Transcription – WCI – 423

INTRODUCTION

This is the White Coat Investor podcast where we help those who wear the white coat get a fair shake on Wall Street. We’ve been helping doctors and other high-income professionals stop doing dumb things with their money since 2011.

Dr. Jim Dahle:
This is White Coat Investor podcast number 423, brought to you by Laurel Road for Doctors.

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All right. Welcome back to the White Coat Investor podcast. We’re glad you’re here. We’re glad you’re doing what you do out there in your life. I had a wonderful opportunity to raft recently with a medical student at the University of Oklahoma. Boy, it’s always refreshing to talk to people at the beginning of this wonderful career and see their optimism and their zeal. As they’re staring at a decade plus of training, it’s pretty wild to compare that to the burned out doctors I talk to in mid-career that definitely have somewhat different priorities.

Kudos to those of you who have come into this career and are doing it for the right reason and can stay committed to it for a long, long time. Obviously, everybody has a little bit of that zeal knocked out of them and a little bit of that optimism and idealism knocked out of them along the way, maybe mostly during their intern year, but trying to keep some of it sure makes the career more enjoyable as you go along.

We have a scholarship. We’re trying to give away money to medical students and other professional students who are eligible as well. The eligibility criteria this year are you have to be full-time, in good standing at your school. It has to be a brick and mortar school. No online schools, no hybrid programs. If you’re doing a whole bunch of stuff online, your school is not going to count.

We don’t take undergraduates. If you’ve already received scholarships equal to or greater than the cost of tuition at your school, you’re not eligible. You’re not eligible if you’re a resident. Even if you’re a dental resident paying tuition, you have to be a student.

But you can be a student of medicine, whether an MD or DO. You can be a dental student. You can be a PA. You can be an NP. Be aware lots of NP schools are hybrid or online schools. So those ones won’t qualify. You can also be a CRNA. You can be an OT or a PT if your program leads to a doctorate degree. It’s basically any high income professional. Law counts, pharmacy counts, optometry counts, podiatry counts, anything counts.

Now in the past, most of our winners have been medical students. Now, occasionally we have a dental student. Most of them are medical students, but any of these categories can apply. Veterinarians. I didn’t mention veterinarians or anesthesia assistants. Those all qualify as well to apply.

You have to be at a school in the U.S. U.S. states, District of Columbia territories, but you have to be in the U.S. We have to be able to verify that you’re actually there and in good standing, but those are the rules for application.

There’s only going to be one category this year. We’re not going to do two categories. We’re trying to simplify things, not only for our staff, but for our judges. So, it’s one category. There’s going to be 10 winners. We’re just going to split the pot evenly between those 10 winners of all the money we can raise for this scholarship.

You can write about anything you want. Past winners like to tell inspiring, but true stories about themselves or family and their background. You can share anecdotes from your experience in medical or other professional school. It’s a financial website. So putting a financial component in there is probably a good idea. Some people have even won just giving tips for how they survived and thrived in medical school in the past.

Humor is good. Interest is good. Inspiration is good. 10 winners are going to be selected. You can apply whitecoatinvestor.com/scholarship. You have all summer to apply and we’re going to try to get as many applications as we can because we want to affect as many people for good as we can here at the White Coat Investor.

Okay. The other problem we have is we need people to judge these essays, these applications. They’re a maximum of about a thousand words. And the judges are going to participate in a couple of rounds. 10 essays per round. You have to read 20 essays to be a judge. It’s a volunteer position. We don’t pay you, but we need judges. We don’t want to be the ones deciding who wins this scholarship money. We feel like we’ve got a little bit too much of a conflict there. And so, we want White Coat Investors, just regular White Coat Investor audience members to be the judges.

You can’t be a resident, you can’t be a student, but if you’re in your career, you’re retired, it doesn’t matter what career, you can be a scholarship judge. Email [email protected]. Just say, I want to be a judge in the title and that’ll be enough. We’ll get you signed up. You’ll have to read these essays in September and October when the judging is happening and you can help us decide who wins.

It’s a lot of fun every year and we get to directly reduce the indebtedness of a whole bunch of students and maybe more importantly, get the word out a little bit more about the importance of financial literacy and financial discipline among professional students.

Okay, enough of that stuff. Let’s get into your questions today. We’re going to spend a lot of time on the Speak Pipe today. If you don’t know, you can leave questions for us to answer here on the podcast on the Speak Pipe. That’s whitecoatinvestor.com/speakpipe.

You can record up to a minute and a half. I think it’s 90 seconds is what the limit is right now. You do not have to use all 90 seconds. It’s fine to leave 30 seconds with your question, but do provide the details you think we’d need to help answer your question. Again, whitecoatinvestor.com/speakpipe.

Here’s our first question. It’s about 401(k)s.

409A – EXECUTIVE SAVINGS PLAN

Speaker:
Hey Jim, I’m a physician in a large multi-structural group. We were recently acquired and will be integrating into a larger parent corporation. In addition to typical benefits, we’ll have access to an executive savings plan. This is a 409A non-qualified top hat plan, meaning it’s only available to employees in certain salary grades.

You can make tax-deferred contributions of up to 80% of your base salary and up to 100% of your incentive compensation with no pre-specified dollar limit that I can see in any of the plan documents. The plan matches 50 cents on the dollar on up to 6% of base or incentive compensation, which at 50 cents a dollar would be a 3% maximum match. Vesting is immediate.

You do have the ability to make planned withdrawals for specific life events like college tuition or for emergencies. When you separate from employment, you have five different options of how things get distributed to you, but it cannot be rolled over into any other vehicle. You’ll pay taxes on the distributions at your then current tax rate on both the contributions and on interest accrued.

The five options are an immediate lump sum, a five-year delayed lump sum, a ten-year delayed lump sum, or you can take it in five or ten equal annual installments. As a non-qualified plan, I know the big thing is to have reasonable confidence in your employer’s long-term solvency. I have no concerns about that in my particular case.

Overall, this seems like a really great way to reduce tax burden for W-2 employed docs in their highest income earning years when they’re in their highest tax brackets and then spread that income out over a long period of time, potentially at a much lower bracket. Any additional thoughts on how to contribute and maximize the benefits of this type of plan?

Dr. Jim Dahle:
Okay, let’s talk about 409As. Probably the best way to think about a 409A is to lump it in with a non-governmental 457(b) plan. These are both types of deferred compensation plans. They are non-qualified. They are as deferred compensation. They belong to your employer still, and this is the main downside of these plans. They’re a great asset protection technique for you because they’re not available to your creditors, but they are available to the creditors of your employer.

And this has mostly been a theoretical risk for decades that we talk about when we talk about these deferred compensation plans. You don’t want to put more in there than you’re really comfortable losing in the event that your employer ends up going bankrupt.

That’s a little less theoretical more recently. Steward, the corporation that used to own my hospital, apparently, maybe some of the docs that work for Steward are going to lose some of the deferred compensation money. This hasn’t all settled out yet, and I’ll be talking about it in great depth once it does settle out, but for the first time that I know of, I think we may be seeing some docs actually lose deferred compensation money.

