Money Has More Power When It’s Put Use Early In Your Career
There are 2 ways you can take advantage of the power of money momentum. One is when you build an investment stash early in your career and the one is when you pay off a sizable chunk of your debt.
How Money Has Momentum
This is essentially the power of compounding. You take $1,000 and add 5% to it in year one, then you will have $1,050. Repeat this for year 2 and of course you wouldn’t just have $1,100 but instead $1,102.50. Scale this up and it becomes a sizable amount after some time.
Compounding also works in regards to let’s say your student loans. If you owe $100,000 in student loans at a 6% interest rate then you will accumulate $6,000 of interest per year, which is divided into 365 days ($16.44). This amount is added to your principal (the $100,000 balance) daily until you make a payments. After 30 days your balance would be…. $100,493.20. So, when you make a payment of let’s say $700 then $493.20 would go towards interest and $206.80 would go towards your principal. The following month you will ‘only’ owe $99,793.20 which is the sum used to calculate your new daily interest rate ($16.40).
I know the loan example is a bit convoluted but read the paragraph a couple of times and it will make sense. Money momentum applies to your debt because by paying down the principal even by $30,000 you would now have a daily interest calculated on $70,000 which would be $11.50. Compare this to $16.40.
Real World Examples
If you hustled and saved up $100,000 early in your career (even within the first 5 years) and invested this you could potentially see this money grow into nearly $270,000 after 20 years. This is assuming you didn’t add a single dime to the money. I used 5% as the average rate of return. It may be lower if the money is invested in less risky assets and higher if you are willing to take on more risk such as real estate or business investments. While this money grows you can use your spare cash to either pay down your student loans or save up for a home or a business etc.
In regards to your student loans, it may not make a huge difference if you are at a really low interest rate. I currently have about $23,000 left in student loan debt at 2.75% and I have a friend who has hers at only 2% with a balance of $130,000.
However, if you have $300,000 in student loans averaging 5-6% then paying down even $50,000 would make a huge difference. This would come out to $45.21 of daily interest accumulating vs. $37.67 which is nearly $8 per day saved.
How To Accomplish This
I think the best way to accomplish this is to max out your 401(k), max out any other defined contribution account you might be offered (cash balance plan, Keogh, 401(a) etc.) early in your career. Then simultaneously save 50% of your disposable income and use the other half to pay down your debt principal.
In my case I had nearly $100,000 saved in my 401(k) which I cashed out ignorantly in 2010. I lost 5 years of momentum coincidentally in a very strong bull market. This was a great lesson of course. As of this month I have approximately $400,000 saved which can grow to nearly $890,000 in 20 years without any additional savings from me and assuming a 4% market return. Realistically, I will always add some money to this $400,000 and when the market takes a big dip I might add even more.
In 5/2015 I had a balance of $72,000 in student loans. The daily accrued interest was a little over $5.00 and just 4 months later now I have a balance of $23,700 and my daily interest is $1.87. Even if I only made minimum payments on this debt I would be in great shape.
If you are able to cut your expenses the first few years as an attending, use the money you can save to establish ~$100,000 in savings (whether in your tax-deferred or your after-tax accounts) and use the other half of your money to pay down the debt early on. If you have any windfalls (inheritance, bonuses, refunds) use these to pay down the debt as well.