Definitive Guide to Investing for Physicians

For beginning investors, it can be really tough to really grasp investing, right? Here’s a secret that Financial Advisors won’t tell you, it’s only as complicated as you make it.

You might be reading this article because your peers told you about a Roth IRA, or that you should open a brokerage to start investing. There’s serious FOMO around not being invested in the markets when your peers, family, or the media constantly says you should be, however, when and how to invest depends on your unique situation.

Before diving into random stocks on the next popular investing app, spend a few minutes to learn the ins-and-outs of investing and mapping out your objectives.

Creating an Investment Policy Statement

Your Investment Policy Statement is the roadmap for your investments. These documents lay out your rules for investing, your investment goals and objectives, as well as the strategies your portfolio manager can use to meet your objectives.

Although an Investment Policy Statement is typically used between a portfolio manager and their clients, you can create one for your own investments as well.

The main sections of an Investment Policy Statement include:

Executive Summary

Your name, age, portfolio descriptions, state of residence, tax id, the value of your current assets, your return goal, and your risk tolerance and capacity.

Objectives

Some examples of objectives you might find in an Investment Policy Statement include long-term growth and capital preservation, your risk profile, your time horizon, your short-term liquidity needs, and your long-term rate of return expectation.

Financial Advisors Duties and Responsibilities

If you’re working with a Financial Advisor this is where they would share their duties and responsibilities, typically including their fiduciary duty, when they need to confer with you, how they should invest, as well as how, what, and how often they report back to you.

Portfolio Selection Guidelines

This dives into your asset allocation guidelines and should give a breakdown of what percentage of your portfolio should be invested in stocks vs. bonds and a further breakdown of the percentage by asset class.

Know Your Risk Tolerance

Investing without knowing your tolerance for risk is like driving without knowing the speed limit. You might think you are driving at a pace that is comfortable for you, but soon the drivers around you are passing you at a speed that induces anxiety and unrest.

Your risk tolerance is the amount of variability in investment performance you can withstand. Oftentimes this is tied to your age, such as through the rule of thumb of 120 – your age. This rule of thumb aims to tell you what percentage of your investments to invest in equities, such as stocks. A 30-year-old would invest in 90% stocks based on this rule of thumb.

What this rule of thumb does not consider is your own tolerance for risk, and what level of volatility keeps you up at night worried about your hard-earned savings. It also does not consider how much you have saved. A 30-year-old with $1 million saved could have a much different tolerance for risk compared to a 30-year-old with $10,000 saved for retirement.

Risk tolerance is how much risk you as the investor are comfortable with.

Know your Risk Capacity

Your risk capacity is another component that compliments your risk tolerance. Although this measure of how much risk you can tolerate is rarely discussed, it is just as, or more important than your risk tolerance.

This measure of risk considers how much risk your portfolio needs to meet your goals. If your goals require a high rate of return to obtain, your risk capacity would be much higher.

If your risk capacity and risk tolerance do not match, it might be time to reevaluate your goals.

Risk capacity is how much risk is required to meet your goals.

Rebalancing of Asset Allocation

This section dictates how often your portfolio should be rebalanced to match your asset allocation.

Rebalancing is the process of buying or selling investments to realign them with your target asset allocation.

There are plenty of times in every portfolio’s lifetime when it needs to be rebalanced. Market changes will alter your portfolio, and your financial goals will change.

You’ll need to reassess your assets. You may need to buy or sell assets to protect yourself against risk and meet your personal financial goals.

You can rebalance monthly, quarterly, or annually, or when your asset percentage changes over 5%.

Performance Monitoring

Here is where you layout how you will monitor how your investments are performing. A benchmark and accepted deviation from that benchmark should be detailed out in this section.

Your Investment Policy Statement is the roadmap to how you invest, how you monitor those investments, and how your Financial Advisor reports back to you. Having an Investment Policy Statement in place gives you a place to reference back to before making changes to your portfolio.

Where You Invest Matters

When you are earning a high-income, it is important to understand the difference between an asset location strategy and an asset allocation strategy.

Your asset allocation is the diversity of your investments typically represented by a percentage based on the different asset classes in your portfolio.

For example, if you have $200,000 in stocks, and $300,000 in bonds, your asset allocation would be 40% stocks ($200,000/$500,000) and 60% bonds ($300,000/$500,000). Commonly, when you are younger, you will have a more aggressive asset allocation, meaning you will hold more growth-oriented investments such as stocks. As you near retirement, your asset allocation typically will become more conservative and may switch to a higher percentage of bonds than stocks. Asset allocation is based on your own goals, time horizon and risk tolerance.

Your asset location strategy, on the other hand, is where you hold a specific investment. You can hold investments in a pre-tax retirement account, post-tax retirement account or a taxable brokerage account.

The key with your asset location strategy is understanding how different investments are taxed and what that means for your tax bill when you hold them in the different accounts available to you. Bonds are taxed differently than stocks which are taxed differently from REITs, and by having a tax-efficient asset location strategy, you can invest these assets in the vehicles that will save you the most on your taxes.

How are Different Asset Classes Taxed?

Coming up with a good asset location strategy starts with understanding how different asset classes are taxed, how short-term capital gains are taxed and how long-term capital gains are taxed.

How are Short-Term Capital Gains Taxed?

Short-term capital gains are taxed at your normal, ordinary income marginal tax rate. A gain is considered short-term if you sold an asset after holding it for one year or less.

So if you are in the 35% marginal tax bracket, hold a stock for less than a year and sell it for a gain, you will pay a 35% tax on that gain.

The same goes for selling most other assets for a gain including bonds, REITs and even your personal residence.

How Are Long-Term Capital Gains Taxed?

Long-term capital gains are taxed more favorably.

There are three long-term capital gain tax rates: 0%, 15% and 20%. The tax rate you pay on a long-term capital gain depends on your marginal tax bracket and filing status.

A gain is considered long-term if you held the asset for more than a year before selling it.

How Are Stocks Taxed?

Stocks, mutual funds holding stocks and passive index funds tracking a stock index can be taxed in a multitude of ways.

First, stocks typically pay dividends on a semi-regular basis. When a stock pays a dividend, the dividend is either considered a qualified dividend or non-qualified dividend.

You pay tax on qualified dividends at the more favorable long-term capital gain rate.

You pay tax on non-qualified dividends at your normal, ordinary income marginal tax rate.

You will also pay tax related to stocks when you sell them. If you hold a stock for the short-term and sell it for a gain, you will pay ordinary income tax on the gain. If you hold a stock for the long-term and sell it for a gain, you will pay the more favorable long-term capital gains tax on the gain.

How Are Bonds Taxed?

Like stocks, bonds can be taxed in multiple ways.

Bonds generate regular cash flow by paying the bondholder interest. Interest is considered ordinary income, so when you receive interest from a bond, you will pay taxes on the interest at your ordinary marginal income tax rate.

You can also sell bonds for a capital gain or loss. Like stocks, if you sell a bond for a short-term gain, you will owe tax at your ordinary-income rate. If you sell a bond for a long-term gain, you will owe tax at the more favorable long-term capital gain rates.

Bonds are a bit more nuanced because of the different types of bonds out there. For example, interest paid by government bonds are taxed at the federal level, but not at the state and local level. Municipal bonds are not taxed at the federal, state or local level as long as you reside in the state that the municipal bond was issued in.

Generally speaking, though, bond interest is taxed as ordinary income, and this will play into how you select your asset location strategy.

What’s the Difference Between Tax Efficient and Tax Inefficient Assets?

When thinking about an asset location strategy, it is also important to understand the difference between tax-efficient assets and tax-inefficient assets.

