More and more frequently lately I do “financial curbside consults” with doctors as I go about my clinical work. I think it's fun to “mix” my two vocations, although I confess it sometimes gets a little weird when they want to take a selfie with me to show their friends. I thought one of these more recent consults would make for an excellent blog post.
Doctor: I'm not really sure what to invest in. Do you think I should buy a rental property? I was thinking a townhome.
WCI: The likelihood that a rental townhome should be your first investment is so low that I think we can dismiss it offhand. Let's step back a minute. Do you have student loans?
Doctor: No, all paid off. I'm not really a big fan of debt so I've paid off my student loans and don't have any car loans or credit cards loans.
WCI: Well, that's great. That debt aversion is usually a good thing that gets you ahead of your peers. How much of your gross income do you save?
Doctor: I think about 50%.
WCI: Wow. That's really high. Where is all that money right now?
Doctor: It's pretty much just sitting in a savings account. I've thought about buying your book, but haven't gotten around to it.
WCI: Well, you should probably get around to it here pretty soon. Do you have any investments at all?
Doctor: No, not really.
WCI: What about your employer-provided retirement accounts? Don't you have a 401(k)? Are you maxing that out?
Doctor: Well, I put $19,000 in there each year and they put a few thousand in too.
WCI: You know that's an investment, right? What is the money actually invested in inside the 401(k)?
Doctor: I don't really know. I think I just picked the “moderate risk” option.
WCI: You probably ought to find out what you're putting tens of thousands of dollars into each year, don't you think? Now, why do you want to invest in real estate?
Doctor: Well, I thought it might be a good investment.
WCI: Why townhomes?
Doctor: I dunno, seemed easier. I didn't really grow up in the US so I didn't learn any of this 401(k) stuff growing up.
Doctor: Well, not really. But I do want my money to grow. But I don't want to lose any of it.
WCI: You know you actually do have to save 50% of your gross income a year for retirement if you aren't willing to put any of it at risk of loss. Once you understand how investing works, I bet you would be comfortable putting at least some of that money at risk of loss in order to earn higher returns.
Doctor: You're probably right. So how do I get started?
WCI: Well, as a general rule, you want to invest in accounts that are tax-protected in some way before you invest in accounts that are not. For example, lots of doctors who want to invest more than will fit in their 401(k) invest in a personal and spousal Backdoor Roth IRA.
Doctor: What's an IRA?
WCI: It stands for Individual Retirement Arrangement. It's basically a retirement account that you open on your own rather than going through your employer.
Doctor: Interesting. [Scribbles down IRA.]
WCI: Unfortunately, it gets a little complicated. A typical doctor with a retirement plan at work can't take a deduction for a traditional or tax-deferred IRA. Nor can she contribute directly to a Roth or post-tax IRA. So she has to do what is called a Backdoor Roth IRA, where you put $6K into a traditional IRA first, then move it to a Roth IRA afterward. Since you didn't get a tax deduction for the contribution, there is no tax cost for the second step, called a Roth conversion. But in the end, it's the same as if you just put $6K into a Roth IRA. You can do one for your spouse, another $6K, even if your spouse isn't working. There's a tutorial on my website that will walk you through it, or you can just read that book. Do you have a high deductible health plan or do any moonlighting anywhere else?
WCI: Because if you had a high deductible health plan, you could also contribute to and invest in a Health Savings Account. And if you had some 1099 income, you could open an individual 401(k) and put some more money in there. But once you've maxed out your employer-provided retirement plans and your individual retirement plans, everything else has to be invested in a non-qualified or taxable investing account.
Doctor: So where can I invest in those?
WCI: Well, my Roth IRAs and my taxable brokerage account are at Vanguard. I think that's a nice default place to start because it is a mutually owned mutual fund company, so the costs are generally lower and thus the returns are generally higher. But the general process of setting up an investment plan is to first set your goals, second decide which accounts you're going to invest in, third decide what your asset allocation or mix of investments is going to be and then finally select investments. Just picking out a townhome to buy is like skipping the first three steps and going straight to step four.
Doctor: That makes sense, but it all seems so complicated.
WCI: Why don't you finish reading the book, it'll only take you four hours, and then let's talk again. The truth is that you've already done all the hard stuff. You've become a doctor and now earn a high income. You're also very frugal and able to save a ton of money. The rest is actually pretty easy. It does take some work, but much less than what you have put in to learn your specialty.
Doctor: Thanks. I'll do that.
Hopefully more updates to come.