their promise.
3a) Make 120 consecutive payments over ten years and get forgiven
3b) If you don’t think 3a will actually happen, invest the amount of money you would have been putting towards a privately refinanced student loan payment into a taxable account. That way, if the government doesn’t follow through, you have a back up plan of some kind to pay off the debt.
I would NOT encourage you to aggressively pay off your debt if you are doing PSLF. Your goal is to get the most forgiven.
TPP, interesting take on your situation detailed in your guest post. Looking forward to reading more posts over at your site! I also agree with your approach for the PSLF – all very strong points. Perhaps a more detailed post on scenarios to consider in your 3b step would be a good read : )
I’m on it! I’ll write up a post on the subject. Let me know if you have any other post ideas you want me to do the leg-work and research on. Always happy to help out!
I like this article. I have finished paying my student loans, otherwise I would have used this. What I got is that go aggressively towards investment and loan. I was more aggressive towards loan after I started developing deep hatred for it.
A deep hatred for loans and debt is essential for ridding yourself of it. Strong work!
Ummm… I’m not sure. I really like TPP, his blog, and his writing in general though. Maybe I’m reading this too early in the morning… but I find the logic confusing. I don’t see debt as an asset class like bonds.
I did think about buying stocks “on margin” when I was equity investing despite a mortgage though. Debt adds a layer of leverage and risk.
It is all simpler and stress-free when you have no debt. I advocate for eliminating debt completely as soon as you can. I recommend we see it as our enemy, not as our friend.
Those arguments against 100% stock investing sound like something I would say too. Although intellectually I accept 100% equity as an option since it is rational. The issues I have are 1: this may be the top of a long-running bull and 2: I’m not a rational being: I’m an animal with emotions. My frontal cortex only kicks in occasionally to rationalize the emotional behavior I just took. So for me, I’m down to about 40% equities right now.
Thanks for the comment, WealthyDoc! Let me do some explainin’ 🙂
1) I am only taking this approach til my debt is paid off. Maybe this is an emotional way to deal with my humanity and force me to pay off my debt even sooner. I’ll probably scale back to 80/20 once my debt is paid off in 18 months.
2) I have such a long investing horizon I think the chances that my 100% stock investments (placed over the next year and a half before I transition to 80/20) don’t come back up over a 30 to 40 years is extremely low. Yes, we could pull a “Japan.” But if that happens we are all in a lot of trouble. Even if only 50% of your assets are American stocks that is going to hurt a lot.
3) I do NOT advocate for this approach for anyone who is further along in their investing/retirement timeline. The only people I would ever encourage to do this are people who are going to hammer away at their debt and get rid of it entirely in the first 2-3 years after training.
I, too, don’t necessarily view debt as an asset class as much as I view it as another thing I am putting hard earned cash towards that has a guaranteed return on me building wealth.
What timing! I just finished chapter 4 of “How To Think About Money” that just so happened to detail student loans. I looked down to check my Twitter feed for the newest WCI/PoF post and what do you know, a real life physician example of that chapter. Thanks TPP. I look forward to continuing to read about your journey as I am just a couple of years behind on the anesthesia track.
Welcome aboard, Jake! Thanks for taking the time to read the post and check out my website. Anesthesia is a good gig, and I would do it all over again if I had to go back. Good choice!
Thanks for the guest post, POF!
A few comments about your comments!
1) I am fortunately young in my career. So, this helps me in a couple of ways. I have a very long horizon before I need any of this money. I have time to recover if and when it dips and I’ll continue to dollar cost average my way through any bear market.
2) I have some liquid cash set aside for an “emergency fund,” too. So, technically, I am not 100% stocks.
3) I agree completely with your current asset versus future asset comment. The moment that my student loan debt is paid off (18 months from now, or 2 years after finishing training), I’ll start allocating in a 90/10 or 80/20 (stocks/bonds) method.
4) What matters most early in your investment career is your savings rate. Very little of your success early on has to do with compounding interest or money saved or lost in the market. Now, taken to extremes, that isn’t true. If I bought $50,000 worth of bitcoin and it tanked 75% that would be a problem. However, all of my stocks are low-cost index funds that are placed each month. So, unless America pulls a “Japan” in the next two years, I am going to be okay.
5) I love that book (How to Think About Money). Worth every penny, and it is a very short read. I’d encourage anyone to read it that hasn’t.
Really looking forward to seeing what others think! Fire away and I’ll try to answer when I can today.
On Jonathan Clement’s website (Humble Dollar):
“Bonds pay you interest. Debt involves paying interest to others. Got $100,000 in bonds and $100,000 of debt? Your net bond position is zero.”
Does that have you rethinking your decision to wait until the loans are paid off to invest in bonds? Not judging either way, but that logic would support you owning some bonds to cancel out the negative bond that is your student loan debt.
OTOH, it seems silly to invest in a bond or bond fund that’s unlikely to give you the guaranteed return that paying off the loans will. Either way, paying down the loans quickly seems wise.
Hope you are enjoying the conference!
I think I’ll stick to my guaranteed returns of paying off debt while I stay at 100% for the two year timeline. Once the debt is paid off, I’ll switch to 80/20.
But who knows! I am one to keep an open mind and change it as I learn more!