Welcome back to the Financial Pulse. In today’s brief lesson we will be reflecting on the topic of Resident Debt, and review the concept of compounding interest.
Debt. We have all heard of it and for some more than others, it can strike fear into our hearts. Based on the recent data from graduating medical students in Canada, the median debt for medical school graduates is $100,000. However, if you’re like most residents, including myself, this number is not surprising. Most of us were offered and signed up for six-figure lines of credit at the start of medical school and many of us made good use of them during our medical education.
While residency does provide a source of income, a 2018 survey by Resident Doctors of Canada found that residents complete their training with an average of $127,496 of debt by the end of residency2. That means that the average resident incurs more debt in residency.
Again, no surprises here.
While the resident salary helps with certain expenses, many of us live in cities with expensive costs of living and it doesnt cover all expenses we incur as residents.
So why am I discussing this? Well, before we move on to learning different financial concepts, we want to reassure you that if you are a resident who has debt, it is normal and you are not alone! And if you are a resident without debt, that’s awesome too! Regardless of your financial situation, the next lessons aim to equip you with the knowledge necessary to improve your financial health.
The first topic we will cover is simple, yet the impact of it can be profound. This is the concept of compounding interest.
While this won’t show up on your in-training examinations, it is a critical concept to grasp when not only learning about debt, but also about investment strategies.
Compounding is when you take a base number and increase it over and over again by a percentage rather than a fixed number. In the financial world, this is best demonstrated with the concept of compound interest.
Let’s say you purchase a common fixed-income investment product - a bond. And let’s say this bond pays a 2% annual compound interest rate. Say you initially invest $1000 in this bond that pays a 2% compound interest rate. After a year, you have earned $20 interest. Pretty simple. Your bond is now worth $1020.
Next year, you earn that same 2% interest rate, but now it is calculated on your total bond value of $1020, rather than your initial investment of $1000. So now you earn 2% on $1020, which equals $20.40. While $20.40 doesn't seem like much more than $20, if you compound this interest over 20 or even 30 years, your return can be significant.
When it comes to investments, compound interest means you are earning interest on your interest. However, many of us residents don't experience compounding returns as we aren't purchasing investment products yet. Rather, we experience compound interest in the form of interest on debt.
Interest on debt works the same way as interest earned from investments, except that you pay, instead of earn, interest on your interest.
Why don’t we look at this with an example. Say you have a line of credit that charges an annual interest rate of 3% and say you have a balance of $250,000 on your LOC. At the end of year one, you pay $7500 in interest. This interest charge gets added to your balance, so now your LOC is $257,500.
If you dont pay anything off during the next year, that 3% interest is calculated on your new balance of $257,500, meaning your interest charge is now $7725, bringing your LOC balance to $265,225. Just as compounding can lead to exponential growth of your investments, it can lead to exponential growth of the interest charges on your debt.
So why does this matter to us as residents? The concept of compounding interest means that:
If we have debt, the sooner we can decrease our debt, the more interest we can save
If we are wanting to invest, the sooner we can invest, the more interest we can earn
As you can see compounding interest can work both for, and against you. The sooner you get it working for you, the sooner you benefit from compounding interest, rather than being hurt by it.
Whether you are a resident who is carrying a significant debt load, or a resident preparing to invest, the next few lessons will review some foundational topics related to financial planning.