Personal Finance for PhDs

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Emily

What Is the Best Way to Pay Down Debt?

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The fastest way to get out of debt is energetically. If you want to get out of debt ahead of the schedule the minimum payments have you on, you must put forth effort and discipline both to free up cash flow by earning more or spending less and actually applying that cash flow to your debt in the form of additional payments.

One Debt

If you have only one debt or one type of debt and it’s going to be a long payoff process, you are going to have to find ways to keep yourself psychologically motivated through the process. You can do this by creating a visual representation of your progress, celebrating debt repayment milestones, treating yourself occasionally, reporting your progress to other people, etc.

Further reading: How to Get (and Stay) Motivated for Long-Term Debt Repayment, How to Stay Motivated While You Pay Off Debt

Multiple Debts

If you have multiple debts or multiple types of debt, there are two popular math-based methods for prioritizing your debt payoff journey, and one other practical option. In any case, it is considered psychologically beneficial to focus your energy on only one debt at a time. Make the minimum payments on all your debts, but channel your extra payoff money to just one until it is completely paid off.

The question is how decide in what order you should pay off your debt.

The Debt Snowball

The debt snowball method’s main champion is Dave Ramsey, a get-out-of-debt guru practicing today. In this method, you prioritize your debts by the payoff balance, smallest to largest, irrespective of the interest rates. The idea is that by getting an early win of paying off one debt completely, your motivation will grow and you will process through your list of debts at an ever-increasing rate. By the time you get to the debt that you expected to take you the longest to pay off, you have many smaller wins behind you to give you confidence to see the process through. Empirically, it has been shown that people who employ the debt snowball method get out of debt the fastest (psychology wins over math).

Further reading: ‘Snowball’ Debt Method Is Fastest Way To Pay Off Your Bills, Research Shows

The Debt Avalanche

In the debt avalanche method, you prioritize your payoff list by interest rate, highest to lowest. This method is the most mathematically optimal way to approach your debt payoff. If you devote the same amount of payoff money into the debt snowball method and the debt avalanche method, you will get out of debt faster with the debt avalanche method. Some people can become very motivated by interest rate math, and these people are especially suited to start their debt payoff journey well with the avalanche method.

Further reading: The Correct Way to Pay Off Personal Debt: The Debt Avalanche

What Bothers You the Most?

The debt snowball and debt avalanche methods both try to argue that there is one best way for everyone to approach paying off debt. But you know you best. If the goal is to pay off debt quickly and with great energy, you should ask yourself which debt bothers you the most or which one you are most excited to eliminate. Perhaps the answer will be the debt with the smallest payoff balance or the debt with the highest interest rate. Perhaps the answer will be the debt associated with the collector who is calling you multiple times per day or the debt you are most embarrassed to have taken out. Use what you know about your own individual psychology to start your debt payoff process off well and use that motivation to carry yourself through your list. It’s also perfectly fine to switch focus once you are left with only low-priority debt, if saving or other financial goals are more pressing than your remaining debt.

What Should I Do about My Existing Debt?

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If you have debt from the past and are currently living within your means, you have the option of doing more than making the minimum payments. How fast you want to get out of debt will depend both on the math of your situation and on your personal disposition toward debt and risk.

While you are a graduate student, you have the option of deferring your student loans, but the analysis laid out below will still be helpful in deciding whether to pay down those loans while you are in graduate school or to wait until after graduation.

Math and Facts

When deciding how quickly to get out of debt (or when evaluating new debt), the math of the situation should be given considerable weight. The most important factor is the interest rate on the debt. How does it compare to the long-term average rate of inflation? If you are considering paying down debt vs. investing, how does it compare to the long-term average rate of return you expect on your investments? How much interest are you paying on a yearly, monthly, or daily basis on your current debt balance? The higher the interest rate, the more weighty the argument that you should aggressively pay off that debt.

