Financial Consult for the Severely Anemic Resident Wallet Part 1: Invest in Yourself
Wender Hwang, MD, Loma Linda University Medical Center, Loma Linda, and Erik W. Thurnher, MD, CFP, Kaiser Permanente Medical Group, Lakewood, and Physicians' Financial Advisors, Newport Beach, Calif
Published Online: May 17, 2007 - 11:48:20 PM (CDT)
Wender Hwang, MD Chief Resident Department of Emergency Medicine Loma Linda University Medical Center Loma Linda, Calif Erik W. Thurnher, MD, CFP Emergency Physician Kaiser Permanente Medical Group Lakewood, Calif Certified Financial Planner Physicians? Financial Advisors Newport Beach, Calif
A lifetime of training has prepared us for many exciting firsts: the first time someone calls you ?doctor,? the first intubation, the first chest tube?but the first paycheck? We expect to live comfortably as physicians but were never taught financial-planning skills to achieve that goal.
This several-parts primer highlights financial opportunities viable only during residency and discusses the following financial tools:
? Roth IRA (Individual Retirement Account), 529 plan, and Coverdell education IRA, which are all tax-free investments ? Student loan consolidation secrets ? Buffing your credit score ? Getting cash back ? Reducing the federal/state withholdings by changing your W-4 exemptions ? Reducing the federal taxable income with before-tax deductions to lower your tax burden by using the 403b option and flexible-spending accounts ? Spending pretax money on medical and childcare expenses.
Our purpose is to help you become familiar with these tools and programs, feel comfortable in trying them out, and avoid greater mistakes after residency, when you have more money to play with.
In this article we cover basic investment terms and strategies. In the next installments you will learn which investments are most beneficial to residents, how to use the tax code to your advantage and keep Uncle Sam?s fingers out of your meager paycheck, and how to reduce your debt, with specific focus on your existing debts and spending patterns (?stop overspending? is nowhere to be found in this series). Save the Action Checklist as a reminder of the financial tasks you need to accomplish.
Financial Disclaimer Please consult your tax advisor or employer if a particular topic is right for you. Side effects of learning about or using the tools outlined here may include increased wealth, early retirement, thicker wallet, or sounding educated at a cocktail party.
Getting Started With so many types of investments, it can be difficult to choose the best mix for your few dollars. Financial planners can help you determine an appropriate mix based on your preferences and stage in life, but few residents have the resources to hire one.
For our age-group and career stage, financial planners suggest the following priorities:
Start a Roth IRA Your marginal tax rate as a resident is most certainly lower than when you will be a retired doctor. In addition, you will soon exceed the income ceiling and become ineligible for the huge benefits it provides. Thus, maximize the low annual contribution limit every year.
529 plan Start a 529 plan account if you have or plan to have children. It is exactly the same as a Roth IRA, but you save for college expenses (instead of retirement). The lifetime contribution limit is high (about $300,000), so you will have to decide how much you want to put away. One 529 plan can be used for several children. An alternative is the Coverdell education savings account if you plan to send your kids to a private elementary, middle, or high school.
Retirement plan Set up automatic payroll deductions for a tax-deferred 401k or 403b retirement plan with whatever money you have left. You have a wide selection of mutual funds from which to choose and a generous interest rate on the capital preservation fund. There is usually no fee to join or to purchase or sell funds, and only a small annual maintenance fee; no brokerage or bank can beat that.
Although any major financial institution will be happy to take your money, we recommend Scottrade, Vanguard,1 and/or ScholarShare (529 plan) because of their low-cost, long-term, investor-friendly philosophy.
Even with a large monthly rent or mortgage, you should still try to invest a little at the end of each month. Regular investment, however small, will give you experience with investing principles, allow you to make beginner?s mistakes of little financial consequence, ideally make a return on investment, and jumpstart your investments after residency.
The pros and cons of home purchasing are not discussed in this guide, except that residents are the perfect candidates for interest-only and 3- to 5-year adjustable-rate mortgages, because, after residency, our income increase coincides with the larger payments. These loans allow us now to buy and live in a home that our future income can afford. If you purchase a home at a later date, and spend all your money on mortgage payments, you likely will not have anything left to invest in retirement or for your children?s education. Instead, by buying a house now, you are investing in your home and building equity.
Although income and expenses are generally taxed by calendar year, investment contributions can count toward the previous tax year up until you file your tax return.
Investment Basics ?Equities? are ownership in the form of stocks. Most mutual fund ticker-symbol acronyms have 5 letters, and the last letter is X. NASDAQ stock symbols have 4 letters, NYSE symbols have 2 to 3 letters, and AMEX symbols have 3 letters.
