Sell, Sell, Sell! Investing for Healthcare Providers
Posted on January 19, 2008
Filed Under Finance
by Ivan Edwards, D.O.
SDN Contributor
“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.
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 [1].
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 [2].
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 [3]. 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 [3]. 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 [4].
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 [5]. 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.
References
1. http://www.consumerfed.org/pdfs/CFA_…lease_12_10_07.pdf, pg 2 & 3.
2. http://www.consumerfed.org/pdfs/CFA_…e_12_10_07.pdf, pg 3.
3. http://www.planningtips.com/cgi-bin/savings.pl
4. http://inflationdata.com/inflation/i…/inflation.asp
5. http://www.iht.com/articles/2006/01/02/news/bxsmall.php
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33 Responses to “Sell, Sell, Sell! Investing for Healthcare Providers”
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I have always known docs are poor money managers, I am one. In times like these, investing for retirement is critical.
good article
I know of a doctor that at age 59 had 280K in credit card debt. No, I am not kidding - as good a money as the doc made, it took him about eight years to pay the balance.
A rule of thumb I tried to teach my children, one who plans to attend medical school. It will almost guarantee you the ability to retire at 60 if you’ll follow these simple steps.
Take 10% of your gross pay from each paycheck starting with the first one, stick it in a mutual fund that closely correlates to the S&P 500/600, and forget about it. Then live within your means, only financing your home. Pay off your school loans as quickly as possible and absolutely pay your credit card bill(s) in full every month.
Follow these three steps and I can almost guarantee you will be okay for retirement.
Very sound and helpful advice.
Great article…. my question to anyone who can answer is if you have a 410(k) from your employer and you plan to contribute the maximum, should you still get a Roth IRA or instead put any extra money in a separate mutual fund?
Good article.
Another good piece of advice is simply to avoid debt. If you promise yourself that you will only buy something if you physically have the money, you will be able to live more peacefully and worry-free. I also tend to advocate avoiding mortgages on homes. Especially evidenced lately by the crash and continuing depression of the housing market, real estate is not a sure-fire investment strategy. It really is a terrible situation, which many are experiencing right now, to have a mortgage on a home which costs $750,000, when the home just fell in value to $500,000.
Also, I would argue caution regarding mutual funds, especially in light of the current market crises and high inflation and low interest rates. With interest rates so artificially low, and rates that will continue to be decreased by the Federal Reserve, more money will be pumped into the stock markets, artificially inflating the value of stocks. When the joy ride comes to a close, as in 2000, as in 1929, and as it is now, the value of your investments can decrease in value significantly. I wish that the author of the article would have avoided being so bullish on mutual funds and given a bit more consideration towards fixed-income securities, including treasuries and bonds. Volatility in markets can wreak havoc in investment and retirement portfolios, even if most are in mutual funds.
One last thing: it should also be mentioned what happens when coming out of residency and getting the big pay-checks yet still having loans to pay off… it is very wise to spend everything you can on a monthly basis to pay off the loans to avoid future compounding interest AGAINST you. Compounding interest is awesome if you are the person racking up the wealth, and pretty terrible when you are the one getting the shaft from the banks.
CMS- I have always been told to to contribute the maximum that my employer will match into a 401(k)/403(b) and if I feel I am able to contribute more, then I should put it into a Roth IRA. I was told the reason is this: the money going into the employer matched 401(k)/403(b) is PRE-tax, thus we will have to pay taxes, fees, possibly penalties when we use this money in the future. However, with the Roth IRA this is a moot point because all of the money going in there has already been taxed (theoretically).
Great article, as I watch co–workers and my folks get nearer to retirement, this issue has been weighing on my mind.
Confused Medical Student:
Great question! I echo EricL’s thoughts.
Depending on your circumstances, there are three possible scenarios.
First of all, if your employer provides you with a 401k or other similar plan, you can still continue to contribute to it and also have a ROTH IRA at the same time. In other words, you can have both (the cake and icing). In the employer 401k plan, you get “free money” from your employer in the form of matching funds—making your investment grow even faster. In the ROTH IRA, you reap the benefit of tax deferred growth and final tax free withdrawals upon retirement.
Two, favor contributing to your employer’s 401k or similar plan if your employer makes matching contributions to your plan—specifically, contributions that you will not lose (prior vestment) when you quit your job (find out from your employer when you could lose their matched funds to your plan if you leave, say, in x amount of years).
Three, favor or choose a ROTH IRA (and contribute to the max) if your employer makes zero or very insignificant matching contributions to your plan.
I hope this helps and doesn’t sound confusing.
Ivan
The prior annonymous post was from me, sorry.