This is your big risk to use a 409A or to use a non-governmental 457(b) program, and that’s what you got to be thinking about as you choose whether to use these. Other things to think about, you got to think about fees. You got to think about the options. Make sure those are acceptable. Make sure especially the distribution options are acceptable, and it sounds like you’ve got enough options there that the distribution options are acceptable.

If those all look okay and your employer seems financially stable, then the question is “How much do you put in there?” Well, first of all, make sure deferring taxes still makes sense for you. If you’ve already got $5 million in tax deferred accounts, you may not want to put more into tax deferred accounts. You may be better off at that point in tax-free accounts or doing more Roth conversions or making more Roth contributions or possibly even in a taxable account, although most of the time you’re going to be better off in some sort of a tax-protected account like a 409A than you would in a taxable account, at least when saving long-term for retirement. That tax-protected growth is just pretty valuable.

So, those are the things to be thinking about. It sounds like they’ll let you put a whole bunch of money in. You probably ought to put in at least enough to get the match, and I’d probably put something in every year. But if they let you put $100,000 in there a year, I might not do that. Do you really want to have two or three or four million dollars in there that you’re lying awake at night worrying about your employer going under for? So, maybe trying to get that account to a mid-six-figure amount is reasonable, that sort of amount a multi-millionaire retiring doctor could afford to lose in the event that something happened to the employer. But I don’t know that I’d try to get a lot more than that into a deferred compensation plan that’s not yours.

Now, this is different from a 401(k). This is different from a 403(b). This is even different from a 401(a), but a 409A or a non-governmental 457(b) plan, you might want to be careful exactly how much you put in there. I know the tax deferral is valuable, but I’ve talked to a few people over the years who have been sweating it out wondering if they’re going to lose some of this money, and even the ones who didn’t end up losing any money said it wasn’t worth it, that I have to worry about it for six months or 18 months or whatever while they were worried they were going to lose that money due to their employer going bankrupt. So, keep that in mind. I hope that’s helpful.

QUOTE OF THE DAY

Our quote of the day today comes from P.T. Barton, who said, “Money is good for nothing unless you know the value of it by experience.”

All right, another question off the Speak Pipe. This one about rollovers.

ROLLOVERS

Shweza:
Hi, Jim. This is Shweza from Irvine. If I have an old employer rollover IRA and also some post-tax traditional IRA contributions, how can I then roll over my rollover IRA into my current employer 401(k) and separate the post-tax traditional contributions? Is this a possibility if my plan allows? Thank you.

Dr. Jim Dahle:
All right. Hope Irvine is treating you well. I spent a month out there as a resident doing an ultrasound rotation. It was a great experience. I went out to the beach almost every day. I was doing some boogie boarding. Every day, I wish the waves were bigger. Well, one day, the waves were bigger, and I still went out, and I learned an important lesson that you don’t always want the waves to be bigger. It turns out they can be too big.

As far as your question, here’s what I would do. In general, most qualified plans like 401(k)s and 403(b)s that accept rollovers from an IRA will accept tax-deferred money and may accept tax-free money, Roth money, but they generally don’t accept after-tax contributions.

That’s not a bad thing, though, because here’s what you do. You look at how much of it is tax-deferred, and you say, “I’m going to roll this much in my 401(k).” Great. You do that rollover. That money comes out, and all the money that’s left is now after-tax money. You just do a Roth conversion on that. There’s no tax cost to it since you didn’t get a tax deduction when you put the money in. Now, it’s in a Roth IRA and can grow tax-free forever after that.

This is called isolating your basis so it can be converted. This is a good thing to do. Lots of people with after-tax money in IRAs or in the Federal Thrift Savings Plan try to do this sort of thing deliberately to try to isolate that basis and do a Roth conversion on it. I think that’s probably the solution to your issue.

All right. Next question is about mega backdoor Roths.

MEGA BACKDOOR ROTH

Matt:
Hi, Dr. Dahle. Thanks for everything that you do. I’m a urologist in the Midwest. I have a question for you about mega backdoor. It’s become a pretty popular item these days. My 403(b) plan, I’m a hospital-employed physician, allows for either pre-tax or after-tax contributions to 403(b). Given that, I thought that would be a nice setup if it offers both to potentially also be able to do mega backdoor rollover.

I’ve asked people in my hospital in the HR department. No one seems to have heard of mega backdoor. I even called the plan administration through Lincoln Financial Group, and they couldn’t tell me if the plan was eligible for mega backdoor. In fact, even the guy on the phone said he’s never heard of mega backdoor.

I’m a little bit stuck in knowing or understanding if I’m able to contribute to that. How else would I know? Even if I got the plan documents, I’m sure it may not be spelled out there. Any advice you can give me on that or who to talk to would be great. Thanks a lot. Thanks for everything you do. Bye.

Dr. Jim Dahle:
Okay, Matt. Here’s the problem. You’re using the phraseology that informed investors, financially literate people use, which is the mega backdoor Roth IRA process. Your HR people, the people running your 401(k), they may not be in that category. That’s why they’ve never heard this term. This is not unusual at all.

You need to ask the right questions rather than asking, “Can I do a mega backdoor Roth IRA?” You want to ask, number one, “Can I make after-tax, not Roth, employee contributions to this plan?” Because remember, there’s three types of contributions. There’s pre-tax, there’s Roth, and there’s after-tax.

A lot of people don’t understand the difference between Roth and after-tax. The Roth account, future earnings are all tax-free. After-tax money, future earnings are all tax-deferred. That’s the difference between them.

You’re allowed to make in 2025, if you’re under 50, it’s $23,500. You can make it as a tax-deferred contribution or a Roth contribution. And the after-tax employee contributions are all above and beyond that $23,500 contribution.

So, find out, can I make these contributions in the plan? And the answer will be yes or no. You’re saying it allows pre-tax and allows after-tax. They may think you’re asking about Roth. If all they’re offering is two categories, it’s usually pre-tax or tax deferred and Roth or tax-free contributions. They usually don’t offer pre-tax and true after-tax employee contributions. So first figure out, can I make the contributions?

The second question to ask is, “Can I do in-plan Roth conversions?” Now you’re speaking their language. Now they should understand the questions you’re asking. If your plan allows both of those steps, then you can do the make a backdoor Roth IRA process. Because the process is put in after-tax money and then do a Roth conversion on it. That’s the process.

But they’ve got to allow both steps. If they don’t allow both steps, you can’t do this with your plan. I mean, you could make after-tax contributions, but you probably don’t want to. You’re probably better off most of the time just investing in a taxable account than doing that.

Because the problem is, in a taxable account, you can get long-term capital gains treatment, you can get qualified dividend tax treatment. In that after-tax account, if you ever do a Roth conversion on it, you’re paying ordinary income tax rates on the gains. And you got to have a lot of years of tax-protected growth to make up for the fees in the plan, and especially to make up for the fact that you’re paying ordinary income tax rates rather than the lower long-term capital gains rates in the taxable account.

You can’t donate shares to charity. You can’t do tax loss harvesting. There are all these things you can’t do in that account. But most of the time, I think you’re better off in taxable if you can’t also do the Roth conversion step.

All right. Thanks, everybody out there, for trying to sort this stuff out. Thanks for your regular job, too. This is why you get paid a lot, is because your job is hard. And it’s an important job for our society. So if no one’s told you thank you today, thank you very much.