An investment is considered tax-efficient if it doesn’t generate ordinary taxable income on a regular basis. For example, stocks held for the long-term and passive index funds such as a S&P 500 index are considered tax-efficient investments. Stocks and index funds typically pay dividends on a quarterly basis, and these dividends are usually considered qualified dividends. If a dividend is qualified, that means you pay tax on the dividend at your more favorable long-term capital gain rate. Stocks held for the long-term are also considered tax-efficient because when you sell a long-term asset, you pay tax at the long-term capital gain rate. Notice how you are not paying your ordinary income tax rate in either of these situations, and you are only paying tax when you sell the stock for a gain or when you receive a dividend.

A tax-inefficient investment is one where you will be paying taxes at your ordinary income tax rates for the income the asset generates on a regular basis. Examples of tax-inefficient investments include bonds, actively traded, high-volume mutual funds, and REITs. Bonds are considered tax-inefficient because they pay you interest on an annual basis, and the interest is considered ordinary income. This means bond interest is taxed at your marginal tax rates, so if you are a physician in a high marginal tax bracket, you will be paying a high tax rate on your bond interest, and you will be paying it annually.

When mutual funds are traded frequently, they generate tons of short-term capital gains or losses because the fund is not holding assets for a period longer than one year. Short-term capital gains are taxed at your ordinary-income tax rate, so if a mutual fund is trading frequently, you likely will be paying tax more frequently than you need to.

REITs pay dividends to their unitholders and are considered tax-inefficient because these dividends are typically considered ordinary income which means you will pay tax at your ordinary-income rate.

An Asset Location Strategy for Physicians

Where you hold an asset and invest it matters when it comes to thinking about tax efficiency. You can invest in a pre-tax retirement account, post-tax retirement account, taxable brokerage account or other non-retirement taxable vehicle such as holding government bonds.

Each account has its advantages and disadvantages, especially when it comes to investing tax efficiently.

Hold Tax Inefficient Assets Pre-Tax Retirement Accounts

When you invest in a pre-tax retirement account, you defer paying taxes on your income until you withdraw the money at a later date. Decreasing your current taxable income is a great way for high-income earning physicians to reduce their current year taxes. Another advantage of investing in pre-tax accounts is when you trade in them, you don’t pay taxes on any gains, dividends or interest until you withdraw the assets upon retirement.

So what does this mean for your asset location strategy?

Remember, tax inefficient assets are ones where you pay ordinary income taxes on a regular basis due to a regular stream of income such as bond interest. This makes bonds a great investment to hold in pre-tax retirement accounts. Since bonds generate interest every year, you would normally have to pay tax on that interest at your normal, ordinary income tax rate.

However, if you hold bonds in your pre-tax retirement account, you don’t pay tax on the annual interest until you withdraw the money upon retirement. The same goes for if you sell a bond before retirement. If you sell a bond for a gain in your pre-tax retirement account, you don’t have to pay tax on that gain until you withdraw the money in retirement.

So why not invest in stocks in your pre-tax retirement account?

Nothing is absolute when it comes to investing, so having stocks in your pre-tax retirement account is also a good idea. If we are thinking about it from a purely tax efficiency perspective, bonds are generally the better option to hold in your pre-tax accounts.

Your ordinary income tax rate is going to be higher than your capital gain rate. As we have seen, bond interest is taxed at your ordinary-income tax rate while stock dividends are taxed at your long-term capital gain rates. That means you will be paying a higher tax rate on bond interest, so you should hold that in an account that you don’t pay tax on frequently.

Hold Tax Efficient Assets in Taxable Accounts

The money you invest in a taxable brokerage account has already been taxed once when you received your paycheck or paid taxes on your 1099 income. That is why it is important to invest as tax-efficiently as possible within your taxable accounts. If you invest in bonds in a taxable account, you will pay ordinary income tax on the annual interest. This is not tax efficient.

Investing in stocks in your taxable accounts is tax efficient. Income from your stock investments is taxed when the stock distributes a dividend or when you sell the stock for a gain. Dividends are typically qualified dividends which means you are only paying tax on those at the more favorable long-term capital gain rates. And as long as you hold your stock for the long-term, if you sell it for a gain, your gain will also be taxed at the more favorable capital gain rates.

What About After-Tax Retirement Accounts?

After-tax retirement accounts such as a Roth IRA are a mixed bag. Since the dollars you are putting into a Roth IRA have already been taxed, and there is no tax on the contributions or gains when you pull the money out at retirement, there is no one size fits all strategy here.

Bonds will do better in a Roth than in your taxable brokerage account because you will never owe taxes on the annual interest. Stocks will also do well in a Roth account because the dividends won’t be taxed. Any capital gain you achieve from a Roth account won’t be taxed either. Investing in a Roth account would be tax efficient with both asset classes, however, many physicians won’t be able to invest in a Roth account unless they perform a Backdoor Roth Conversion.

Asset Location Example:

To illustrate, let’s walk through an example.

A single physician has a traditional IRA with $100,000 invested in a total stock market index fund. $60,000 is made up of her contributions, $40,000 is made up of gains. If she withdraws all $100,000, she will owe ordinary income tax on all $100,000 of the distribution because she has never been taxed on this money. With the 2020 marginal tax rates, her total tax bill would be $18,079 (ignoring deductions and credits). This leaves her with $81,921.

On the other hand, if she held this $100,000 in a taxable brokerage account with the same $60,000 of contributions and $40,000 of gains, she would only owe tax on the $40,000 gain and the tax rate would be one of the more favorable capital gain rates. Let’s assume she is in the 24% tax bracket, so her capital gain rate would be 15%. That means she would pay a total tax of $6,000 (.15 x $40,000), leaving her with $94,000 to spend.

In this second scenario, we also have to take into consideration the tax she paid on the $60,000 of contributions that went into her taxable brokerage account. The amount of tax she paid on the $60,000 worth of contributions will depend on the tax rates when she contributed it, but if we use the 2020 marginal tax rates, she will have paid $8,990 in tax on the $60,000 of contributions. This brings her total tax in the taxable brokerage account scenario to $14,990 leaving her with a total of $85,010. This is a little over $3,000 difference by investing tax efficiently.

Please note that this is a simplified example, and there are many factors that go into your asset location strategy.

How Does Net Investment Income Tax Play into Your Asset Location Strategy?

Another thing to consider as a high-income earning physician is the net investment income tax (NII). The NII is an additional 3.8% tax on your investment income if your modified adjusted gross income is over $200,000 for Single filers and $250,000 for married filing jointly filers. When your income is over these amounts, you will owe a 3.8% tax on the lesser of your net investment income or the excess of your MAGI over the threshold amount.

The IRS defines investment income as interest, dividends, capital gains, rental income, royalty income and non-qualified annuities. The implications for physicians are if you make more than the thresholds noted above, and you receive taxable investment income during the year, then you will owe a 3.8% tax on that investment income.

This is where asset location can help. Investing in pre-tax retirement accounts, whether that is stocks or bonds, will shield the income from these investments from the net investment income tax during your working years. When you withdraw the funds upon retirement, there is a good chance you will be withdrawing less than the thresholds for the NII, so you will avoid the NII altogether.

Asset location and asset allocation are both important aspects to an investment portfolio.

How Backdoor Roth IRA Conversions Tie Into Asset Location Strategies

A backdoor Roth IRA conversion is a method of converting your pre-tax investments into after-tax investments in a Roth IRA.

While the process is fairly straight-forward – the tax implications are not.

The purpose of a Backdoor Roth IRA is to allow high-income earners who normally aren’t able to save into a Roth IRA directly, a way to get money into one. It technically is a legal way to get around the income limits on contributing to a Roth IRA.

To accomplish a Backdoor Roth IRA, you’ll first save into a Traditional IRA, with pre-tax funds. This is then converted into a Roth IRA with the assistance of the brokerage who holds the account. You’ll pay taxes on the contributions and any growth, but after the conversion the funds grow tax-free.