Anyway, in regards to Aleitheiei’s insightful observation about fixed income securities . . . For sake of brevity, I had to pick and choose what I could discuss without writing a whole book.
Indeed, Aleitheiei, fixed income securities, e.g. bonds, can be viable tools of investment. However, one would best be served to seek them if one is closer to retirement (say, a 50-60ish year old versus a 20-40ish year old).
Generally, fixed income securities have a much lower return on investment, and investors in them typically seek a fixed and constant return. They are also easily prone to inflation risk.
Now, having said that though, there are some that are index-linked, e.g. TIPS (Treasury Inflation Protected Securities) that investors can expect to reasonably outmatch the pace of inflation.
Overall, nonetheless, almost all fixed income securities are subject to certain common issues, such as: inflation (Zimbabwe’s municipal bonds) and currency risk (think of the Chinese who have purchased billions of dollars of US T-bonds, seeking a very handsome return on the dollar vs. the Euro), default (Enron bonds), and lastly, but not least, the credit worthiness of the issuer.
On the contrary, the beauty of mutual funds is that they provide instant diversification, i.e. a fund can hold many securities (even fixed securities like bonds)—thus providing safety in times of stock market volatility (such as we are in now). They are not only professionally managed, but they are also affordable, enabling middle income earners to participate in the stock market.
If you have an employer matched 401k (evidently they are becoming very common for physicians now), make sure you max that out first. If the employer matches dollar for dollar then the moment you put money in you will have made a 100% return. If they match at 50% of your contribution you will immediately make a return of 50%.
Ivan, thanks for your response.
Regarding the TIPS, I think that it is currently limited to purchases of a maximum of $10,000 worth every year (it used to be $30,000 electronically, and $30,000 by mail). This is likely due to the government’s fear of rising inflation.
Good point on how fixed income securities are vulnerable to inflation. That is one of the most troubling aspects of investing that we are currently in, as inflation on the whole-sale level edged 6.1% for 2007. It is very hard to beat that with fixed income getting rates around 4.5% (soon decreasing thanks to the Federal Reserve).
At this point in the world-wide economy, I think that the smartest place to invest is in internationally-diversified security-based mutual funds… at least up until the point where the economy turns the corner and investors start becoming bullish again. But I have some serious doubts about the health of the United States in the long-term; with the debt bubble bursting, decreased home values, and the falling dollar, I fear that we are in for a major market correction on the level of the Great Depression. But that’s just me being extremely pessimistic.
Some doctors will never be able to retire b/c of their debt.
Being a doctor is overall is middle class and every doctor should know that.
As a doctor, you will surely make more than some professions by a thin margin, but after the taxes get you, you will be in the same category as some of the better paying 4yr degree occupations.
Federal Reserve Chairman Bernanke last week remarked that the “US economy has slowed,” indications that we could be in a recession. And many economists think we are in one now. Bush then called on the Congress for a $145 billion stimulus package in form of tax breaks for consumers and businesses (and an unspecificied tax rebate for all Americans) in a bid to revive the US economy. The reverberations of our economy have even hit the global scene.
Bleak as that might sound, the American economy is robust and resilient. We have seen recessions before and made it through. This too shall not last.
Again, to long term investors, these corrections we face are temporary. Thus, the long term investors stay the course–time is on their side. To the short term investor with aggressive portolios(and with less than 5 years into retirement), converting to connservative instruments of investment is key.
Typo “connservative” = conservative
Don’t forget to visit SDN’s finance forum …
http://forums.studentdoctor.net/forumdisplay.php?f=176
If you have questions or want to discuss further.
Thank you so much for the answers! Very helpful. I start residency this summer so I feel like I have a game plan. Starting to save for retirement at age 31 is a little disheartening but better late than never.
I found the Suze Orman “Young, Fabulous, and Broke” to be very useful in explaining about 401k and Roth IRAs. Also, the Rich Dad Poor Dad by Robert Kiyosaki is very helpful about defining what is an assets and what is an expense.
Question, Are Roth IRAs a 100% completely safe investment? In other words, is there any way that your money you put in to a Roth IRA could be lost under any circumstances?
Nothing is 100% safe and guaranteed under the sky. You can lose principal, nothing is absolute. Relative safe investments in a ROTH are those with a conservative approach vs. aggressive.
A Roth IRA is not an investment. It’s an account to hold your investments, just like a savings account holds your money.
where does one find a list of recommended or safe mutuals?
Mutual funds are one of the worst types of investments out there. 80% fail to meet the S&P 500 each year, and while you’re losing .8%-2% per annum, the fund managers are driving their BMWs.