But for those of you who are going above and beyond and also trying to get great retirement plans in place, and you’re trying to get plans in place that allow mega backdoor Roth contributions, or lower fees, or better investment options, thank you for what you’re doing. It matters not just for you, but also for your co-workers who may not even know that they’ve got a less-than-ideal retirement plan.

We’ve talked about the mega backdoor Roth. Let’s talk about the backdoor Roth.

BACKDOOR ROTH AND THE PRO RATA RULE

Speaker 2:
Hey, Jim. Longtime lurker, first-time contributor. My question is, I performed a backdoor Roth for my wife, but we have since had a baby, and she decided to quit her job and stay at home. Her 401(k) is now giving her the boot, and the funds need to be transferred out sometime soon. What are my options here to avoid the pro-rata rule?

Dr. Jim Dahle:
Well, the pro-rata rule basically says you can’t have any money in a traditional IRA, a SEP IRA, or simple IRA, or a rollover IRA, which is just another type of traditional IRA, on December 31st of the year you did a Roth conversion, or that conversion will be pro-rated.

If they’re trying to kick her out of the 401(k), you’ve got a few options. One, are they just trying, or are they doing it? Most 401(k)s, once you have a certain amount of money in there, can’t kick you out. They want you to leave because you cost them money, but they can’t kick you out.

In my partnership 401(k), I think the limit is $7,000. Once you have at least $7,000 in the plan, we can’t kick you out. We can encourage you to leave. We can charge you higher fees, but we can’t actually throw you out. So make sure she’s actually being kicked out, because one option is just leave the money in the 401(k). 401(k) money, 403(b) money doesn’t count for that pro-rata calculation. Your conversion won’t be pro-rated if she just has money still in the 401(k) at the end of the year.

If it is less than $7,000 or whatever, and they can kick you out, then that’s not a huge deal either. Just convert it all. Yeah, it’s going to cost you $2,000 or $3,000 in taxes, but just convert it to a Roth IRA, then you don’t have any traditional IRA money, and you can just do spousal backdoor Roth IRAs every year based on your income. That solves the problem as well. If your spouse goes back to work, gets another 401(k) or 403(b), or becomes self-employed and gets a solo 401(k), you can also roll the money in there.

Those are your three options. So you can explore them, but if truly they’re kicking her out of the plan, and it’s got to go into a traditional IRA because she doesn’t have anywhere else to put it. And if you don’t want to convert it because it’s such a large amount, you can’t afford the taxes on it or something, well, she’s going to get prorated. It’s not the end of the world. It’s not illegal to be prorated. It just doesn’t accomplish what you’re trying to accomplish, but it’s not like it’s a terrible thing.

Just get prorated, fill the tax forms out correctly. That’s form 8606 that you do every year to report those non-deductible contributions and conversions, and you can carry those balances forward each year. It’s not the end of the world. It’s just not as good as it could be if you didn’t get prorated.

Okay, let’s take a question about dividend funds.

HIGH YIELD DIVIDEND FUNDS

Speaker 3:
I have a question for you in regards to the high yield dividend funds that are available, specifically the ETFs of YMAX and MSTY. I know they are both very high risk, but do pay significant dividends. I’m about 10 years out from retirement with approximately $1.5 million in the 401(k) that I currently have. Would this be a good option to move into now with the current market, or would this be something to stay away from? Thanks. Any help is appreciated.

Dr. Jim Dahle:
Okay, there’s a lot wrapped up in that question, and it’s actually going to take a pretty extensive discussion to unwrap it all. Part of the issue is when you’re making a financial plan, even just the investing portion of your financial plan, there’s four steps. The first is you set your goals. The second is you choose which accounts you’re going to be investing in. The third one is you choose your asset allocation or mix of different types of investments you’re going to have in the plan, and finally, you select investments.

Now, in the Speak Pipe message, this White Coat Investor has come to me just asking about investments without giving me any information whatsoever about the goals, the accounts, or the asset allocation. So, it shouldn’t be any surprise that I really can’t answer this question without anything more than you need a written investing plan. Make a written investing plan. Follow that plan. If the plan includes MSTY, then invest in MSTY, but if the plan does not include MSTY, then don’t invest in it.

My assumption, based on the fact that I got this question, like most of the questions I get, my assumption is that there is no written investing plan. So, step one is go get in a written investing plan. Now, if you feel competent, you’re financially literate enough that you can do this yourself, go write your own investing plan. That’s what I did. Read some books, spend some time on forums asking questions, read lots of blog posts, listen to this podcast. Eventually, you get to the point where you’re like, “Oh, yeah, that’s no big deal, I can write my own investing plan.”

Another option is taking our Fire Your Financial Advisor course. The whole point of this online course, which is about $800, is to help you write your written investing plan. That’s the point, to take you from zero to hero and basically spoon-feed you everything you need to know to write an investing plan, well, actually a comprehensive financial plan that includes an investing plan, without having to hire a professional to do it.

The third option is to hire a professional just to help you write the plan, then you implement it, you maintain it. And finally, you can hire a professional to not only write the plan, but implement it and maintain it. It’s a full-service financial planner and investment manager. And we’ve got lists of those professionals that we recommend to you that you can find at the website under the Recommended tab.

So you got to take one of those options. Get yourself a written investing plan, and then you can quit asking questions like this, because you’ll have all the answers in the plan. If you’re not sure what to do, you go back to the plan. And it’ll tell you what to do.

Katie and I wrote a plan in 2004 that we’re basically still following. We made a few tiny tweaks to it over the years, but that’s basically the same financial plan we’re following more than two decades later. This works, and if you stick with your plan, stay the course with it, eventually, if you’re like most docs, if you’re like most White Coat Investors, you’re going to retire as a financially independent multi-millionaire. It’s not that complicated. It’s not that hard. You can do it. Thousands and thousands of White Coat Investors before you have done it.

Now that we’ve had that discussion under there, there are a lot of people out there in investment land that focus mostly inappropriately on income. The income from the portfolio. The amount that the portfolio pays out, and rather than focusing on the total return of the portfolio.

For example, if a stock index fund has a return of 10% one year, perhaps 2% of that will be income, and the other 8% will be appreciation of the stocks in that fund. The income is 2%, and the total return is 10%.

Now, does that mean you can only spend 2% if you own that fund? No. You can declare your own dividend anytime you want and sell a few shares of that fund. You’ll probably get long-term capital gains treatment on it, which is the exact same tax treatment that a qualified dividend gets, and you can take out 4% or 5% or 6% or whatever you want. You keep taking out 5% or 6% or 7% or 8% every year, you might run out of money, but certainly taking out 4% is widely acknowledged to be highly likely to be sustainable for 30 plus years.

Some of that comes as the dividends, some of that comes from selling shares. So you’re not stuck just looking for something with a higher income. Higher income does not mean higher return, at least not necessarily. Some people get so fixated on income that they buy investments just for the high income. And sometimes there’s investments out there that have an income of 8% a year, but a total return of 4% a year.

Well, how does that happen? Well, they’re actually paying you out your principal every year. What really matters in the long run is your total return, not your income. So don’t get too fixated on income as that will often lead you to make bad portfolio decisions.