In addition to the interest rate, there are other attributes of your debt that should influence how quickly you pay it off (arguments for slower appear on the left, faster on the right):

  • fixed vs. variable interest rates – interest rates are set to rise at any time, so the low current variable rates are unlikely to stay low forever
  • low vs. high fees and penalties (pre-payment, late payment)
  • flexible vs. inflexible repayment options
  • secured vs. unsecured – this means whether the debt has collateral backing it, such as property, or whether it has no collateral tied to it, such as credit cards and student loans
  • bankruptable vs. non-bankruptable – student loans can virtually never be discharged in bankruptcy

Personal Disposition

Math alone is unlikely to hold 100% sway over your decisions regarding your debt, especially because risk is difficult to quantify. Your disposition toward debt matters greatly as well. There are some financial gurus today who will tell you that any debt you have is an emergency and you should pay it off as fast as possible. There are other financial gurus who won’t get fussed about you keeping low-interest debt while aggressively saving and investing. You have to determine where you fall with regard to your personal disposition toward debt, independent of the math of the situation. Does having debt give you anxiety? Are you more excited about meeting other financial goals while making minimum payments on debt? The only disposition that is really dangerous for your finances is an apathetic one in which you devote no energy to increasing your net worth; in that case, your debt is likely to become expensive.

Further reading: News Flash: Your Debt Is an Emergency, 11 Great Reasons to Carry a Big, Long Mortgage

What you bought with the debt may also play a role in how quickly you want to pay it off. If the debt was for a long-term appreciating asset such as a home or an education, you may be less inclined to pay it off quickly. However, consumer debt such as for cars or shopping (and sometimes student loans), which is debt that enabled you to live beyond your means for a time, is a type of debt that you may want to quickly put behind you.

In the end, the decision of how quickly to get out of debt is up to you, and it will depend both upon the math of your situation and how you feel towards debt. These factors also play important roles in your choice of which debt repayment method to use. As a graduate student, you likely don’t have a lot of disposable income to put toward debt repayment even if you want to. But wherever you start today, if you choose to be energetic about paying off your debt, you can find ways to increase the money you have available to pay down debt by implementing frugal practices or increasing your income.

Further reading: The Goal: Defeating Student Loan Debt

Credit Cards

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Depending on who you ask, credit cards are either dangerous or lucrative, a great convenience or a terrible temptation. What they really are, at their core, is a debt product. The credit card issuer has extended you a line of revolving credit in the amount of the card’s limit.

Further reading: Don’t Buy the Pro- or Anti-Credit Card Hype

When you make a purchase using a debit card, the funds are immediately or within a few days transferred out of your account to pay for the purchase. When you make a purchase on a credit card, you are incurring debt to the credit card issuer. Between the time you make the purchase and when the payment is due, the credit card issuer is giving you an interest-free loan. If you fail to pay the balance in full by the payment due date, the credit card’s interest rate then applies to the balance.

Credit cards can be very dangerous products, especially for those who live paycheck-to-paycheck, are inexperienced with money and banking, or are unorganized. This is because credit cards typically have a very high interest rate (the average rate is 15%), meaning that if you carry a balance on your card beyond the grace period that debt will become very expensive. (In today’s low interest rate environment, it’s difficult to think of any other debt product aside from payday loans that typically has interest rates higher than those on credit cards.)

However, when used with discipline, credit cards can confer some benefits, such as fraud protection, additional insurance, and rewards (in the form of cash back, airline miles, goods, etc.). The exact benefits the user gains from using a credit card can be learned from the terms and conditions. The terms and conditions will also detail how expensive a mistake can be in terms of the late fees and interest rates.

You must determine for yourself if credit cards are a useful product for you. Credit card companies make money not only from charging interest and late fees, but also from merchants. There is a percentage fee that credit card companies collect from every transaction, so you need to realize that their rewards structures and so forth are set up to induce you to spend more than you intended to. Credit cards can also be very tempting for people who don’t have any cash reserves in the case of an emergency or a month that is more expensive than anticipated, but these people are highly susceptible to getting stuck in a debt cycle with credit card balances that they have difficulty paying down. It may be better to avoid using credit cards entirely, because their very convenience ends up being a trap.