If you want to do absolutely nothing, buy an ETF that follows Latin America and put a 10% stop/loss order on it from a discount broker. Or if you rather follow the S&P 500 (no idea why) buy an ETF that follows that and pay a .08% expense ratio.
Remember compounded interest? When your mutual fund managers take .8%-2% out of your hard earned money per annum, you lose A LOT. Go run the numbers yourself, but I’m sure you can garner a guess.
CMS, most “financial experts” recommend that you fund your 401(k)/403(b) up to your employers match and then fund a Roth ($5000 for 2008) or traditional IRA next. (Since, you’re going to be a resident, you certainly fall below the federal income limit, 101K for individuals for 2008) You could contribute up to $15500 in your 401(k). After that, you can just buy index funds (I like the retirement target date funds, as a set it and forget it type of thing) from a low-cost mutual fund company (Vanguard generally has the lowest expense ratios in the industry) outside of a retirement account and hold them. After you sell them, you just pay capital gains taxes (which are going to be much less that ordinary income tax). So, you can contribute up to 20,500 in retirement accounts (15.5k for employer sponsored and 5k for an IRA). There are many, many debates of Roth vs traditional IRA and which is best. If you think that you’re going to be in a LOWER tax bracket when you retire, a traditional IRA makes more sense, but I’d go with ROTH if possible. That’s what I have.
1) Roth IRA makes sense if your current income level (tax now and get taxed at a lower rate) is lower than your income level during retirement (take out the money later tax-free!). However, since people probably cannot predict what their future income later will be, they should just max out their Roth IRA.
2) Roth IRA and 401(k) etc are great because while you are investing the money, you pay zero tax every year. So the accounts can compound all of the “annual capital gains/dividends” fully, without taxman taking a cut from it. The difference is that since Roth IRA is post-tax earning, you will get to keep all the gains/dividends 20-30 years later, while 401(k) etc. are pre-tax earning that you put in, all of the principal and gains/dividends will have to be taxed when you take the money out in retirement.
3) For most people in their 20’s, 30’s or even 40’s, I would not recommend ETF’s nor bonds. Currently, with a flight to safety, U.S. Treasuries with their super low yield should be considered overvalued.
Instead, for index mutual fund, You should look at Fidelity Spartan series that follow market index, whether domestic or foreign. They have lower yields than anything out there, Vanguard and ETF included. You can also trust your money with some mutal funds ran by the value investors, such as Fairholme, Weitz Value, Dodge and Cox, Baron, Third Avenue, etc. I would not touch any mutual fund that charges you more than 1.1% for management fee. Or you can always buy BRK-B, as run by Warren Buffett himself.
Good say, jj. I concur. Stay away from etf’s. Also, for Ginger, here are some good mutual funds: T Rowe Price (cap appreciation), Aim dynamics, Buffalo funds, Vanguard.
Good buys for individual stock to invest in Roth IRA’s: Exxon Mobil, Disneyland, Capital one, and Walmart.
Agree. Stay away from ETF. The urge to trade is too much and that will cut down on return. Fidelity Spartan Total Market Index Fund (FSTMX) has only 0.1% fee.
If you want some fun for your ROTH IRA’s and pick stocks individually, you can’t go wrong with large-cap U.S. stocks that have substantial foreign revenue; you can the best of both worlds: American rigiorous companies who get money from foreign currencieis.
Agree with RB on his/her picks. There are just so many out there to pick because large/mega caps have been underperforming for so long. PFE with its 5.7% yield and can you imaginge compounding that dividend even more? AA, FCX, PEP,NYX.
Why should you stay away from ETFs? Are the costs substantially different from equivalent mutual funds? The biggest reason I can see why you guys aren’t recommending ETFs is the easy with which one can trade them, which obviously could drastically cut down on returns.
Etfs are costly to run, i.e. buying and selling will cost you tons in fees unless you have a lot of dough to begin with, and the amounts you are wagering are high.
Generally, as the author of this article alluded to, if you invest on a regular periodic basis a set amount of money, avoid etfs like the plague. They will bite into your investment badly. For periodic investments of a set amount, go for mutual funds.
That my 2 cents.
Concur with DD’s remarks.
Alright, that makes sense if you’re investing with a dollar cost averaging strategy. Thanks
Thank you for the excellent article! I am one of those medical students who is incredibly uneducated about finances. How does one strike a balance between paying off loans and beginning to invest?
Thanks for the great article! I am a medical student who feels extremely uneducated about finances. I was wondering, is it better to pay off my loans completely before I begin investing?
Thanks!
Do not wait to invest. Since your loans bear a low-interest rate, paying them off early gives you little benefit.
The rate of return on your investment, however, will be much higher.