The reason why you can spend more than just the income the portfolio is providing is because you’re not immortal. This idea that you can’t spend principal is crazy. If you never spend principal, you will die with at least as much as you retired with. And so, basically you worked for years and years and years and decades and for money you didn’t even need.

It’s okay to spend your principal in retirement. You just have to be careful how much of it you spend. So, it is likely to last you throughout the retirement you’re likely to have. And if you start worrying about not quite having enough or running out of money and having to live on only social security, well, there’s some other things you can do like buying single premium, immediate annuities, putting a floor under your spending to be sure you’ll never run out of money. There are other things you can do if that’s the big concern. Just spending principal is probably foolish.

Okay, I hope that’s helpful as a discussion of income. Now let’s talk about the specific investment, which I know nothing about. When I get asked about an investment or I’m curious about investment, first thing I do is I put the ticker symbol in this case, MSTY into Google, along with the word Morningstar. That takes me to morningstar.com. which gives you lots of basic information about funds and exchange traded funds.

When I put in MSTY into here, I see that this fund has an expense ratio of 0.99%. Okay, so 99 basis points. By comparison, a total stock market index fund ETF at Vanguard, VTI, has an expense ratio of 0.03% or three basis points. In essence, this mutual fund is 33 times as expensive as one that just buys all the stocks in the US.

That kind of gives you a sense of what’s going on here. Somebody is selling their services to pick stocks to pick these option income strategy, whatever they’re doing in this fund. You know you’re going to pay more. And that’s going to cost you more.

Now, are you getting more? I have no idea. Let’s click on the performance tab and see how long this thing’s been around. Oh, looks like it just started in 2024. It’s brand new. Has it done pretty well in the last year? Well, let’s see. We got some trailing returns. It made 85% in the last year. That sounds pretty awesome. 85% is a great return for the last year.

Now, I think what you ought to do, knowing this now, is I think you ought to get in a time machine and go back one year and buy MSTY a year ago. That’s what I recommend you do. If you don’t have a functional time machine, you’re going to need a new investing method. You’re going to have to invest based on how something’s going to do going forward.

I recommend a crystal ball. Unfortunately, I don’t know where to send you to get an accurate crystal ball. I have no idea what the returns for this fund are going to be going forward. I can tell you they’re not going to be 85% every year.

And in fact, a typical fund that has a return of 85% in one year will often have terribly negative returns in other years. That’s a really risky fund, the fact that it had an 85% return in one year. So, no idea what that’s going to do in the future. For example, this last week as I’m recording this, it dropped 8%. So this is pretty volatile stuff.

Now, what are they doing in this fund? I have no idea. It sounds like more than just picking stocks though. The name says option income strategy. So I’m guessing they’re buying some options. If we look under the hood and see what’s in the fund, it tells us that there’s a whole bunch of large cap blend stocks in it, but that there’s also a lot of derivative income. It sounds like, yeah, they’re buying options. So you’re paying somebody to buy options for you. And hopefully they’re really good at it and only buy options that make money and avoid options that don’t make money.

I’m not a huge fan of options. I think it’s a lot more complicated way to invest than it is to just go buy shares of companies that are profitable, the most profitable corporations in the history of the world and holding them for decades. And when they make money, you make money. These are your Exxons. These are your Apples. These are your NVIDIAs. These are your whatever stock of choice you might have. As they make money over the years, you share in those profits.

When you’re buying options, you’re gambling on future price increases or future price drops, depending on what kind of options you’re buying. Now, there are reasons for certain people or companies to buy options so they can lock in pricing and those sorts of things for their inputs and that sort of stuff.

But in general, as an investor, I’m not a huge fan of it. And I think most people buying MSTY right now are probably performance chasing. Not only are you paying 1% a year in expenses, but you’re just trying to get another 85% because that’s what it did in the last year.

Well, I’ll tell you what, if these guys are talented enough to get 85% every year, they will soon be managing many, many billions of dollars. Right now, they’re managing just $4 billion, just to give you a sense of how much that is, let’s compare that to the Vanguard total stock market ETF, which is VTI. That’s about 25% of my portfolio. It manages $1.7 trillion. The other one’s $4 billion, this is $1.7 trillion. It’s like 500 times larger.

I think if I were considering this sort of a strategy, I would spend a lot of time researching it. And my written investing statement would say, “I’m going to try to pick mutual funds that follow an option strategy to try to have supercharged returns so I can retire in three years or something.” That’s what my written investing plan would say if I was going to include an investment like this in it. But this is pretty risky business to be chasing performance in funds like this. I hope that’s helpful for you.

Our next question is from Dan. Let’s take a listen.

ASSET ALLOCATION AND ASSET LOCATION

Dan:
Hi, Dr. Dahle. This is Dan from the Midwest. I had a question regarding asset allocation and then also asset location. I’m in the sixth year of my training program and going to be attending next year. For the first three to four years of residency, I just did 90% total US stock market and 10% total US bond market, kind of based on my risk tolerance.

And over the last couple of years, I’ve started dabbling in individual stocks. I’m thinking about switching my asset allocation to 80% total US stock market, 10% total US bond market, and then 10% individual stocks. That would include anything like individual publicly traded securities, real estate in the future, anything like that. Keep it at a maximum of 10% of my portfolio.

And then my other question is regarding where should I place these assets in terms of traditional, post-tax, and then Roth? I recently read that you should be placing your highest expected return assets in Roth, so like total US stock market and individual securities. And then bonds should actually go in pre-tax or taxable. I haven’t really been paying attention to asset location too much. I just wanted to get your thoughts on both my asset allocation and asset location. Thanks for all you do.

Dr. Jim Dahle:
All right, Dan. Lots to talk about there. Let’s start with this idea of picking stocks. What you’re talking about, this 10% of your portfolio, is what a lot of people call their play money account. They use it to chase crypto assets or to pick NVIDIAs and Tesla or whatever the stock of the day is or to short things or to buy options or to play around with their money a little bit.

This never made a lot of sense to me. If I have play money, I’m probably buying a raft with it or I’m going to Turkey with it. This investing stuff is serious business for me. I don’t have play money. I don’t have 10% that I fart around with. If I’m going to put money into something, I expect it to make money. I expect it to make some sort of contribution to the portfolio. I want high returns. I want low correlation with the other assets. And I want, if I can get it, simplicity. I want tax efficiency.

Those are the goals when I’m putting together my portfolio, when I’m choosing my investments. It’s not the investment du jour. That said, if putting 5% or even 10% of your portfolio into a play money account allows you to stay the course with the other 90% plus of the portfolio, it’s probably fine to do.

You can basically do anything you want with 5% of your portfolio. You can light it on fire if you want, and you’ll probably be okay if you’re like most White Coat Investors, saving adequately, your career lasts a reasonable period of time, and you stay the course with a reasonable plan with the rest of them. Do whatever you want. It’s your money.

But let’s talk about a few things when it comes to stock picking. It doesn’t make any logical sense to me to pick stocks with 10% of your portfolio. If you can pick stocks well enough that you can beat an index fund, why wouldn’t you do it with 90% of your portfolio instead of 10%? That doesn’t make any sense to me.

And if you can do it well enough to beat an index fund, why are you only managing your money in the first place? You could be charging a lot of money to other people and other institutions for your stock picking ability.