Once converted, a new distribution rule is added to the converted funds – the five year rule which places additional penalties on distributions within five years of converting with limited exceptions.

Once in retirement the Roth IRA is the only retirement savings account that does not have Required Minimum Distributions (RMDs).

Getting money into a Roth IRA can help diversify the types of accounts you have to pull from once in retirement – creating additional withdrawal strategies.

Asset allocation will help you diversify your investments while asset location will help you invest as tax-efficiently as you possibly can. Every physician’s situation is different, and investing diversely and tax-efficiently requires looking at multiple factors such as your risk tolerance and investing time horizon.

In summary, hold tax-efficient assets such as stocks and index funds in taxable accounts and tax-inefficient assets such as bonds in pre-tax accounts, and don’t forget to consider how the net investment income tax plays into your situation.

Knowing the basics of how to invest tax-efficiently could save you thousands of dollars in unnecessary taxes.

Types of Investments

By following the Portfolio Selection Guidelines section of your Investment Policy Statement, it becomes easier to narrow down what exactly to invest in. These guidelines guide you through the various asset classes, and the percentage of your portfolio that you should invest in each.

The main asset classes are:

• Equities (stocks)
• Fixed Income (debt)
• Cash and Cash Equivalents
• Real Estate and Commodities

Your asset allocation is the mix of investments within your portfolio. Some examples include:

• 60% Equities, 40% Bonds (60/40)
• 70% Equities, 30% Bonds (70/30)

This mix is found by first determining the level of risk you can tolerate in your portfolio. If you are able to withstand more risk, you might choose an asset allocation with a higher percentage of equities.

A 70/30 asset allocation, 70% Equities, 30% Bonds, might breakdown further into:

70% Equities

• 30% US Large-Cap
• 15% US Mid-Cap
• 5% US Small-Cap
• 15% Non-US Equity Developed
• 5% Non-US Equity Emerging

30% Bonds:

• 5% US Corporate Bonds Core
• 5% US Corporate Bonds Long Duration
• 5% US Corporate Bonds High Yield
• 7% Non-US Debt Developed
• 2% Non-US Debt Emerging
• 5% US Treasuries
• 1% Cash or Cash Equivalents

As you age, and your situation changes so should your asset allocation. One common timeline we use is based on how far you are from retirement.

If you’re getting close to retirement and you mostly have stocks, it could mean trouble and you could be at the mercy of the stock market. As you get closer to retirement, you’ll need to reduce your risk exposure by increasing the percentage of bonds and cash in your portfolio.

What if you are a new attending physician, who is just starting out?

How would your investment choices look, if there was a 60% decline when you are just starting to invest?

Look at your assets, the first one is your financial assets, which is what you are considering. However, you can also think about your human capital (lifetime earning stream).

The scenario looks at your earning potential for the next 30 years, so you have that potential converted into future financial assets!

With that time and money stretching out in front of you, there’s the ability to be a more aggressive investor, and have more in stocks.

It also depends on how much money is in the portfolio. If it’s very large and it falls by half, you may not feel the impact on your lifestyle. On the other hand, if it’s small, you may feel the impact quickly!

Just as your budget needs to be tailored to your individual situation and goals–so do your investment choices.

Each asset class is broken down into more sub-groups based on the location, market capitalization, and the growth or value potential of the company.

Stocks and Bonds

How do bonds differ from stocks? Very simply, a stock is a share in a company, a small percentage of ownership; a bond is when you buy debt from a company or government.

A stock is a share and a public company. When you buy stocks, you’re actually buying shares in a public traded company. Think about any brands that you buy today, Pepsi, Kraft Foods. These companies put their company shares into the stock market and divide up the shares so that individual investors, you, can go in and buy shares of that company. At its core, what you’re doing is buying an investment in a company and becoming a very small owner of that company.

These shares are worth more, or less based on how the company performs and how others value the company.

A bond is when you’re buying their debt of a company or from the government. You’re making a loan to the company.

Let’s say Walmart puts out a corporate bond. Investors will come out and they’ll buy the bond. By buying that certificate, you give the company the money to use and in exchange, they will pay the principal back plus something additional based on the terms of the bond.

It’s not just companies that have debt, the federal government has debt as well. These are referred to as Treasury or T bills.

Passive and Active Investments

There are two main methods of investing, passive or active. Within each of these two main investment strategies are many other investment techniques.

Passive investing is like a buy-and-hold technique and involves dollar-cost-averaging. This method involves less transactions, as investments are held for a longer period of time. Once an asset allocation is decided, this allocation isn’t changed for years at a time. Because there is less trading, this strategy is typically more tax-efficient than an active investing strategy.

Most passive investors use index funds, ETFs, or mutual funds. Because these typically have lower fees, and you’re not paying high management fees for an investment manager to pick stocks, passive investing has historically had higher real returns compared to active investing.

Active investing is more involved than passive investing as an investment manager is constantly running analysis on what stocks to buy or sell. This strategy is typically more expensive than a passive investing strategy as you’re paying this manager for their time and expertise.

There’s always a risk when investing, however, when using an active investing strategy you’re exposed to more risk due to relying on an active investment manager. These analysts don’t always get it right, and when they don’t your investments could take a significant hit.

Active investing does have a place in some investor’s overall strategy. Because of their ability to use advanced investing techniques, such as short sales and put options, active management could help investors hedge themselves against loss.

So, should you use a passive or active investing strategy? The answer to this question lies in your overall investment strategy, and will vary person to person. However, many investors actually use both by allocating a smaller percentage of their investment portfolio to active investing through a tactical sleeve, and the majority is allocated to a passive investment strategy.

Location

Types of investments are broken out by location, normally US and non-US. Non-US companies are grouped by the development stage of the country they are in, either developed or emerging.

• US: companies in the US
• Non-US Developed: companies outside of the US with developed economies
• Non-US Emerging: companies outside of the US with undeveloped economies

Non-US Emerging is typically a more volatile and riskier class.

Market Capitalization

This breaks investments into groups by the size of the company, either micro, small, medium, or large. The dollar values below represent the total value of the company’s tradable stock. To get this number, just multiply the shares outstanding by the price of the share.

• Micro-Cap: under $300 million
• Small-Cap: under $2 billion
• Mid-Cap: $2 to $10 billion
• Large-Cap: over $10 billion

Growth or Value

Stocks can be identified as either a growth or value stock.

• Growth: the price is considered expensive, but there’s a high potential for future growth
• Value: the price is low compared to the companies earnings, dividends, or book value
• Blend: a mix of the two!

Equity Style Boxes

When comparing stocks to buy, you might come across this equity style box. Your stock should fall somewhere on this matrix based on its market capitalization and whether it is growth or value.

If my stock was a mid-cap value stock, the equity style box would look like this:

ETFs and Mutual Funds

ETFs and mutual funds are collections of many stocks or bonds. These funds allow investors to diversify their risk of being too heavily concentrated in one company.

They typically invest in companies based on the purpose of the fund. For example, an ETF for large-cap growth stocks would only invest in large-cap growth stocks. A portfolio manager oversees the fund and ensures it is invested properly.

ETFs can be bought and sold like a stock, whereas a mutual fund typically sells at the end of the trading day based on the closing price.

Mutual funds are normally actively managed, and often times have higher fees and expense ratios to compensate the portfolio manager. ETFs are normally passively managed and in turn, can offer lower fees and expense ratios because of their lower overhead costs.

Fixed Income (Bonds)

Discount or Premium Bonds

When purchasing a bond, the amount of pay for it dictates if you purchased it at a discount or a premium. To determine which, just compare the amount you paid to its face value, the amount you receive back at the end of its term.

For the examples below, we’ll assume that you hold the bond until maturity. In practice, you could sell the bond before it reaches maturity.

