Out of curiosity...
For those of you who favor paying off loans before investing, do you also favor extra loan payments over contributing to 401k, IRA, and/or HSA?
It depends.
In general, I would max out my retirement accounts first because the tax savings will far outweigh any benefit from paying off the loans early, especially with loans at 5% or less.
You want to fund the retirement accounts because they are tax advantaged. This is a long topic in itself, but you either pay taxes now with a Roth because your taxes are lower now ( eg 5 or 10%) than they will be when you retire ( eg 20-24%), or you defer taxes in a traditional 401k because your taxes are higher now as an attending ( eg 39%) but will be lower ( 20-24%) in retirement. Plus, you put the money in at your marginal rate, but withdraw it at your effective (blended) rate which is almost always lower. There are exceptions, but that's why you use tax advantaged accounts.
So you generally want to use those accounts to get the match ( if employed) and the tax benefit. But if you have credit card debt at 24%, for example, you should probably pay that off first.
I get your reasoning and appreciate the analogy of buying a bond with a guaranteed rate. I know 7% is not guaranteed but it my mind it is close enough. I have basically 90+% equity with no bonds in my portfolio.
That's fine. Go for it. I still think you should pay off the 5% loan, but I can't argue with your logic. Just remember, when the market drops, buy, don't sell. You should be fine as long as you avoid individual stocks.
As for your specific situation, you should be able to refinance your loans at a lower rate, at least the 5% loan. Have you tried that? Also make sure you looked into all the relevant repayment plans.
I own muni bonds, but their tax equivalent yield is 7-9%
How did you get bonds paying that much, 3.5-4.5%? You must have them a long time. I don't trust California municipal bonds. Some have defaulted. If I were to buy bonds, I would do if for the guarantee, i.e. treasuries.
. The choice is not whether we should pay off student loans or not. The point is to pay off AS FAST AS POSSIBLE to minimize the damage of interest. Basically fighting against TIME.
Right, but the overall issue here is that time and inflation cut both ways. Time increases the total amount of interest you pay on the loan. Time increases the value of the investment. So you want to do what maximizes the interest rate in your favor.
Inflation decreases the value of the investments, but it also decreases the value of the loan. It balances out.
As you point out, paying off the loan is a sure thing. The investment is not. Strictly speaking, the investment will give you the best rate of return long term. However, as I mentioned before, most people will tell you to pay off 4% or more as soon as is reasonable. Most might keep a loan of less than 3%. But don't buy bonds paying less than your loans; pay off the loans instead of buying bonds.
It's a GAIN FROM preventable YEARS (12, 10, 8, ect. years) of COMPOUND INTEREST. Would you agree on this?
This is correct. You can't ignore gained opportunity cost of paying off the loan. By paying off the loan, you save the interest, which you can then invest, and it will then compound. While the interest on a loan won't compound if you pay it off as it accrues, you will have that much less money to invest, so you lose the compounding of your net worth.
The big issue is just the difference in interest between investing and paying off the loan. As you point out, you get a higher return by investing, but it's not guaranteed. This is the basis upon which all investing works.
In general,
in order to get a higher return you have to take more risk. You need to decide for yourself how much risk you're willing to take, and how much of a return you need in return for greater risk.
Unfortunately, many, if not most, people find out too late that they have a lower tolerance for risk than they once thought.
How will you feel about this discussion when the stock market loses half its value, like it did in 2000? How will you feel when it loses 60% of its value, like it did in 2007? What if it loses 70% of it's value 3 years from now? You will wish that you had paid off that loan instead. Think about it, and be sure you're comfortable with your decision now, and that you will be comfortable with your decision when the next big market drop comes.
Too many people panic and sell at the bottom after a market drop. You have to be confident that you won't do that. That's a vote in favor of paying off your loans. I have been through several big market crashes. I know that I can ride through them and can keep investing. Most people can't. You won't know how you will react until you have been there. Keep that in mind.
Regarding the above discussion about loans vs investments:
An investment is just the other side of a loan.
For those who still don't get it, try looking at it this way:
You invest $100,000 for 10 years. The investment pays you 7% a year for 10 years.
Your investment is someone else's loan: 7% for 10 years.
Your investment is someone else's loan. Your loan is someone else's investment. They balance out.
If you lend yourself money and charge yourself interest you will come out even.
If you lend one person money at a given rate and borrow it back from someone else at the same rate you will break even.
If your investment is a loan or if it's "an investment" it comes out the same.
The interest you pay on a loan doesn't compound against you if you pay it. But the interest that you pay is no longer yours so it can't compound in your favor. That's why it balances out.
If you get paid interest from a bond or a loan or from mutual fund dividends, it's up to you to re-invest it. It doesn't magically compound. There's a box you check when you open the account, where you choose between getting a check for dividends and interest, or to automatically re-invest. Compounding occurs when you re-invest those interest payments. If you re-invest, then it will compound. If you don't re-invest, it won't compound.
So in the above example, if you want your investment to compound, you have to re-invest the proceeds. Think about that. If you have to pay money on your loan, then you will have less to invest, or re-invest. That money won't compound. That's why you break even when you have a loan and an investment at the same rate at the same time.
I can't make it any simpler than that. An investment is just the other side of a loan.