“Never buy a plane or horses just out of residency!” said my soft-spoken attending, staring at me intently. “I did, and I learned my lesson well.”
Indeed, he did. He was newly married, had no money in his account . . . and salivated when his first sizzling $13,000 monthly paycheck was deposited. A year later, he had a $1 million home with land and horses, a Jag, and a Cessna. He was living life in the fast lane! Needless to say, the cost of managing his horses ate into his finances, the Cessna broke, and he and his family were left financially devastated. They had minimal savings, high consumer debt, and no money invested in anything.
Sadly, these experiences are common.
SDN Finance and Investment Forum: https://forums.studentdoctor.net/forums/finance-and-investment.176/
Recently, one financially savvy resident in our program sent an email to all the residents regarding the utility of opening up a Roth IRA account — even while in training. One resident (who I will call Joe), upon reading the email, developed jitters about his future retirement — despite the high income he would most likely earn as a practicing physician. Joe was not feeling desperate about his bright future; rather, he was unsure about soundly managing his finances to prepare for retirement.
“What? . . . Man, thinking about that stuff makes me sick to my stomach,” said Joe, eyeing me peevishly, his voice resonant with hopelessness. “No one ever taught me much about investing, let alone money matters.”
“Well, we all have to start from somewhere,” I replied.
Joe looked at me as if I had told him to leap off the Eiffel Tower.
I pressed on. “We all can certainly learn. Investing is, after all, not nuclear science.”
And, sure enough, it isn’t. We don’t have to go crazy when we hit that high-income bracket after our training — finally! No purchasing horses, planes and RVs.
Indeed, there is a stereotype that physicians, dentists, and other health professionals have limited knowledge in matters related to investing. No doubt, we have been trained to provide optimal care to patients, and we make life or death decisions without hesitation. However, the mere thought of investing unsettles many of us in the health professions.
A recent comprehensive survey conducted by the Consumer Federation of America and Wachovia revealed that 52% of Americans were not saving enough money. 72% identified unexpected major expenses, job loss and consumer debt as obstacles to saving, while 37% cited impulse spending as the culprit .
Interestingly, the same report illustrated that while most Americans were generally pessimistic about how they perceived themselves, other Americans saved for their futures—individuals in high income brackets (those making $75,000 and above per year) were more than twice as likely to have saved enough resources to sustain themselves in emergencies and cater for their retirements versus those making $25,000 and less per year.
One more interesting thing was that when the survey respondents were illuminated about the “miracle of compound interest,” the interest to save was gendered in about 80% of them. What they were simply told was that saving $200 a month for 30 years at a conservative 5 percent interest would accord them over $300,000 in their retirement .
However, I would argue that the strict terms “saving” and “investing” do not necessarily mean the same thing. Investing money entails saving while mere saving does not entail investing. To illustrate, if you put an initial $1,000 (e.g., from a tax refund) in a mutual fund with a 9% compound interest and made consistent $300 monthly contributions into it, you would generate, over 25 years, a total of $345,745 . Now, that is true investing! On the contrary, if you were to take the initial $1,000 tax refund, clip it into your mattress and religiously deposit the same $300 monthly contributions in that “mattress account” for 25 years, you would end up with a relatively shabby $91,000 . Now, that is simply saving. Moreover, the benefit of saving alone would not be sufficient to beat the rate of inflation — which now runs about 4.31% per annum and is projected to climb higher .
For the sake of brevity, I will deal with investing as it relates to achieving a good retirement nest egg versus attaining other goals, such as saving money for a child’s college education, buying a home or boat. These are important goals, but considering that as we get older we are bound to face a future punctuated by inflation, increased health costs and uncertain Social Security benefits — the need to invest then for retirement should predominate.
Before discussing some vehicles of investment, however, I will point out some important principles. While not professing to be a financial guru, I have had enough business courses to be considered knowledgeable. I have also read widely, as I still do. I have owned 4 homes, opened and managed my children’s UTMA accounts (my teens now have ROTH IRA accounts), ran my own karate studio/fitness club, and I have been investing for my retirement for several years now. A word of preface: the investing I am talking about is NOT a “get-rich-quick” scheme. It is dedicated financial investing. So, enough said, let’s explore the principles.
Firstly, you must start paying yourself. Moreover, the earlier you begin, the easier it will be to build up a comfortable retirement nest egg. If you start at age 25, for example, investing $300 per month, you will get a handsome $1,047,302.35 by age 65 — assuming you earn 8% annually. If you start at the age of 45, and invest along the same terms, you will earn $176,706.12 at age 65. To play catch-up with the 25-year-old, the 45-year-old would have to invest $1,800 per month for 20 years to earn $1,060,236.75. So, suffice it to say, in the area of investing, paying yourself first over a period of time works to your advantage. If you start late in the game, you will have to invest a larger amount. Either way, you end up doing better than the guy who invests nothing.
Secondly, you must take advantage of what Einstein called the 8th wonder of the world: compound interest. This phenomenon occurs when interest is added back to principal, and the growing amount plus interest generates more interest, interest then is compounded upon interest and so on. An investment vehicle with compound interest is therefore a must in one’s financial tool chest. It generates capital growth and appreciation, often outpacing the rate of inflation.