For example, a $1,000 face value bond sells for $900. This bond was sold at a discount and if it doesn’t pay any interest through a coupon payment, then the rate of return is based on the $100 difference, accounting for the time to maturity.

If you purchased this bond for $900 and it pays interest every year, then your rate of return will be higher than the coupon rate because you will receive interest every year plus the $100 difference at its maturity.

However, if that same bond sold for $1,000, the same amount as its face value, then the rate of return is equal to the coupon rate, or annual interest.

When you purchase a bond for less than its face value, you are buying it at a discount. When you purchase a bond at its face value your rate of return is equal to the coupon rate. Purchasing a bond for more than its face value is considered paying a premium.

Cash and Cash Equivalents

Cash and cash equivalents include liquid assets, such as actual cash, cash that is not invested, and liquid investments such as money in a money market account.

This is normally a very small percentage of a portfolio, 1 to 2% maximum until you reach retirement. Once in retirement, it’s common to see 3 to 5% in cash or cash equivalents to make it easier to access without having to sell to access your new income source.

Don’t expect to make high returns in cash equivalents. These securities have low risk, but they also have a low return.

Some examples of cash equivalents include:

• US Government Treasury Bills
• Bank Certificates of Deposit (CDs)
• Bankers’ Acceptances
• Corporate Commercial Paper
• Money Market Instruments

TIPS (Treasury Inflation-Protected Securities)

TIPS are one of the securities issued by the US government. These were created to provide investors a security that changes with inflation to protect them from a reduction in purchasing power.

The value of a Treasury Inflation-Protected Security changes with inflation, and the interest payments change with the value of the TIPS itself.

These are often a small percentage of investors’ overall asset allocation and fall under the main allocation of “safer” asset classes with bonds.

Government Securities and Corporate Bonds

Municipal Bonds

US Corporate Bonds Core

This group of corporate bonds is fairly new and offers investors access to a bond fund product with a diversified bond exposure. The way they are designed provides diversification on the maturities and investment-grade of many bonds.

These funds can be active or passive, meaning some US corporate bond core funds could be actively managed by a manager and have frequent trading.

As this is a new term, there is not a clearly defined meaning of the “core” concept. Before investing in a US corporate bond core fund, be sure to research the fund and its manager if necessary.

US Corporate Bonds Long Duration

Long duration bonds have a duration of more than 10 years to maturity. These bonds typically have higher interest rates compared to shorter-duration bonds.

As with other bonds, your income and principal are relatively safe. However, long-duration bonds are considered riskier because of the risk that inflation will reduce the purchasing power of the bond over such a long time period.

US Corporate Bonds High Yield

US corporate high yield bonds offer higher yield compared to other bonds, meaning you receive a higher rate of interest. However, these bonds typically also have a higher risk of default and are often called “junk bonds.”

When companies are not able to obtain a higher, investment-grade rating for their bonds, they need to pay a higher interest rate to entice investors looking for a higher reward, but who are also willing to accept the level of risk they pose. High yield bonds carry a bond rating of BB or lower.

Companies who cannot obtain an investment-grade rating aren’t necessarily bad companies, much smaller or emerging companies may be unable to obtain this high rating and may resort to issuing a high yield bond. However, if a larger or more established company offers these “junk bonds” that may mean they are highly leveraged or experiencing financial difficulties.

Non-US Debt Developed

International bonds made up 35% of the world’s investable assets according to a 2012 Vanguard study. International bonds are grouped by the stage of development of a country, either developed or emerging.

Non-US bonds from developed countries are considered a less-risky investment compared to non-US bonds from emerging countries, they are, however, not without risk.

An important risk to consider when investing in non-US debt, developed or emerging, is currency risk. Currency risk is also sometimes referred to as exchange-rate risk. Currency risk becomes an issue when the currency of the bond you are buying changes in relation to the US Dollar.

The risk of currency fluctuations can be hedged against and is by many professional investment managers and institutional investors with the use of the forex market and derivatives like futures and options.

Currency risk might be fine for the occasional traveler, but for investors, it poses a serious risk of loss.

Non-US Debt Emerging

Emerging market bonds are a small, but growing segment of the overall market. These securities typically offer higher returns and yields but also come at a higher risk of default compared to non-US bonds from developed countries.

Interestingly, according to a 2018 Vanguard study, they found the emerging market bonds actually “performed more like equities than like bonds.”

In the same Vanguard study, they found that 68% of the total emerging market bond market was from 10 of the larger emerging countries including:

• 13.8% in Brazil
• 10.3% in Mexico
• 9.7% in China
• 6.4% in Indonesia
• 5.7% in Russia
• 5% in Poland
• 5% in Turkey
• 4.2% in South Africa
• 3.5% in Colombia
• 2.5% in Thailand

Because of the nature of these bonds, they typically fall into the same group as US corporate high yield bonds due to the non-investment grade rating of the countries that issue them.

Equities

Common Stock vs Preferred Stock

Common stock and preferred stock are two classes of stocks, and are fairly similar.

The value of common stock and preferred stock both fluctuate with the earnings of the company. Preferred stocks pay a dividend, and have the first “right” to dividends when they are called and have an agreed-upon cadence. Common stock may or may not pay dividends, depending on the financials of the company.

As interest rates rise, preferred stocks can loose their value as the dividend they pay has less purchasing power and competitiveness than before.

Preferred stocks are great for investors who need a stable stream of income when interest rates are low and do not require voting rights on the company. If held to maturity, normally 30 to 40 years later, you will receive the full value back just like a bond. There isn’t a guarantee that the issuing company won’t call them back before you reach maturity, however.

US Equity Large Cap

Large-cap stocks are for companies with a market capitalization of more than $10 billion.

These large firms typically have a history of paying dividends and steady growth. The brand names are fairly recognizable and maybe household names.

Large-cap equities are considered conservative, compared to investing in small or mid-cap equities. The returns of large-cap equities are typically lower, but their risk is also typically lower as well.

Some companies that are large-cap include:

• Apple
• Alphabet
• Microsoft
• Amazon
• Facebook
• Johnson & Johnson

Large-cap stocks can be found in the leading benchmark indexes such as the S&P 500, the Dow Jones Industrial Average, and the Nasdaq Composite.

US Equity Mid Cap

Mid-cap stocks are for companies with a market capitalization between $2 and $10 billion. These fall between large and small-cap equities.

These mid-size firms typically are growing fairly quickly, and have the potential to become large-cap firms.

The risk and returns of mid-cap equities typically fall between that of small and large-cap equities. They typically provide a nice mix of growth and stability.

US Equity Small Cap

Small-cap stocks are for companies with a market capitalization of under $2 billion. Their size places them in between mid and micro-cap equities.

These small firms typically are newly established and growing quickly. The risk and returns of small-cap equities are typically much higher than that of large-cap equities.

Because these small-cap equities have smaller market capitalization, there isn’t as much available for investors to purchase. Mutual funds are oftentimes limited on buying small-cap equities because they cannot hold a majority share in a company.

Non-US Equity Developed

International equities, just like international bonds, are grouped by the stage of development of a country, either developed or emerging.

Non-US equities from developed countries are considered a less-risky investment compared to non-US equities from emerging countries, they are, however, exposed to currency risk.

Currency risk is also sometimes referred to as exchange-rate risk. Currency risk becomes an issue when the currency of the equity you are buying changes in relation to the US Dollar.

Non-US Equity Emerging

Emerging market equities typically offer higher returns, but also come at a higher risk compared to non-US equities from developed countries.

Not only do non-US equities from emerging countries have currency risk, but they are also at a higher risk of default or extreme volatility.

When investing in non-US equities from emerging countries, ensure that it is a small percentage of your overall portfolio asset allocation to limit your exposure to the high level of risk these equities pose.

ETFs and Mutual Funds

What is the future of index investing?