?Bond prices? go up when interest rates go down, and vice versa.2
In ?mutual funds,? investors pool their money and hire a manager to buy a set of stocks and bonds. The fund can buy many securities and diversify more than most individual investors. The expense ratio fee covers the manager?s salary and other administrative costs.
A ?front load? is a fee paid when you buy a mutual fund; a ?deferred/back load? is a fee paid when you cash out of a mutual fund. A 5% front load means that if you deposit $100, only $95 will be invested. With a 5% deferred load, if you withdraw $100 you only receive $95. These load fees are usually waived if purchased within your IRA or 401k/403b. Most financial planners categorically advise against buying a mutual fund that charges a load, especially since equal or better-performing mutual funds without loads are available.
An ?index fund? is a mutual fund that mirrors an established index, such as the S&P 500. Because there is no active management needed, index funds have very low fees and are tax-efficient choices for nonretirement accounts.
?Exchange-traded funds? (ETFs) are ultra-low-fee index funds that can be traded like a stock. Popular ETFs include SPY tracking S&P 500 Depository Receipts, Diamonds tracking the Dow Jones Industrial Average, and QQQQ tracking the NASDAQ-100. These must be purchased through brokerage and are subject to commissions, much like an individual stock.
The specific investment options are essentially account classifications defined by the Internal Revenue Service (IRS), each with its own tax benefits. Your financial institution (not account classification) determines which funds, stocks, or bonds you can purchase.
Investment Strategies Several popular strategies can help you choose the right investments (assuming long-term goals).
Dollar-cost averaging Because the market is dynamic and fairly unpredictable, it is difficult and generally inadvisable to time the market and buy only when a stock hits a low (it may slide further or you may never jump on a skyrocketing stock). Dollar-cost averaging refers to regularly scheduled investments throughout the year (ie, $100 every pay period). This averages the cost of each share, allowing you to buy more of the stock when the price drops and less when the price is high.
Asset allocation In a 1986 landmark study, Determinants of Portfolio Performance, economists concluded that asset allocation explained more than 93% of a professional investment manager?s average returns over time.3 In other words, it is the proportion of stocks and bonds in your portfolio that is the main determinant of performance and risk rather than individual stock-picking skills. A 100% stock portfolio has the highest potential return on investment and the highest risk of loss, whereas a 100% bond portfolio is usually the safest but lowest yielding.
Thus, base your asset allocation on your risk tolerance-an aggressive investor who can wait out periodic severe market drops may choose a 100:0 to 80:20 allocation of stocks/bonds ratio. Self-questionnaires to assess your risk tolerance and ?ideal? asset allocation are often available when you sign up for an investment account. Theoretically, you should redistribute annually because your allocation changes according to market performance.
Lifecycle mutual funds These are mutual funds that change their asset allocations annually, based on the number of years until retirement/cash-out. They generally start aggressively, with 100% stocks 30 to 40 years out from the target date and then gradually shift toward 100% bond/money market at retirement. These are the newest and fastest-growing funds, and they are very useful for those without the time or inclination to manage their accounts on their own.4
Choosing lowest fees in a class Fees are built into the price of the mutual fund. If you put $10,000 into a fund with 0.5% expense ratio and it earns a 10% return in 1 year ($1,000), the fund actually earned 10.5% ($1050), and they already took their 0.5% cut ($50). Although it may seem like a trivial amount, some funds charge 1.5% or more, cutting deeply into your investment over time. Almost every brokerage offers similar index, sector, or lifecycle funds with differing expense ratios. You can shop around, compare expense ratios among those of the same class, and purchase the fund with the lowest fees.
Index funds outperform Looking at all mutual funds past and present, it is impossible to figure out which will perform each year. Some funds perform strongly one year, only to tank the next year. A fund?s performance is typically compared against a standard industry index, but most funds do not consistently outperform the index over time. Instead of buying a fund attempting to beat an index, some financial gurus advocate buying the low-cost index rather than the higher-cost mutual fund, because high fees cut into long-term returns.5,6 Be the benchmark and not someone trying to beat the benchmark year after year.
Conclusion In the next article, we will discuss the specifics of Roth IRA, section 529 plans, Coverdell savings accounts, and tax-deferred 401k/403b retirement plans. Each fund will be presented with specific examples of cost considerations and a discussion of the benefits and limitations of each investment for residents.
3. Brinson GP, Hood LR, Beebower GL. Determinants of portfolio performance: study of 91 large pension plans over 10 year period. Financial Analysts Journal. 1986;42(4):39-44.
4. Wang P. The march of the all-in-one funds. Money. 2005;34(8):69.
5. Bogle J. The triumph of indexing. The Vanguard Group. 1995 (April):1-45.
6. Fortin R, Michelson S. Indexing versus active mutual fund management. Journal of Financial Planning. 2002:15(9):82-94.
Financial Disclaimer 