If you don’t have the ability to pick stocks well enough to beat an index fund, is this really fun enough for you to be losing that much money doing it? 10% of your portfolio might not be that much now, but eventually, it will be a huge portion of your portfolio or a huge amount of money, the same portion of your portfolio, I suppose. But now, all of a sudden, you’re losing real money. And you can calculate if you’re underperforming by 1% or 2% or 3% a year of that 10% of your portfolio, how many thousands of dollars is that? And is it really that fun that it’s worth losing all that money?

Not to mention the tax consequences of buying this and selling that and buying this and swapping to this. There are tax consequences to changing things around, particularly in a taxable account. I think you really need to step back and ask, “Is this really that fun? Is this really what I want to do with that 10% of my portfolio?”

I think it’s okay to invest a small percentage of your portfolio into alternative assets or real estate or whatever. But when it comes to picking stocks, I think the data is pretty clear that the best way to invest in the stock market, the publicly traded corporations of the world is to just buy them all via an index fund.

It’s very tax efficient. You’ll outperform over the long term 95% plus of active investors. And it takes basically no time and no money. It’s basically free and takes 30 seconds. It’s a very good way to invest in stocks. I think you really got to ask yourself if you really want to invest in stocks in some other way.

As far as asset location goes, well, it depends on what you’re investing in and how you’re investing in it. If you’re buying and selling stocks every week, you need to have this thing in a tax protected account. You don’t want to be paying all these capital gains taxes from all your buying and selling activities. That would suggest you put it in, probably not your 401(k), because it’s probably not going to let you do this. Some do, they have a brokerage window, but it’s probably going in your Roth IRA. If you’re buying and selling stocks all the time, that’s probably the place to put it just because the tax consequences won’t be so bad.

Now, you’re right. In general, you’ll end up with more money on an after tax basis, if you have more aggressive investments that have a higher long term return in the Roth account. Now, I’m not sure you’re going to have a higher long term return trying to pick your own stocks, but if you’re convinced that you’re going to have a higher long term return, then that’s probably where you want to put that money, especially if you’re churning it pretty rapidly.

But if you’re talking about investing in other stuff, it might be a little trickier to invest in that in a Roth IRA. For example, you mentioned real estate. If you’re going to buy the property down the street, I don’t recommend putting that in your Roth IRA. I think you’re better off having that outside of your retirement accounts. It really depends on what you’re putting in there as far as asset location goes.

But there’s a lot of principles to asset location. Go to the website, type in asset location in the search bar, and my post on this will come up. It’s a lengthy post, talks about a lot of the principles to consider. And anybody who tells you this stuff is simple just doesn’t understand the issue. There’s a lot that goes into asset location. I don’t have nearly enough information from you to really tell you exactly where to put this account, especially since I don’t know exactly what you’re going to be investing in it or how you’re going to be investing in it.

All right. Let’s take another question about an individual stock.

S&P 500 NOW INCLUDES COINBASE

Speaker 4:
Hi, Dr. Dawley. I saw that Coinbase is getting added to the S&P 500, much to my dislike. I do not want to own any crypto as I do not see any value in it, but I own a lot of the S&P 500 index funds. Do you have any suggestions on how to change my portfolio to limit my exposure to Coinbase? Do I need to be concerned about this? Thanks.

Dr. Jim Dahle:
Okay. Well, if this is really your concern and you really want to invest in the S&P 500, the way you deal with this is by shorting Coinbase. So you buy the S&P 500 and then you short Coinbase. That essentially zeroes out the amount of Coinbase that’s in the S&P 500. And it’s like you now own the S&P 499.

But bear in mind, there’s lots of companies that have some of their assets in cryptocurrency and other crypto assets. If you’re trying to get all crypto out of your portfolio, you’re going to have to short a lot more than Coinbase. In fact, there’s quite a few companies. I’ll bet if we Google a list, companies that own Bitcoin, we’ll see a pretty good list here. 215 public companies. That’s a whole bunch of them. Tesla’s on the list, for example. Lots of others. I don’t recognize all of them, but there’s plenty of companies out there.

If you go down this road and you’re trying to get rid of everything with any exposure to crypto, I think you’re going to end up with a really complicated portfolio. I’m not sure I’d recommend that.

In general, something like Coinbase is going to make a relatively tiny contribution to the S&P 500’s return. I think you’re fine to just ignore it. Just buy them all. And you know what? There’s one that does something you don’t like, big deal. You got 499 others.

Okay. Now a larger question. I’m not a huge fan of the S&P 500. It’s only large cap stocks. It’s obviously only US stocks, but it’s only large cap stocks. And some people actually can front run this index when they announce they’re going to add Coinbase to it. Well, everybody goes out and buys Coinbase and then all the S&P 500 funds have to go buy Coinbase and they pay kind of a little bit too much money for it because it got front run.

The nice thing about a total stock market index fund is you own everything. So you’re getting front run. It’s not lowering your returns that way. It’s a broader, more diversified index. It owns large caps, mid caps, and small caps. I just think it’s better than an S&P 500 fund.

I’m not a big fan of an S&P 500 being your primary holding or your primary US stock holding. I’m much more of a fan of the total stock market index fund. I have 25% of my portfolio in the total stock market index fund. I have none of it in an S&P 500 fund. Even when I do tax loss harvesting, I generally swap into another total stock market index fund rather than a 500 index fund.

So you probably ought to ask yourself, “Why am I investing in 500 index funds to start with?” And then maybe switching over if there’s no tax consequences to doing it, switching over to a total stock market index fund, having a little bit more diversification.

I fear a lot of people in S&P 500 funds these days are just performance chasing. The last few years, large caps have done better than small caps. And so, S&P 500 funds have had better returns than total stock market funds. But I would not expect that in the long term.

But as far as trying to limit exposure to various companies because they grow tobacco, or they are big pharma, or they invest in crypto, I think you’re better off not trying to dabble in all that kind of stuff. Just buy them all. Recognize that you can affect the things you care about in this world with your charitable contributions and your work and not try to get out of everything like that.

Another option might be simpler than trying to short all the companies that own crypto is just pick an ETF that invests in companies that are really exposed to crypto. I’m sure there’s one out there and just short that. That would be an option as well. I hope that’s helpful to you. I’m not sure I like what you’re wanting to do, but if you want to do it, that’s how you do it.

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Transcription – MtoM – 226

INTRODUCTION

This is the White Coat Investor podcast Milestones to Millionaire – Celebrating stories of success along the journey to financial freedom.

Dr. Jim Dahle:
This is Milestones to Millionaire podcast number 226 – Family doc and PT pay off their student loans.

This podcast is sponsored by Bob Bhayani of Protuity. He is an independent provider of disability insurance planning solutions to the medical community in every state and a long-time White Coat Investor sponsor. He specializes in working with residents and fellows early in their careers to set up sound financial and insurance strategies.

If you need to review your disability insurance coverage or you just need to get this critical insurance in place, contact Bob at www.whitecoatinvestor.com/protuity. You can also email [email protected] or you can call (973) 771-9100.

Welcome back to the Milestones podcast. We want to feature you and your stories and use it to inspire others to do the same. You can apply at whitecoatinvestor.com/milestones.