There is an analogy that index investing can be so large that it’s herd investing, and it’s like a bubble. That bubble is expected to eventually pop.

While everyone is not indexing, it still has benefits. The biggest benefit is that it’s an easy way to invest.

You may have heard of fundamental indexing, which is weighted by revenue earnings. The benefit of being weighed in that way is with most index funds the bigger the holding, the bigger the weight is going to be.

What if the stocks aren’t priced right?

An example is when investors are forcing the price to increase too much. The stocks will have a sizable weight index fund. You can compare that to something that’s weighted with revenue or earnings. The weights will be smaller with those.

The fundamental indexing approach will underweight the most expensive companies and overweight cheaper companies.

There is never a time to say, indexing is bad or good. It depends on what’s inside. This goes back to being able to explain how an index works, what it involves, what it contains.

You’ll still need to understand the research and to know where you’re putting your money. There’s never a time to be an ostrich.

You can’t just follow the crowd and think that if it worked for someone else it will work for you.

Oil and Gas

Oil and gas are considered to be a part of the energy sector. Over time, the energy sector has experienced high volatility and is generally only considered for experienced investors.

Given the political and environmental risks these stocks are exposed to, even slight changes to environmental policies or the political landscape can cause large fluctuations in price, and quickly.

Oil majors, oil and gas exploration, and production companies are typically the most covered subgroups of the oil and gas energy sector. Over the years these companies have aggressively restructured their cost bases to adapt to the ever-changing environment. However, this does not remove all risk of high price fluctuations.

Try as they might, investment managers are typically unable to accurately predict changes to oil prices, making the oil sector extremely unattractive.

If highly skilled investment managers are unable to forecast changes to the energy sector, don’t fool yourself into thinking you can either.

Oil and gas can hold a small weighting in your overall portfolio asset allocation, however. By exposing yourself to this risk in a small percentage of your total investments, you may be able to withstand the ever-volatile nature of this sector.

Gold and Other Precious Metals

Professionals suggest investing in gold and silver because it’s an asset class. Depending on your timing, it can be either a good investment or a bad investment for physicians. It all depends on the “why”!

What is your motivation for investing in gold and silver?

From a psychological standpoint investing in gold and silver can be extremely comforting. It is extremely portable. When you carry gold coins while traveling you have instant liquidity–across markets!

Other than the comfort factor of investing in gold and silver there is really no difference as to when you should buy it. It is just like any other stock.

However, there are other reasons for investing in gold and silver, such as protecting a portion of your portfolio against inflation. There is also one very bad reason for investing in gold and silver — fear.

Have you thought about where the fear is coming from? Are you getting either a subliminal or direct message of impending doom? Where is it coming from?

The answer might be Uncle Sam. Our government has a history of using fear as a tactic for getting people interested in investing in gold and silver. Or, it might be analysts and commentators attempting to scare people into investing in gold and silver by making references to a financial market collapse. It has happened before.

For example, relative to other assets, gold did very well during the financial collapse in 2008. There is no other market that does as well when the spotlight of fear is shining on it.

It turns out that the people who invest in gold tend to fall into several psychological categories. These groups have remained steady since the 1970s when our government disassociated the value of the dollar from gold.

• The first group believes the world as we know it is ending
• The second group is a conservative investor
• The third group are the traders
• The fourth group are the collectors

The first group is planning to use gold as a safeguard in the event our currency system crashes. The second group holds a small portion as an investment. The third group invests in gold for capital gains. They may consider themselves to be bullish (believing the price of gold will rise) or bearish (believing the price of gold will fall). However, their beliefs about the market are not an indication of what action they might take. The fourth and final group are coin collectors.

Investing in gold and silver can be a good investment. It will depend on the timing and momentum in the market. There are good times to invest and good times to pull back from investing in gold.

It will also depend on the balance of your portfolio.

You need to check your security market investments (stocks, bonds, and gold) every six months to see if they are lining up with your objectives. If they aren’t–you will need to calibrate them.

How did my portfolio get out of balance?

Think about the time when you bought the gold. Now think about what has changed in the market until now. The fluctuations in the market have affected the price of gold. Meaning it raised or lowered to a new percentage the gold represents in your portfolio. This throws your portfolio out of balance.

How on earth do I calibrate my investment portfolio?

That depends on how long it has been since you’ve assessed your portfolio.

You start with your expectations. Look at the difference in your portfolio’s current asset allocation and compare it where it should be.

Is the percentage more than your original allocation– then it’s too high for your portfolio, and you might need to sell some. Is the percentage too low? You might need to buy to restore balance.

You also take this time to reassess your portfolio in relation to your age, earnings, assets, your current situation, and future goals. Consider your risk tolerance. All of these factors play a part.

Why are you interested in investing in gold and silver? Is it because you’ve done your research and you want to diversify your portfolio? Have you learned something from a reputable that convinces you that it’s a good move? Or are you listening to an analyst who has an ulterior motive?

The same analyst or dealer who wants to sell you gold or silver.

I’ve talked on my podcast and written on my blog many times about conflicts of interest. Here are some things to keep in mind:

• Is someone wanting you to buy something or do something?
• Is there a conflict of interest? Does the person have something to gain? A motive?
• Keep in mind that an indirect suggestion is like subliminal advertising
• Are they selling something?
• Will they be compensated?

When you are making a decision about investing in gold and silver here are a few things to ask yourself:

• Does investing in gold and silver make sense for my portfolio?
• How does the market for investing in gold and silver work?
• How risky is investing in gold and silver?
• Do I understand the gold and silver market?

Coin Collectors

I know, you are here to learn about financial independence and building your wealth–not hobbies!

So, unless you are someone who falls in one of the four groups of people who are investing in gold and silver, you’ve probably never given gold or silver much thought. Or been conscious of anything to do with this topic.

Except for coin collectors. They’ve given investing in gold and silver plenty of thought.

Hasn’t almost everyone at least heard of coin collecting?

Is coin collecting for both fun and profit?

Coin collectors investing in gold and silver take up a good portion of the market. They may choose themed coins with a bullying content of one ounce of either silver or gold.

Why do people collect coins?

Where do they find these coins?

I started collecting coins when I was five with my grandpa. I’ve always been interested in coins. It’s almost like stamp collecting, I don’t think there are very many people left doing it. I would say most of the other coin collectors are a lot older than I am.

A collector may start collecting and investing in gold and silver according to a chosen motif. Examples are Nautical, ancient Rome, animals, or a Star Wars theme. Maybe they have a variety of interesting pieces.

A collector has the choice of searching for old coins or buying newly minted coins. Places to search for old coins may include:

• Check your pockets!
• Walk around old abandoned houses with a metal detector (beware of going inside of an unstable building)
• According to Treasure Pursuits, farmers kept their money in a “posthole bank”
• Near large trees or under bridges
• Check out the backs of antique picture frames

Hopefully, this list will jumpstart your imagination!

It’s exciting to finally come across a coin you’ve been intrigued with or searching for a long time. They are fun to look for and collect. But, if you are looking at coin collecting as a way to make a profit they are probably not a good investment.

The gold content or silver coin is going to have the value of the metal content for the relative market. You may spend $50 on a collectible coin that comes in a nice display box or on a limited edition. However, there is no guarantee you will make a profit when you decide to resell it.

Investing in gold and silver coins is a great hobby, It’s just not usually profitable!

Experts have a golden rule of holding no more than 10% of your assets in gold. After all, gold is a commodity. The price of gold will depend on the supply and demand for it. If the US dollar has strengthened, the commodity market will be weak. And vice versa.

Are we talking about investing in gold and silver as the actual physical bar or part of the market?

Are you building a locker and storing food? You might choose to invest in an actual bar.

When you want to hold the actual bar of gold there are some things to think about and questions to ask:

• Shipping costs
• Research the dealer
• Research the product
• Where is it being held?
• Who is backing the product?
• What type of transaction confirmation is there?

