The most common question that I get (in real life and online) is the following: “So, I am finished (or about to finish) training. How do I invest my paycheck?” I recognize that for many readers this question may be too basic, but I don’t want to skip it for those that are about to start their life as an attending. Hopefully, even for those that have it all figured out, they’ll find useful information in answering the question.
Before we get started
First things being first, let me lay out some basics for my philosophy on investing and the following recommendations will make more sense:
Assumption Number 1
It is not necessary to strictly choose between only investing money or only paying off debt. You can do both effectively, but at some point you are going to have to place priorities on how you think through that dilemma. Hopefully, this post will help.
Assumption Number 2
I am a believer in low-cost passive index fund investing. Passive versus active investing is an academic question that can be studied and has been answered. Paying expense ratio’s of 1% for a fund that will not outperform the index fund (expense ratio <0.1%) over your 30 year career just doesn’t make sense.
Recommended Further Reading: If you want more information on this, then read A Random Walk Down Wall Street.
Assumption Number 3
I fully believe that your worst enemy in your financial success is you. Therefore, I am a huge proponent in “set it and forget it” investing. When someone asks you, “Hey have you seen what the market is doing today?”
The most gratifying answer is “No, I haven’t because I don’t need to.” They’ll assume it’s because you know nothing about money. You’ll know it’s because behavioral finance (and preventing yourself from selling low and buying high) is supremely important.
Recommended further reading: A great book on this is How to Think About Money by Jonathan Clements.
Assumption Number 4
You should be saving 20% of your income and your wealth accumulation rate (WAR) should be at least 30% if you want to be making serious financial progress.
So, when I start saying “if you have more to save” in the below recommendations, look at your savings rate. When you first start as an attending you need to be putting at least 30% of your income towards destroying debt and/or investing. 20% is a bare minimum.
Assumption Number 5
This assumes that you do not have a massive amount of consumer debt that is costing you 17% interest each month. If you have really high interest (i.e. >7%) on consumer debt, credit card debt, etc….then pay this off first. You shouldn’t have ever had it, really. But, if you do, fix this first before doing anything else. Period.
Assumption Number 6
The following algorithm isn’t going to work for everyone, but it will work for the vast majority. Examples of people for who this may not work include: People with a massive amount of debt that decided (for some reason) not to do PSLF. In this case, you may need to run some numbers before deciding.
Assumption Number 7
I am not discussing asset allocation or pre-tax versus Roth in this post. You should have a good mix of stocks and bonds (likely different for each person based on age and risk tolerance). You should also have a diversified portfolio of US versus international and large/mid/small caps. Diversification is key. If you want some ideas on various portfolio’s, White Coat Investor can help you out.
Here are the steps, in order, of how you need to address both your debt and your investment plan.
Step 1. Make a Plan to Destroy Your Debt in Residency
If you don’t have student loan debt skip this.
One of the first items you need to address (particularly in your last year of residency once you have a contract in hand) is to figure out whether you are doing Public Service Loan Forgiveness or not. [I fully recognize that residents need to decide much earlier to do PSLF. That said, this is the point where you’d either continue to do PSLF or privately refinance.]
If not, then once you have an attending physician contract in hand during training, you can refinance through several private refinancing companies to the same rate you’d get as an attending physician.
Make the change early, and save yourself the money in your last year of training.
Step 2A. Once you finish residency max out your 401K/403B
The first thing you need to do when you finish residency is to max out your 401K/403B. There are several reasons for this. I’ll highlight the important ones.
First, most employer’s provide a matching percentage and/or employer contributions if you max out your 401K/403B. If you don’t participate, it is the same as leaving part of your salary on the table. [That said, don’t max it out at the beginning of the year unless you check with your employer to make sure this doesn’t screw up your match…defeats the point].
For example, where I work I put in $18,500 and my employer contributes/matches the rest up to $47,000. So, if I didn’t participate in the 403B at my employer, I’d be leaving an extra $36,500 on the table. That’s just not smart.