Also, by the way, those of you who need some help with your student loans, you’re not sure what to do with them, especially with all the changes going on in Washington. Here’s a deal for you. If you book a consult with studentloanadvice.com, this is the company we started to help answer all these questions, you’re going to get a free course.

It’s the Continuing Financial Education 2024 course. It comes with CME. It’s like 50 hours of content. It’s a great course. Just because it says 2024 doesn’t mean it’s like out of date. Come on, what course actually goes out of date every year? Hardly anything. It’s a great course. You get it for free when you book the consult.

The course itself is worth more than the consult costs. But we want you to get that advice if you need it. And if this sort of a deal entices you to do that, we want you to do so. But just getting the advice might be worth thousands or even tens of thousands of dollars to you.

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Okay, we got a great interview today. As mentioned in the title, we’ve got a couple that paid off their student loans very quickly. You won’t be surprised how they did it. We preach about it all the time here, but it really, really, really does work. So let’s get into the interview.

INTERVIEW

Our guests today on the Milestones to Millionaire podcast are Meg and Shane. Welcome to the podcast, guys.

Meg:
Thank you.

Shane:
Thank you.

Dr. Jim Dahle:
All right. Let’s give a little bit of background information. Let’s tell people where you live, what you do for a living, how far you are out of your school and training.

Meg:
Sure. We live in a small rural mountain town in the Southeast. I do family medicine.

Shane:
And I do physical therapy.

Meg:
And I’m 22 months out of residency. So just shy of two years.

Dr. Jim Dahle:
Okay. And Shane, how far are you out of school?

Shane:
Just about three years now.

Dr. Jim Dahle:
About three years. So about the same, really. Okay. Very cool. Now tell us what you’ve accomplished.

Meg:
Yeah. We paid off our student loans and we have a positive net worth.

Dr. Jim Dahle:
Awesome. Back to broke and no loans. That’s pretty cool. So how much total did you have in student loans?

Meg:
I had $195,000 from medical school and Shane had about $90,000 from PT school. So together, $285,000.

Dr. Jim Dahle:
Okay. That’s actually pretty good, considering what you’ve done. Those are probably slightly below average. What did you guys do during school to make sure you didn’t rack up $300,000, $400,000 or $500,000 in student loans?

Meg:
Yeah. I actually ended up returning some of the money that was dispersed to me after doing some budgeting in med school, realizing I didn’t need the full amount. I did that a couple of times.

We had very few financial lectures in med school, but there was one that stuck with me when the guy said, “If you buy a $20 pizza now with loan money, by the time you pay it off, it’s going to be like an $80 pizza.”

Dr. Jim Dahle:
Yeah, that’s true. It’s really depressing to run those numbers and realize that, but you do start spending differently when, assuming you’re paying back your student loans like you guys did, you start thinking differently about those pizzas, don’t you?

Meg:
Oh, yeah.

Shane:
And I worked.

Dr. Jim Dahle:
Do you worked during school?

Shane:
Yeah. Wasn’t the funnest, but it helped in the long run though.

Dr. Jim Dahle:
Tell us about that. What did you do?

Shane:
Well, when I went back to school, I changed careers from firefighting to physical therapy. And I just wanted to be sure that I liked physical therapy. So I went in and I worked kind of in an office as a technician, just helping around and doing it that way. And then I realized I could go to school and do that at the same time, even though it was a little tight at times, but I made it work. And it really helped lower the amount of loans that I needed to take out.

Dr. Jim Dahle:
That seems challenging. It seems like PT clinics are open the same hours that school is going on.

Shane:
Pretty much, yeah.

Dr. Jim Dahle:
But you worked it out and nobody threw you out of school or anything?

Shane:
Yeah. School or work. Yeah. Everybody had to compromise a little bit and I had to do a few extra hours here and there, but it worked out though.

Dr. Jim Dahle:
I can’t help but think given your background that pulling a fire shift on the weekend might have been a better option. Did you consider that?

Shane:
Well, if I didn’t have, I got out of firefighting for an injury. Otherwise I would have done that. It would have worked out pretty well with the way the shifts work and firehouse and everything and school and everything. But I had to do it the hard way.

Dr. Jim Dahle:
Very cool. All right. Well, listeners want the details. Tell us what your net worth is now and what it’s made up of.

Meg:
Sure. Our net worth now is a little over $300,000.

Dr. Jim Dahle:
Okay. And break it down for me. How much is investments? How much is home equity, et cetera?

Meg:
We rent. We have zero home equity. It’s mostly investments. We’ve tried to max out our 403(b)s and Roth IRAs since becoming attendings. Shane had a decent IRA prior to us getting together. Savings accounts is less than investments. I don’t know the exact amount, but we don’t have any liabilities. We have no car loans, no student loans, no mortgage. So it’s actually all.

Dr. Jim Dahle:
You owe nothing. You’re totally debt free.

Meg:
Correct.

Dr. Jim Dahle:
Awesome. That’s pretty cool. Only three years, two plus years, not even two years for you out of training. That’s pretty cool. Okay. Give us a sense of what income looked like for you. I hear a small town in the Southeast and I think, “Well, that might not be very well paid at all.” And then other times I’m like, “Well, actually some docs make a lot in small towns.” What’s your income look like over the last two to three years?

Meg:
With 2024 being the first full year out of residency at this job, I made about $225,000.

Dr. Jim Dahle:
Okay. If I looked at a family medicine salary survey, that’s probably less than average, I would guess. Now your cost of living is probably much less than average, but certainly the answer was not income to how you guys did this so quickly. And how about you, Shane? How’d you do in small town physical therapy?

Shane:
Yeah, I actually came out a little above average, around $80,000 last year.
Dr. Jim Dahle:
Between the two of you, it’s a $300,000 income or so. Okay. Tell us how you managed to pay off basically $300,000 on a $300,000 income in less than two years.

Meg:
Yes. First creating our financial plan and sticking to it was probably the biggest piece. What we decided to do was to figure out our monthly budget. And we were able to set aside $3,000 from every paycheck to a separate money market account, one that we don’t really see or do anything with. And that’s where we grew our student loan fund and let that sit there until we had enough to pay chunks off. I will say that we stuck pretty closely to a residency budget, spending about $6,000, give or take, per month so that we had that extra to put towards the loans.

Shane:
Yeah. And anytime it came in under budget.

Dr. Jim Dahle:
Well, that’s boring. You just live like a resident in a work, huh?

Shane:
Pretty much. Yeah.

Dr. Jim Dahle:
Did you all hear that in podcast land? Living like a resident. Student loan is gone in less than two years. That’s all it took. All right. Very cool. But you also were putting money away it sounds like because you’ve built a substantially positive net worth. It didn’t all go toward loans. How did you decide how to split it up? How much toward loans and how much toward investments?

Meg:
We kept our investments pretty consistent just with plans to max out the 403(b)s and then have enough for the IRA to do the backdoor Roth. That came out to be about 20%. It was 19.75% was our savings rate last year. Anything that we didn’t spend from our monthly budget that was extra, we skimmed off the top and put into that separate money market account. And so that puffed it up a little bit besides just the six grand per month that was going in there.

Shane:
And that was after we already made a good emergency fund for ourselves and kind of stocked up for something like that. And then after that, it was a certain amount for retirement and a certain amount for loans and anything else just went to loans.