If you choose an actual bar you will pay a premium relative to the gold price. And a disadvantage is the liquidity is diminished.

However, if you are comfortable with the markets instead of buying gold bars you might choose to invest there, instead of buying the physical gold bars!

You will want to get as close as possible to the value of the true market. To that end, you have the option of using an ETF.

Who wants to hold a Gold Eagle?

When investing in gold and silver American’s want to hold the Gold Eagle!

The bad news is it is one of the worst coins you can buy from an American perspective. The pricing is the same as when the eagle coin was first issued in the 1980s. That’s right 33 years ago!

There are no deals for the dealers. They pay the same price for each coin regardless of how many coins they buy and they don’t get anything under melt value.

Let’s say I’m a dealer. I will pay 3% ($38 per coin). If another dealer comes to me, I’ll sell to him at a slight increase ($45). If a customer comes to me directly I will sell it for between $50 and $60.

This is harking back to high school economics, but think about the law of supply and demand, nobody is paying attention to the premium. Why? Because there is so much demand for the Gold Eagle and Silver Eagle.

The US mint has the mindset: If it’s not broke, don’t try to fix it.

The Gold Eagle coin is fine in the United States. However, other countries prefer a 24-carat gold coin–and the Eagle is not that.

So, if the Gold Eagle isn’t equal to the coins in other countries–which coin is?

The US has the Buffalo which is a four nines gold coin which compares equally with the Royal Canadian Mint Gold Maple Leaf, the British Britannica, and the Australian kangaroo. They are all four nines gold coins.

The US Buffalo sells at the same rate as the US Gold Eagle–sometimes even higher. The dealers get their mark-up. It is the retail investor that pays an additional $30 or more.

An even better deal is to buy a gold bar. They can be traded for $15-$20.

Since the US mint is at 3%, it’s opened a window for the other sovereign mints to offer their coins on the US market. That discounts the Golden Eagle.

As a lifelong collector, I’m continually disappointed that the US Mint chooses not to be more competitive when it could.

Derivatives

Derivatives are securities whose value is driven by the underlying asset or group of assets. The term derivative refers to contracts between investors, whose price is directly tied to some asset.

For example, a farmer might purchase a derivative contract on corn to protect themselves from changes in the price of corn before they are able to sell it on the market.

Corn is one type of asset a derivative contract can be used on, a commodity.

The most common assets used for derivatives include:

• Stocks
• Bonds
• Commodities
• Currencies
• Interest Rates
• Market Indexes

Investors use derivative contracts to hedge themselves against changes in the price or value of the underlying asset.

In our farmer example, let’s say corn is selling for $10 a unit when the farmer goes to plant their fields. They run all of their projections based on a selling price of $10, however, they are fairly concerned that the price of corn might decline to $7 by the time their harvest is ready to sell.

Another investor believes based on the information they have that the price of corn will actually go up by the time this farmer’s crop is ready to sell.

This farmer could purchase a derivative contract, called a futures contract, from this investor locking in a rate of $10 per unit.

If the price of corn goes down like the farmer is predicting, the farmer has the right to sell his corn to this investor for $10. The investor then can sell the corn for the going rate, probably losing money.

If the price of corn goes up like the investor is predicting, the farmer could sell the corn for $10 to the investor, and the investor can turn around and resell the corn for a profit on the market. The farmer might be upset from not being able to make a higher profit, but they also might be thankful they didn’t have to worry about their initial analysis turning out much worse.

While this is a fairly simple example, it does follow the general structure of most derivative contracts.

The various types of derivative contracts include:

• Future Contracts: contracts traded on an exchange
• Forward Contracts: off-exchange contracts
• Swaps: interest rate swaps
• Options: puts and calls

Futures Contracts

Our farmer example above is an example of a futures contract if it was done through an exchange. The contracts on these exchanges are standardized, reducing the risk of an obscure requirement from either party involved.

By trading on an exchange, future contracts reduce the credit risk involved in the transaction as each party is obligated to fulfill their commitment.

Not all futures contracts end with one party actually receiving the asset, such as the corn in the example above. These contracts are typically sold, or cash-settled before actual delivery of the asset occurs.

So, in our farmer example, the investor wouldn’t actually receive the corn.

Forward Contracts

Forward contracts happen off of an exchange. Because these investments occur between two parties directly, they are exposed to a high level of credit risk. If one of the parties is unable to fulfill their commitment, the other party might be out of luck or need to sue.

These contracts are highly customizable. The terms, size, and settlement process can be adjusted based on the needs of parties involved.

Swaps

Swaps are used to exchange one form of cash flow for another, such as interest rates.

Let’s say I issued a loan to another company at a 5% variable rate. I think interest rates will increase soon, and decide I now want to charge 6%. I could swap this investment to another party and they will pay me the 1% difference.

However, if interest rates fall to 4%, I will have to pay the other company the 1% difference.

These contracts can be used to exchange currency rates, mortgage rates, and other cash flows for businesses.

Options

An option is a contract between investors that allows one party the right to buy or sell an investment and obligates the other party to buy or sell.

A stock option typically is written for 100 shares, but they don’t have to.

To purchase an option, you’ll pay a premium to enter into a contract. The seller of the option keeps this premium even if you do not decide to buy or sell the underlying asset.

In The Money (ITM), Out of The Money (OTM), and At The Money (ATM)

The value of an option decreases as it gets closer to its expiration date because there is less time for the stock price to become more favorable for the buyer of the option to buy or sell. The intrinsic value of a stock is the difference between its strike price and the current stock price.

In The Money (ITM):

• Call: the option buyer has the opportunity to buy the security below its current market price.
• Put: the option buyer can sell the security above its current market price.

An option being in the money doesn’t mean the buyer stands to make a profit, but it does make it more likely that they will after considering the premium, taxes, fees, and possible commissions.

Out of The Money (OTM):

• Call: strike price that is higher than the market price of the underlying asset.
• Put: strike price that is lower than the market price of the underlying asset.

An option can also be at the money (ATM), which means the market price is equal to the strike price of the option.

Put

The buyer of a put has the right to sell their investment to the other party in the contract, and if they decide to sell, the seller of the put must buy it to meet the requirements of the contract.

The buyer of a put must own the underlying asset in order to sell it per the terms of the contract. They typically have until a certain date to sell, and they must sell it at a specific price based on the details of the contract.

Call

The buyer of a call has the right to buy the underlying asset at the specified price by the expiration date. The seller of a call must sell their asset if the buyer decides they would like to buy.

Annuities

Annuities are contracts that aim to provide income. They are long-term income, not investment, strategies, and are not meant for short-term goals. The main benefits of annuities include retirement income, diversification, and principal preservation.

Annuities are essentially contracts issued by an insurance company. The type of annuity and the details of the contract determine your future annuity payments.

The main purpose of annuities is to transfer your longevity risk, the risk of outliving your savings, to the insurance company.

Immediate Annuities

Immediate annuities are funded with a lump-sum payment. As the name suggests, the payments begin immediately and are not deferred to a time in the future. This limits the time for tax-deferred growth from investing your premiums.

Deferred Annuities

Deferred annuities can be funded with a lump-sum or periodic payment of a premium. These annuities grow tax-deferred until the payout phase begins.

Fixed Annuities

Fixed annuities guarantee a rate of return for a set period of time, and may renew at a different rate after the initial period ends.

Variable Annuities

Variable annuities earn interest through investments that you select. These annuities do not guarantee a rate of return.

Indexed Annuities

The rate of return is tied to a market index, such as the S&P 500, for indexed annuities. They offer a guaranteed minimum rate of return.

Key Features of Annuities

Free-Look Period

This is the time, as defined by your state, that is required to allow you an opportunity to cancel the contract without paying a surrender charge.

