A physician’s advice on extra cash flow

When it comes to destroying debt, many of us are familiar with the two most common methods to pay down debt. Many choose the debt snowball method where you pay off your smallest debt first while paying the minimum on others. Once that first debt is gone, you roll that payment into the next. Eventually, you gain a ton of momentum as your debt snowball accumulates. This allows you to take down your debt in short order. But what happens after that? What do you do with extra cash flow after paying down your student loans, car payments, or mortgage?

Extra cash flow in our home

When my family and I finished my fellowship in regional anesthesia, we had approximately $300,000 in non-mortgage debt. This included our student loans ($210,000) and two car loans (~$80,000). Over the next 24 months, we would pay off all of that debt and the interest that was continuing to accumulate.

While I previously mentioned the debt snowball method, my wife and I preferred a different approaching to paying off our debt. The debt avalanche method. While maxing out our tax-advantaged retirement space, we paid minimum payments on all of our debt, except for our student loans.

According to the 10% Rule, we enjoyed 10% of our increase in post-tax pay after training. The other 90% went straight towards our student loans after we refinanced them at a great rate. This allowed us to take a sledgehammer to our loans as we averaged a little more than $10,000 a month towards our loans. It took 19 months to get rid of the $200,000 in loans.

After the loans were gone, my wife and I purchased our new home. In other words, my family of five (and our two dogs) lived in the same 1,100 square foot home we lived in during medical school, residency, and fellowship for a year and a half after finishing training. Living like a resident is what allowed us to destroy our loans.

Following the house purchase, we continued our progress and destroyed the rest of our debt over the next six months.

Now that we are faced with extra cash flow each month that no longer goes towards student loans and car payments, we have to determine where to put the extra money. With a desire to be intentional with our financial life, here are several ideas or placed where extra cash flow could be spent.

1. Increase your emergency fund

After finishing training, our first financial step was to create an emergency fund. Since then, we have maintained a three-month emergency fund in case an unexpected expense comes up. By “three month,” I mean that the value of our emergency fund consists of three months worth of monthly expenses. So, if my family spends $10,000 per month, we would need $30,000 to have a three-month emergency fund.

Our three-month emergency fund has served its purpose while we aggressively paid down debt. We have only needed to dip into it once, which happened after we moved and had multiple unexpected expenses. Hint: Buying and selling a house costs a lot of money.

Given the extra cash flow we have after paying off our non-mortgage debt, you could argue that we need an emergency fund less now than we did over the last two years. Yet, I’ve recently learned that dipping into that fund and knocking it below $30,000 causes me financial stress.

So, one of our first moves with our extra cash flow will be to increase our emergency fund to a five or six-month emergency fund.

2. Give more money to charity

I am a big believer in giving from a position of strength. That’s the only reason giving more money away isn’t listed as the number 1 option for extra cash flow.

Giving more to charity may mean giving your time or services to those who need it. You could even move to part-time work now that you can afford it to allow you to be more available for these opportunities.

You could also give more to charity in a strictly financial sense. While my wife and I have tithed 10% of our take-home pay since the day we got married, we have recently made a decision to start tithing from our pre-tax income. Our church has relationships with local shelters, food pantries, and other outreach ministries to help those who are in need in our local community.

Not only will our additional charitable giving work towards helping others – and make us feel good – it also decreases our taxes since we itemize our deductions.

3. Increase your savings rate

Increasing your WAR (wealth accumulation rate) is another option for your extra cash flow. Given that your savings rate is the most important determinant of your investing success for the first 10-15 years you invest, this is a wise place for many to put their extra money.

Let’s say you save $50,000 each year, and your financial independence number is $2.5 million. Assuming an 8% interest rate, you would reach your goal in 24 years. What would happen if you started saving an extra $2,000 per month ($74,000 per year)? Well, you would shave seven years and achieve your goal at year 17.

Being able to retire seven years earlier sounds mighty fine to me. Yet, everyone’s situation is different. You might also look at that extra $2,000 and feel that you could find a better use for it. It is up to you!

4. Pay off the mortgage

Even after paying off your student loans, car payments, and any credit card debt, you may still find that there is one other large source of debt that many like to ignore. Your mortgage.

What if you paid two mortgage payments per month instead of just one? You might find that your mortgage will be gone in only 10 to 15 years, if you have a 30-year mortgage.

For the math purists out there, you might argue that your money would be better spent chasing after 6 to 10% market returns rather than paying off low-interest mortgage debt with rates between 2 to 5%.

Where do I stand on the issue? Honestly, I think either approach is fine. Either way, you are doing something smart with your money, which means you are likely way ahead of your peers.

5. Buy more experiences

All of the options above involve giving money away or putting it towards a financial pursuit of some kind. What if you want to spend some of it? After all, you’ve worked really hard to get to the point where you have extra cash flow!

I think spending money is fine. In fact, going forward, my wife and I will probably convert our classic 10% rule into something more like a 15-20% rule. If we are crushing our financial goal, why shouldn’t we spend more money to enjoy today?

If you do decide to find a good use for spending, I recommend that you spend it on experiences (rather than things). Why? Because research has shown that money spent on experiences leads to more sustained happiness.

So, one way that you could spend extra money is to increase your annual vacation fund. That way, you could take a trip to Europe, go to Disney World, or whatever else floats your boat.

Take home

After you put in the hard work to destroy your debt, you have a lot of options for your extra cash flow. Where you put it is up to you. There are many options, though I do encourage you to enjoy some of it.

As for my wife and me, we will probably do a little bit of everything mentioned above. Our first step will be to increase our emergency fund and increase our charitable giving. Then, we will likely invest more through a taxable account, increase our vacation fund, and put extra money towards our mortgage.

James Turner, also known as “The Physician Philosopher,” is an anesthesiologist who blogs at his self-titled site, The Physician Philosopher. He is the author of The Physician Philosopher’s Guide to Personal Finance: The 20% of Personal Finance Doctors Need to Know to Get 80% of the Results.

Image credit: Shutterstock.com

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