Dr. Jim Dahle:
So, you wrote down a plan and you followed it.

Meg:
We did.

Shane:
Yeah.

Dr. Jim Dahle:
That’s boring too. Extremely effective as you’ve now learned. Did either of you consider looking for a job that qualified for public service loan forgiveness or a contract program that would have helped pay for school because you were going to go to a small town or anything like that?

Meg:
Thought about it. I didn’t know for sure where I wanted to go after residency. And so I never wanted to be stuck with having to go to a certain town or doing one of the military tracks or something like that. I left my doors open. Looking back, it would have been great to do the… So there’s a two-year program. I can’t remember what it’s called.

Dr. Jim Dahle:
Like the National Health Service Corps or something?

Meg:
Yes. Something like that would have been ideal for my situation. I have colleagues here that are doing it. But as far as the PSLF, I couldn’t do it mentally. I hate having debt. And it was something that I thought about on a daily basis for my student loans. And so I couldn’t imagine carrying that for 10 years, knowing that I owe something. So it came down to not as much necessarily the numbers and how they worked out. But I couldn’t do it.

Dr. Jim Dahle:
Yeah, it would certainly be another five, five and a half years anyway if you’ve done everything perfectly before you received that forgiveness. Now, knowing the pathway you were going down, or maybe you’d completed it by this time, how have you felt with all this discussion in the media, social media, changes going on in Washington with the Federal Student Loan Program? How has just deciding to just pay our loans off made you feel when you heard those sorts of things going on?

Meg:
It feels great. I love not having to think about it anymore and keep up with the latest news and redo my calculations and Excel spreadsheets, trying to figure out estimated time of having them paid off. So it’s freed up a good bit of time and mental space.

Dr. Jim Dahle:
Very cool. So if there’s somebody else out there like you that wants to be rid of student loan debt within, one and a half, two, three years coming out of school, what advice do you have for them?

Meg:
I would say that you can still do it within a few years of graduating residency, even without being a high paid specialist. Don’t forget to negotiate for your first job. And it starts with educating yourself. And then based on that, creating a plan and sticking to it and staying motivated. One of the things that helped me a ton was listening to these type of podcasts. And that kind of kept us motivated and going and then celebrating the small wins as they came.

Shane:
Yeah. And just kind of making a game out of it, too. We’ve always come from frugal backgrounds, I’ll say. And we like to have a lot of fun. We do a lot of things, a ton of traveling. Even right after you finish residency, we took a month long road trip around the country and up to Canada and all that.

We enjoy sort of doing that while saving money. So trying to save money wherever we can, meet up with friends, stay with them, or find a good hotel cost, or find a good Taco Tuesday somewhere at a restaurant or something like that, where we’re like, we enjoy that part of it. It’s almost like a game to us. That really, really helps along the way.

Meg:
He has thrown some jokes about my frugality before, when I tear paper towels in half at home.

Shane:
Yeah. Yeah, even in quarters.

Dr. Jim Dahle:
Does he ever feel deprived over the course of that 20 months, though?

Meg:
No, we’ve had a great time. Like he said, we took a whole month off after residency, just playing. And actually worked way less than full time for three months after that. We took PRN jobs in Iowa, just to be close to family. And I think I worked, was it like nine hospital shifts a month for three months?

Shane:
I think so, yes, around nine.

Meg:
We had a good time those three months. And then I’ve been having fun here in the mountains.

Shane:
Yeah. And then if there’s something that we want to do, we just make it happen. We’ll let ourselves loosen up a little bit. My weakness is outdoor activities. I’ll get extra gear. And Meg’s always pulling the reins on me a little bit from time to time. But it always works out.

Dr. Jim Dahle:
Time spent biking or paddling or hiking can’t be subtracted from your life. You’re aware of that?

Shane:
Amen.

Dr. Jim Dahle:
All right. Very cool. So it sounds like you guys were kind of on the same page from the beginning. No big money fights, no big one person having to convince the other to do this.

Shane:
Wow. Maybe early on, she got me on board with this. I hadn’t really thought about it too much. She had done the research with your books and a few other resources and kind of convinced me. But it didn’t take much, though. I like the idea of just taking life kind of one thing at a time whenever you can. And this is one of those things that I really enjoy the process. And I’m glad that we’re done with it.

Meg:
I will say the conversation started before we got married, as far as how we would do finances and decide to combine everything.
Shane:
That would be good advice for some other people in our position, for sure.

Dr. Jim Dahle:
Yeah, absolutely. That’s great advice. Well, Meg and Shane, you should be very proud of yourselves. You have accomplished something very impressive and surprisingly not that commonly done. And hopefully it will inspire some other people to do the same. Thanks so much for being willing to come on the podcast and share your story.

Meg:
You bet. Thank you.

Shane:
Thank you.

Dr. Jim Dahle:
All right. I hope you enjoyed that interview. We get feedback all the time. We’re like, we need more regular people on the podcast, not gazillionaires, not people with super high seven-figure incomes or people that hit financial independence two years out of residency.

Well, here’s some real people. They did something that’s completely reproducible. They went and got jobs in a reasonably small town. The jobs didn’t even pay better than average. And in the case of the family doc, this was less than average, given family doc salary surveys I’ve looked at showing the average salary is like $275,000. Her job paid $225,000.

But what did they do? Well, they lived like a resident for two years. That was all. And not only did they pay off the loans, they built some significant wealth as well. This stuff works. I don’t want you living like a resident forever. That’s not the point. The point is to do it to get a head start on your financial journey. Knock out the student loans, save up and down payment, catch up to your college roommates with retirement savings, and just front load your financial life a little bit.

And then you can grow into your income, at least 80% of your income. You still got to save something. And it’ll be amazing because every year you’ll feel wealthier and you’ll be wealthier. And every year gets better and better and better throughout your career and throughout your retirement.

FINANCE 101: DEBT VS. INVESTING

All right, I promised you, or I don’t know if I did promise you. I probably didn’t promise you at the top, but I wanted to talk today for a few minutes about debt versus investing. There are two really common questions that don’t necessarily have right answers that we get in this community. The first one is, “Should I make Roth contributions or tax deferred contributions? Or should I do a Roth conversion?”

We’re not going to talk about that one. We’re going to talk about the second most common. Maybe it’s the first most common one. It’s hard to say sometimes. And that’s, “Should you pay off your debt or should you invest?” And there’s no right answer. It’s a great big fat, it depends. Let’s talk about some of the things that it depends on.

The first thing I want you to think about when you think about this question though, is that you probably ought to avoid the extremes. For example, if somebody decides “I hate debt, I’m going to pay off my mortgage before ever saving anything.” And they’ve got a 2.75% mortgage. That would be extreme to spend a decade or more paying off that mortgage with every bit of cashflow you can come up with and not investing in anything. Meanwhile, missing out on employer matches, missing out on tax protected growth, missing out on what are likely higher returns than 2.75%. That would be an extreme thing to do.

On the other hand, carrying around 30% credit card debt is extreme. That’s a huge debt emergency. You ought to be running around like your hair’s on fire if you’re carrying around credit card debt like that. And carrying that while trying to out-invest your 30% credit card debt and your Roth IRA, it’s probably not going to happen.