Riders

Riders are addendums that allow customization to annuity contracts. While riders allow you to add additional benefits to your annuity contract, they typically come at an additional cost.

Death-Benefit Rider or Guaranteed Minimum Death Benefit Rider

This rider allows you to add beneficiaries to your contract who will receive a portion of the contract value at your death.

Disability Income Rider

This rider ensures higher income will be paid for a limited time if you become disabled.

Impaired Risk Rider

If you have documented health risks that may lead to a shorter life, this rider can accelerate your annuity payments to account for a shorter payout time.

Long-Term Care Rider

This rider increases your income if you require long-term care. It is typically based on a multiplier of your normal monthly annuity payment and is limited to a couple of years.

Cost of Living

This rider increases your monthly annuity payment with inflation or a specified percentage dictated by the annuity contract.

Return of Premium

This rider gives the unpaid portion of your premium to any beneficiaries upon your death. The unpaid portion is equal to your contributions minus the payments made to date.

Fees and Commissions

When an annuity is sold, the financial professional selling it typically makes a commission. On top of the commission, additional fees can be charged for added riders, management fees, and more. Ensure you are provided a clear breakdown of the fees and commissions you are expected to pay before purchasing an annuity.

If you find yourself needed to withdrawal more than the contracted annuity payment, expect to pay fees to do so.

Taxation

If you purchased an annuity with after-tax money then the portion of your annuity payments that came from earnings is taxable. This is similar to a brokerage account taxation, however, with an annuity the taxation is deferred until you withdraw the funds. The amount you pay taxes on is calculated by using an exclusion ratio.

If you purchased an annuity with pre-tax dollars then the entire annuity payment is taxable with withdrawn.

Alternative Investments

Real Estate

Traditionally, real estate investing has been considering an addition to a well-diversified investment strategy. Many investors get into real estate to expand their portfolio.

For more information on real estate investing, visit our mega-post on real estate investing here.

REITs

REITs, real estate investment trusts, are companies that own or finance income-producing real estate. These securities provide many of the financial benefits of real estate investing, without the hassle of actually managing properties.

REITs can be publicly traded on an exchange, or be non-traded. Non-traded REITs are fairly illiquid investments that cannot be quickly sold on the open market.

REITs must payout at least 90% of their taxable income to shareholders through dividends, some pay 100% out through dividends. They must also invest at least 75% of their assets in real estate, have a minimum of 100 shareholders, be managed by a board of directors or trustees, and have now more than 50% of its shares held by 5 or fewer individuals.

mREITs, or mortgage REITs, don’t own income-producing real estate – instead, their income comes from the interest on the real estate financing they provide.

Asset-Backed Securities

Asset-Backed Securities are bonds or notes that are backed by a pool of assets. These assets can include loans, leases, credit card debt, royalties, or other receivables. Asset-Backed Securities help lenders raise money to issue more debt, and reward their investors through cash flow.

There are typically three main tranches of Asset-Backed Securities; A, B, and C

Tranch A is the highest quality, investment-grade debt with the lowest default rate. This is the most attractive to investors.

Tranch B has a lower credit rating and is considered riskier than tranch A. However, due to its higher risk this tranch also includes debt with higher rates and better cash flow opportunities for investors.

Tranch C is the riskiest and is sometimes too risky of debt to actually sell through an Asset-Backed Security.

CryptoCurrency

Cryptocurrencies are a digital or virtual currency that is secured using cryptography. While a fairly new player in the investment world, cryptocurrencies were introduced in 2008 by Satoshi Nakamoto (a pseudonymous person or persons) who came up with the idea of blockchain. It is a way to pay someone without the use of a middleman (like a bank).

Wallets

First of all, you’ll need a “wallet”. You can get the app for your computer or phone. The wallet will have an address–sort of like an IP address. It can be used to pay someone or receive payments. The wallets hold your “private keys”.

There are many different types of wallets.

• Downloaded or cloud-based wallets
• Software wallet-directly on your computer
• Online wallets (you will need passwords)
• Mobile Wallets-apps for your smartphone
• Hardware wallets (electronic device)

Keys

Keys are only for you and have the same importance as your social security number. They are proof that the transactions come from the owner of the wallet.

We can use bitcoin keys as an example for understanding the keys:

• You have a private key that allows access to your bitcoin address.
• Your bitcoin address is actually your public key.

Keeping yourself safe is simple: Don’t share or write down your key information anywhere including your phone apps, such as Evernote. If your phone was hacked they could potentially steal your cryptocurrency.

The crypto-influencers have had it happen to them. In fact, there is a lawsuit against AT&T because of hacking.

If you are not planning on trading your cryptocurrency soon and you want to keep it safe, you can consider putting it into “cold” storage which is not “centralized” and is offline (think USB drives).

Where to Buy Cryptocurrency

There are a number of ways to buy cryptocurrencies, one of them is at coinbase.com. You will need to sign-up and verify your ID, perhaps by the user submitting a picture of yourself holding a driver’s license next to your face. There are Bitcoin ATMs in the United States, and you can buy fractions of it, for example, .0001 bitcoin.

Types of Cryptocurrency

Stable coins, which were started last year, are backed by a national currency. Their price remains fairly stable.

Tokens can be used as an investment contract, for example with real estate. They reflect legal ownership of the property. Proof of the ownership must be verified in the blockchain.

An example of an altcoin that has its own blockchain and protocol is Ethereum.

Ethereum is an open software program that is founded on blockchain technology. It is centered on running the programming code of any decentralized application.

Ether is another type of crypto and is used to fuel the network. It can also be used as payment within Ethereum’s network!

Blockchain

The blockchain is basically a virtual ledger with a secure history of data exchanges. The data exchanges are the record of where the cryptocurrency transfers. So, before there was Bitcoin–there was blockchain.

Data exchanges or money transfers are recorded through the use of a peer-to-peer network to time stamp each cryptocurrency exchange. Once the information is added to the blockchain it is a permanent record. The permanent record or validation can involve contracts, records, or cryptocurrency.

Mining

How do you mine for cryptocurrency?

Mining happens with computers. That means that computers are at work all over the world trying to solve an algorithm. There are actually several ways to mine for cryptocurrency. The simplest way is through an app that you download on your computer, that mines in the cloud.

For the serious miner who wants to make an investment, application-specific integrated circuits (ASIC) hardware is needed. This hardware or microchip was created for the specific use of mining. Just like an oil-rig they constantly run 24/365! When they finally solve the algorithm, they hit the jackpot and are awarded bitcoin.

Initial Crowd Offerings (ICO)

Initial Crowd Offerings (ICO) is fundraising by crowdfunding in the cryptocurrency world. They are typically used by startups to avoid all the regulatory control in place when raising capital. This capital is used to develop other types of software, cryptocurrency, or other projects.

Desensitized Autonomous Organization (DAO)

May 2016 brought about the creation of the Desensitized Autonomous Organization (DAO). It was a virtual organization using blockchain technology to offer the sale of its coins. The sale of DAO tokens was being used to raise capital for crypto and decentralized space. This platform allowed anyone with a project the ability to present it to the community. If the project was popular it received funding from the DAO. It was sort of like a free-for-all. Then, the DAO was hacked and millions were stolen. In 2017, the SEC stated that the Desensitized Autonomous Organization (DAO) was violating its policies because they were raising capital.

Security Token Offering

Introduced in 2019, Security Token Offerings (STOs) were an answer to the unregulated process of Desensitized Autonomous Organization (DAO) and Initial Crowd Offerings (ICOs). Initial Crowd Offerings (ICOs) avoid regulations because they are to be used for fundraising. Security Token Offering (STOs) are registered with the government and considered more trustworthy.

Is Cryptocurrency Legal?