At the VERY least, you need to put enough in to get all of the employer matching/contribution. After that, the decision to invest versus paying off debt comes into play.
The second important reason is that retirement accounts like 401K, 403B, and 457’s provide tax deferment benefits. You put money in pre-tax (that lowers your AGI and tax burden) and also grows tax free. You only pay taxes on it when you take it out. Missing out on this tax benefit can be costly.
Step 2B. Max out your spouse’s 401K/403B
This is redudant, but necessary to mention. If your spouse has access to a 401K/403B, you should probably do the same for them as you do for yours.
Step 3. Decisions, Decisions, Decisions
After you have done Step 2A and 2B, I believe you are at a point where you have to decide what to do next. I cannot tell you what to do, because everyone is different.
At this point, you need to decide how much you hate debt. Some people choose to hammer away at their debt as hard as they can. Others recognize that if their debt is lower (3-4% interest) than what they can expect to average in the market (6-8%), then they put more money into the market.
You do you. Make your own decision here on this one. If you choose to invest further, I’ll tell you what to do next.
Step 4. Health Savings Account (HSA)
The IRS provides people with a high-deductible health care plan the opportunity to stash some good money away for healthcare expenses. In 2019, tehe annual limit for individuals is $3,500 and for married couples it is $7,000.
If your employer doesn’t offer a match or contributions into your 401K/403B, you could argue that the HSA should be the first place to put your money. Why?
It is triple tax advantaged.
Pre-tax money goes in, it is not taxed on the growth, and as long as you use it on qualified medical expenses it is not taxed when you take it out. Additionally, if you do not have health care costs, any money in this account can be used for whatever purpose you desire after the age of 65.
**Any money taken out for non-medical expenses prior to age 65 will incur a penalty.
Step 5. The governmental 457
If you have decided to invest while paying down your debt or have already paid down your debt, then this (a governmental 457) would be your next option. Unfortunately, not everyone has access to a governmental 457 and non-governmental 457’s are not the same (more below).
Step 6. The backdoor Roth
The next move is the Backdoor Roth Conversion. If you haven’t done this before I have a Step by Step Guide to your First Backdoor Roth. You can put $5,500 in for you (and another $5,500 in for your spouse, if married, regardless of whether they work or not).
The advantage of the backdoor Roth IRA is that you put money in post-tax. It then grows tax free and when you take it out (because you’ve already paid the tax) it is given to you tax free.
Roth contributions are also the best way to leave an inheritance for those that you love.
Step 7. Non-Governmental 457
Whether you should invest in your non-governmental 457 at all is a tough topic; I have discussed it here. I would choose this last over a taxable account if it meets all the criteria I lay out in my other post.
Regardless, this should be performed after performing a Backdoor Roth IRA the Roth IRA has certain protections that a 457 does not.
Step 8. The taxable account
This is the last place to put your money because it offers none of the other tax advantages mentioned above. It is placed post-tax into this account and when you take it out you have to pay capital gains taxes on your gains.
If kept for more than one year, you pay the substantially lower long term capital gains tax. If you take it out before then, you pay it like normal income tax. Another reason that the “set it and forget it” method is best.
What did I do?
When I finished residency we had about $200,000 in student loans. I wanted this to be paid off in two years. So, we have paid $5,500 per month towards this goal with plans to put additional bonus/incentive money towards it as well via The 10% Rule.
However, this did limit our ability to invest a little bit, but it was an important goal to us. The following is what we did.
We maxed out my 403B ($18,500), put my wife’s entire income (part-time teacher at the time) into her governmental 457 (~$17,000), and performed a backdoor Roth for my wife and me (total $11,000). When a HSA opened up in my second year as an attending, we filled that space up, too.
Then everything else went into our debt ($100,000-120,000 per year).
Once our debt is gone, we will split that $5,000 monthly payment in half. $2,500 will go towards our monthly mortgage payment. $2,500 will go into various investments.
This is really a big picture item. Not a lot of nitty-gritty detail, but we will fill the rest in as we go. As always, feel free to ask questions, leave comments, etc.