Avoid the extremes when you’re trying to figure this out. And recognize that both of these things are good things. They both increase your net worth. The less you owe or the more you have, the higher your net worth. And that’s the real measurement of wealth. It’s everything you own minus everything you owe. Both paying off debt and investing increase your net worth. So don’t beat yourself up on trying to get this exactly right. It doesn’t have to be exactly right because they’re both working toward the same thing.

Here are seven principles to keep in mind when you’re trying to decide whether to pay off your debt or invest the money. The first one is your attitude toward debt. Some people hate debt. We just heard from Meg. She hates debt. She does not like debt. She doesn’t want to have debt. Getting rid of it quickly is very important to her.

That’s not the case for everybody. Other people are like, “Well, debt is a tool.” And as long as you have a reasonable amount of debt with good terms, low interest rates, maybe it’s not crazy to carry it for a little while while investing on the side. But you got to figure out your attitude toward debt because it matters. This is personal finance. It’s only 10% finance. The rest is personal.

Number two is risk tolerance. One of the beautiful things about paying off debt is it’s a guaranteed return. If you got 30% credit card debt, that’s a guaranteed 30% return. But if you’ve got a 7% mortgage, it’s a 7% guaranteed return. If you got a 5.5% student loan, that’s a 5.5% guaranteed return. Now you might have to adjust it for taxes. Maybe your debt’s tax deductible. And so it’s a little bit less than whatever those percentages are, but it’s guaranteed.

And if you look around and look at other guaranteed investments, buying a treasury bond for a couple of years or putting your money in a money market fund, well, what are those guaranteed things paying after tax? And sometimes your best guaranteed investment is just paying off your debt. So keep that in mind.

All right, the next factor is your available investment accounts. Money just grows faster in a retirement account or an HSA or even a 529 or a UTMA than it does in a taxable account.

What a lot of people do is they max out their accounts, their retirement accounts, their backdoor Roth IRAs and their 401(k) at work. And then everything else goes toward the debt because your returns are going to be a little bit lower when you’re investing in a taxable account. And so, that’s the way a lot of people split the difference.

The next factor, the fourth factor that you ought to be thinking about is what you’re going to invest in. If you’re going to invest in a bond fund and you’ve got 6% debt, well, paying off the debt is probably going to do better than that. On the other hand, if this is the greatest investment you’ve ever seen, you’re being offered sweetheart terms to get in on a dialysis center. Maybe you’re okay carrying debt a little bit or even taking out some extra debt in order to be able to invest in that early in your career as a nephrologist.

The investment you’re going to put the money into matters. And the better the investments, the higher the expected returns, the more likely you should be to put money into the investment rather than paying off your debt.

The fifth factor is the interest rate of the debt. My next door neighbor who we had on this podcast not long ago, he’s a radiologist, remember the guy who took a year off. I think he’s still got student loans. He graduated with me in 2003. It’s probably a four-figure amount at this point, but he refinanced them back in 2003 at 0.9%. If you’ve got 0.9% debt, it’s probably okay to carry that for a while and invest the money. At 1, 2, 3, 4% debt, it’s not that hard to out-invest it in the long-term. In fact, if you can’t out-invest those sorts of interest rates, you got to worry about reaching your financial goals as it is.

The interest rate of the debt doesn’t matter. As it gets into moderate interest rates, 5, 6, 7, 8%, well, then you got a little bit harder decision, sometimes splitting the difference or even paying off the debts is the right move. Certainly, if you get to high interest rates, right, you’re paying 9, 10, 12, 30% that debt becomes very attractive as an investment to pay it off. So the interest rate of the debt does matter.

The sixth factor is how wealthy you are. At a certain point, as we built wealth, we started looking at our mortgage. And I think at that point, we owed $275,000 or something like that. And the interest rate was like 2.75%. But it got to the point where that mortgage was not a significant factor in our financial life. And we just wanted to simplify things. We took a lump sum of money and went and dumped it on and paid off the mortgage.

Because we’re wealthy, we made a different decision than I think we would have made if our net worth had been $400,000. If our net worth had been $400,000, we wouldn’t have taken $275,000 of it and paid off the mortgage. We probably would have carried that debt for a while and continued to invest. So, how much wealth you have already probably matters in this decision.

And the last factor is the asset protection and estate planning factor. There are asset protection implications of having debt. For example, let’s say you’re in Florida or Texas, you have this great homestead protection for your house. Basically, if you got sued and had the above policy limits judgment and you had to declare bankruptcy, you’re going to keep your home.

In that case, you might be more likely to pay off a mortgage than you would in a state like Utah, where not that much of your home equity is protected. Those sorts of decisions can come in when you’re trying to make this decision in paying off debt or investing.

Here’s another scenario. Let’s say you’ve got a grandpa, he’s 85 years old, he’s not in very good health. And he’s got a very low basis on all of his taxable assets and he needs some money. He’s going to either pay a whole bunch of money in capital gains taxes to get that money or he can borrow against it instead and actually have more debt. But the interest might be less than the capital gains taxes, especially if he’s going to die in a few months or a few years and there’s not that much time for the interest to really work. But those capital gains taxes will be paid all up front.

There’s not always a right answer. You got to keep these seven factors in mind as you try to decide what to do. But here’s some general advice if you’re weighing these factors.

First, get any employer match. If your employer is going to match your contributions in your 403(b) or your 401(k), that’s like part of your salary. Don’t leave part of your salary on the table. Put enough into that account to get your employer match. Even if it means you’re going to be paying off your debt a little bit slower.

Next, pay off your high interest debt. If it’s 8% plus, that’s a huge priority for me. Guaranteed returns of 8% plus, that’s really attractive. So pay that stuff off first. Next, maybe max out your retirement accounts. Maybe it’s tax deferred accounts if you’re in your peak earnings years. Maybe it’s tax-free accounts in the other years. Although, as I mentioned earlier, that’s a very complicated decision to make. There’s a lot of factors that go into that. Maybe include other types of accounts as well, HSAs and 549s and UTMAs, et cetera. But those are the next thing you may want to do.

After that, look into assets with high expected returns. It doesn’t make sense to carry around 5% debt and then have a bunch of money in a municipal bond fund in your taxable account. You’re not going to make 5% on that after tax.

So, keep that in mind as you invest. The returns matter. But if you’re going to carry a little bit of debt and buy a couple of rental properties, well, you’re probably going to out-invest your debt at least over the long run.

Next step would be paying off moderate interest rate debt. And after that, investing in assets with moderate expected returns. And then pay off your low interest rate debt. And then finally, invest in assets with low expected returns.

You’re kind of going back and forth between the debt and between the investing as you work your way down, depending on how attractive the investments are, especially if they’re in tax-protected accounts, along with what the interest rate is of the debt, what the terms are of the debt.

It’s complicated. You don’t have to get it exactly right, but it should be individualized to your situation. I hope that’s helpful to you in our discussion today about paying off debt versus investing.

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Keep your head up and shoulders back. You’ve got this. We’ll see you next time on the podcast.

DISCLAIMER

The hosts of the White Coat Investor are not licensed accountants, attorneys, or financial advisors. This podcast is for your entertainment and information only. It should not be considered professional or personalized financial advice. You should consult the appropriate professional for specific advice relating to your situation.