Thirdly, you ought to know that the stock market has historically performed well against all other vehicles of investments, and beaten the rate of inflation as well. Hence, despite the bearish moments (what investors call corrections) in the market, of late, investing in the stock market still comes far ahead in comparison with other investments. For the last eighty years, for instance, the S&P 500 has returned an annual 10.4 percent gain . Likewise, bonds have historically grown at 5.4% annually. Hence, if you are going to invest your hard-earned dollars, it better be in stocks versus bonds, precious metals or your local bank’s savings account or even certificates of deposit. However, unlike savings accounts or certificates of deposit, stock funds are not FDIC insured, which means you could stand to lose your principal when the market hits rock bottom and stays there. But the probability of that happening is very low. Remember that time is on your side if you have many years until retirement; the market highs will even out the lows. If retirement is just around the corner, then amassing your earnings in a less volatile and FDIC insured instrument (like a CD) would be optimal.
Fourthly, having said all the above, you ought to build your investments in a Roth IRA (if you are an individual earning less than $114,000 or a married couple earning less than $166,000, per current IRS income eligibility limits). Your accumulated earnings, blessed by the charm of compound interest, will be available to you in retirement — absolutely tax-free! If the income limits do not permit you to invest in a ROTH IRA, then you could still invest in a traditional (non-deductible) IRA — or even in a 401(k) or 403(b). You would get the benefit of compound interest, a reduction in taxable income, and tax-deferred growth.
There is more good news! Because of the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA), signed in May 2006, a high income earner will be able to convert the traditional IRA funds into a Roth IRA, with half of the converted amount taxed in 2011 and the other taxed in 2012. So, high-income earners can still contribute to a non-deductible IRA today knowing that in 2010, they can convert their precious monies into the coveted ROTH IRA.
On a different note, a 401(k) is typically a plan set up by an employer, such as a corporation or a government body. You could also easily set up a 401(k) plan if you are self-employed. Another plan, the 403(b) is an investment retirement tool available to you if you are employed by a school or by a recognized non-profit. Like the 401(k), your pre-tax dollars are invested in the 403(b) account on a tax-deferred basis until you get to withdraw them in retirement. However, from as recent as 2006, 403(b) and 401(k) plans could also be invested with post-tax dollars, permitting tax-free withdrawals in retirement.
As many of you already know, there are plenty of ways to invest. But now I’d like to focus on mutual funds, regular index stocks, and Exchange Traded Funds.
A mutual fund is a corporation that pools together investors’ money, and invests it in areas that bring the optimal return — in accordance with the goal(s) of the fund. You become a shareholder by buying shares in the fund. Your money is then managed by a group of professional managers who diligently research and invest your money in stocks, bonds and money market assets. This approach offers you the advantage of diversification, reducing the risk of placing all your eggs in one basket.
Mutual funds have distinct strategies of investment. Some are growth-oriented, i.e. they invest in the stock of fast-growing companies. Some are value-oriented (equity-income or growth-and-income funds) that invest in companies that pay dividends. Finally, some are sector-oriented, i.e. they invest in specialty areas (such as technology and healthcare). Others have an international flavor. The approaches to investment can be conservative (desirable if you are closer to retirement age or cannot stomach steep changes in the stock market), intermediate, or aggressive (desirable if you are far from retirement age).
Naturally, the mutual fund managers charge a nominal annual fee — usually ranging from 0.5% to 2.5% of assets. An expense of 1% or less is desirable. Some funds charge a sales fee; these are called load funds. Others with no sales fee are called no-load funds. Most financial experts recommend no-load mutual funds for optimal investment return.
For many of us who don’t have the time to follow individual stocks on a daily basis, mutual funds are a great deal. For some mutual funds, monthly contributions as low as $50.00 can be made in lieu of the high amounts needed to open a new account (great for health practitioners in training). This dedicated monthly contribution also offers you the advantage of dollar cost-averaging (when the price of shares is low during one month, you get more for your money and vice versa). The right fund for most people then would be a low cost, no-load mutual fund with automatic monthly contributions.
On the other hand, another vehicle called Exchange Traded Funds (ETFs) exists. An ETF is an index fund, somewhat different from a regular index fund that you see a lot of people (like residents) buy into and then sell each day. A regular index stock is priced once a day after market closing while an ETF is invested in an entire index (like the S&P 500) and is constantly priced throughout the day. Moreover, an EFT is usually bought via a brokerage or discount brokerage—and will cost you commission/brokerage fee associated with buying and selling.
While ETFs and regular index stocks are viable options of good investment, they are best left to the seasoned investor who can stomach frequent fluctuations in the market and has loads of money to spare. Financial advisers will commonly advise you to refrain from these vehicles if you are committed to making monthly contributions over time, versus lump sum investments. For periodic investments, therefore, staying with mutual funds is paramount.
In a nutshell, pay yourself first by investing in a low cost, no-load mutual fund ROTH IRA or 401(b)/403(b). You can invest automatically, either through your employer’s retirement plan or by setting up a regular deposit into a mutual fund. If a ROTH IRA is out of the question because of high income, you can consider a traditional IRA with an eventual conversion to a ROTH IRA in 2010 (great idea). Other good options for high income earners (not significantly discussed in this article) would be participation in specific 401(k)/403(b) plans, company pension plans with high contribution limits, Keogh accounts (for self-employed practitioners), and salary deferment plans.