Further reading: “I Want a Credit Card, but I’m Scared”

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Perfect use of a credit card, or it never costing you more than cash would, entails always paying the balance off in full on or before the due date and never spending more than you would if you were using debit or cash.

One of the most important attributes of credit card usage to be cautious about is its ability to dissociate the act of making a purchase from the consequence of paying for it. Even if you pay off the balance in full every period, it is possible to get 1-2 months behind in your spending in comparison to if you used debit or cash because of the grace period credit cards give you. Even if you never actually pay fees or interest, this is an undesirable position to be in because you are borrowing from your future paychecks when you make a purchase.

Further reading: Living on Time with Your Credit Cards; Credit Cards Are a Necessity, If You Are Responsible

Emily, Duke University, biomedical engineering — Targeted savings accounts

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In grad school, I took the idea of saving for irregular expenses in a separate savings account to an extreme – and it had a great psychological effect! Instead of saving into a single general account, I created multiple targeted savings accounts for different purposes. The first two I created were for travel (that was in The Year of the Weddings) and entertainment (for the season tickets I wanted to buy). Another really important account early on was for my car – that covered insurance (paid every six months), my parking permit (paid once per year), repairs, registration and taxes. Over the years, the accounts had proliferated to about ten, all for different single or grouped purposes! Dividing out my savings rate like this helped me to aggressively save. In many of the accounts, I overestimated my need, so some money built up. By the end of grad school, I had built up quite a balance in the accounts, and ultimately I transferred all the money into a general account, which helped me with my unexpected transitioning-out-of-grad school expenses.

Emily, Duke University, biomedical engineering — Frugal cell phone plan

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When I heard about Republic Wireless, I jumped on the chance to use their service. I’ve been with them for two years now and recommend them (and other MNVOs) to everyone. Republic Wireless’s business model is for your data (including VOIP) to go over wireless when it is available and over the Sprint network when it is not. This allows them to offer low prices on (effectively) unlimited service. I pay $25/month for my unlimited everything 3G plan, but you can get a plan for as little as $5/month (no contract). I think the service is perfect for most grad students because we’re under our university’s wireless all day. The downside is that you have to buy one of their Android phones up front. This is a great example of being frugal (and not cheap) because I’m paying very little for a plan that is just as good as or better than what I would get from the major carriers.

Grad Student Parents

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There are so many vital ways parents need to prepare for the arrival of a new child, yet money often rises to near the top of their concerns. Grad students have the additional wrinkle of not being considered full employees by their universities, and likely have never met with or even have access to a Human Resources department.

Take stock of your benefits

Some graduate students may have well-defined parental leave options, while others may have to negotiate their time away with their advisors or departments. You also need to match your insurance benefits with your desired care provider to anticipate your out-of-pocket expenses for the pregnancy, delivery, and initial medical care.

Save

Between your medical costs and buying supplies for your child, you are likely going to have significant out-of-pocket expenses. You can cash flow some expenses before the baby’s arrival, but you will also likely need to save up a fund to have flexibility close to the birth. Your new baby is certainly going to shift your priorities, which should be reflected in a new budget/spending plan to help you pile up money.

Further reading: What Do Newborn Babies Really Need?

Plan for childcare

If both parents are planning to resume working after the baby’s arrival, you will likely need to plan for childcare and the expense of childcare. There are many options for childcare, such as in-home care and daycare. You should investigate any local options that may be available to you for a subsidized rate, such as at or through your university.

One option for adjusting to the cost of daycare is to start living as if you were paying that expense as soon as you decide what price you will pay. This exercise will serve the dual function of helping your budget adjust to the new daycare expense and building up your savings.