We may be so absorbed in the growing business of cryptocurrency and cryptocurrency trading strategies that we don’t consider that just because it’s growing here in the United States, that it is embraced everywhere.

As surprising as it may seem, there are countries where it is actually banned by banks, not allowed to be used for payment or not allowed to be used in business.

Here are a few of the countries where it is illegal or banned:

• Algeria
• Bangladesh
• Bolivia
• Ecuador
• Macedonia
• Nepal
• Vietnam

Why are some governments anti-crypto currency? There may be concerns about that nation’s own currency stability, fear of inflation, or they may want to protect investors. There are a variety of reasons they may want to ban cryptocurrency and cryptocurrency trading strategies.

Blockchain, cryptocurrency, and cryptocurrency trading strategies are the new frontier. That can scare people!

The average consumer may believe that blockchain, cryptocurrency, and cryptocurrency trading strategies are too ephemeral.

There are trust concerns with things that aren’t understood. There are people who don’t believe that as a method of currency it isn’t based on anything solid.

Another strike is that Bitcoin and cryptos are not classified as securities by the SEC.

Cryptocurrency has had a hard past, but that doesn’t mean it can’t have a future. However, there are many who believe it will ultimately succeed in taking a place of at least part of our national currency.

The question is what will it take to build that future?

When to Invest

Deciding when to invest might seem like a difficult question, however, it’s actually quite simple to answer. When you have excess cash flow, you should invest.

What “invest” means to you is the tricky part. “Investing” might take the form of investing in yourself through furthering your education or improving your well being. Investing in your future could mean paying down debt, or saving for your child’s education expenses. Investing could take it’s most common form – investing in the markets and other investment vehicles.

The two most important rules for investing money

The two most important rules for investing money are:

1. Never invest money you can’t afford to lose, and
2. don’t forget to pay your taxes.

If your basic expenses aren’t already covered – and if you’re a resident, there is a chance that might be the case – stop reading now and take care of your basic needs.

Whatever you do, don’t forget to pay your taxes. There are tax implications associated with any number of the options we list below. Your accountant is your friend. Be sure to check in with them before making any decisions about where to invest your money, to ensure that you are not setting yourself up for a major hit come tax time.

The Golden Answer to “Pay Off Debt or Invest”

The most frequently asked question is “Should I pay off debt or invest my money”? The answer lies with the individual—with you. It depends entirely on the unique circumstances.

Some of those circumstances are your percentage of credit card debt, interest rates, how much you are investing in 401K to get a potential employer match, or if you are eligible for tax-protected retirement accounts.

However, something to keep in mind is anytime you have debt, everything you buy is on borrowed money.

If an interest rate is low enough, it might make sense to carry the debt, but only if you are investing the money. Most people fail to invest, they instead treat themselves to a new car or a luxury vacation, which defeats the point of carrying the debt.

Don’t Try to Time the Market

Research shows that investors who try to time the market, as a whole, don’t realize higher returns. Also, given the nature of the market, there is no way to tell what will happen in the markets tomorrow, let alone a year from now.

The media might have you thinking otherwise, as they frequently feature “experts” who convincingly share their predictions for future market performance. However, the hard truth is they are rarely correct.

To help protect your investments from investing at “the wrong time” you can use a dollar-cost-averaging strategy.

Dollar-cost-averaging has been proven to be one of the best ways to build wealth over time. This investing technique entails investing the same amount of money at regular intervals over time. Because you are buying into an investment at different price points, you end up paying an average of its changing prices over time. Your 403(b) or 401(k) already does this for you.

So remember, no one is able to predict what will happen in the markets, no matter how smart they seem. Protect your investments by buying into the market at regular intervals and dollar-cost averaging your investments.

Where to Invest

Deciding where to invest is simple if you know the general order of accounts to save into.

First, invest in yourself by filling your emergency fund and creating a buffer in your checking account.

If you’re offered a match on your savings into a retirement plan through your employer, such as in your 401(k) or 403(b), this is the first place you should be investing. Take the free money to boost the savings going towards your retirement.

Once you’re saving enough into your retirement plan through your employer to get the full match, you can start exploring other avenues for investing such as IRAs, Brokerage accounts, Health Savings Accounts, 529 plans, and alternative investments such as real estate.

If you are in a position where you are struggling to decide where to save and invest congratulations! Having the luxury of this problem is one that many Americans dream they could have, this means you have budgeted well and have excess cash flow.

Even though money can often be a source of stress, in particular when debt is involved, it can be a source of fun, too. Money is fun to earn (usually, right?), fun to spend (definitely), and fun to watch as it grows. Money equals empowerment, as well as control and direction over your life, your goals, and your dreams. It’s certainly okay to not have a lot of disposable income, because thanks to these apps, you only need a little bit of money to get started saving and investing.

Rather than be restrictive, saving and investing money is an act in creating opportunities. Investing what you save allows you to create options for yourself to meet goals, to have fun, or, better yet, both.

To be honest, you probably don’t need as much money as you think you do. As long as you have what you need to be comfortable, to have a good life, do a good job, and be a good person, you are way ahead of the game. As for what “good” means in these contexts, that really is up to you. Our job here at Financial Residency is to help you maximize money on both sides of the needs versus wants equation.

Where to put this extra cash can seem like a daunting task. Depending on your goals and your unique situation, deciding where to save might not be as difficult as you assume.

Starting with retirement, there are normally four main options on where to save; Traditional 403(b) or 401(k), Roth 403(b) or 401(k), Traditional IRA, or a Roth IRA. Each account type has its own limitation on how much you can save in it.

Types of Retirement Savings Accounts

Saving for retirement is important. The only way to effectively save for retirement is to do so slowly, a bit at a time, over a long period of time. There is no instant gratification here.

The upside to saving for retirement is that in reviewing your accounts every month, or every quarter, or every year, you will build a sense of security and peace of mind that you will have what you need when you need it.

It’s hard to put a price on that.

The truth is, saving for retirement – or for anything – is hard. Life is expensive. No matter how well any of us does financially, it’s easy to get caught up in thinking about what we don’t or can’t have.

But inflation and time will keep on moving forward whether we do or not, so it is in the best interest of each of us to develop a solid plan for saving for retirement.

Luckily, there are many ways to do this.

The government helps, by allowing for certain types of retirement accounts that allow you to save money on a tax-deferred basis. Taking advantage of these products can help you develop good saving habits as well as maximize your dollars to save as much as possible for retirement.

Employer-Sponsored Retirement Accounts – 401(k) and 403(b)

You’ve probably heard of one of these plans, called a 401(k). There is also a type of plan called a 403(b). The funky names are based on the section of the United States tax code to which they refer. The tax code is notoriously long, detailed, and intense. In this post, our goal is to break down the basics of the 403(b) plan so you feel confident investing in it should it be offered by your employer.

Most people start with their employer-sponsored retirement accounts because of the convenience and higher contribution limits. If you’re at a non-profit, this will be your 403(b). At a private practice, this is a 401(k). They are essentially the same, with a few minor differences in what you can buy inside of each.

One of the best benefits of participating in a 403(b) is that you can take advantage of your employer matching some or all of your contributions.

If they do, take them up on it, always. To not take the match is to leave money on the table. It’s like saying you don’t actually want part of your compensation.

We know that it’s tempting to not take the match, because to get it, you have to let part of your salary disappear from your paycheck before you even get your paycheck. When money is tight, and debt looms large, this can feel impossible. Do it anyway.

Traditional 401(k) and Traditional 403(b)

Your traditional 401(k) or traditional 403(b) is the pre-tax retirement savings account offered through your employer. This account allows you to save before taxes are taken out, lowering your taxable income for that year.

Say you get paid every 2 weeks. With a salaried position, you can set up certain benefits to be deducted from your salary before Uncle Sam takes his cut.

Think of it this way: If I hand you $100 in cash, and then at tax time in April, you have to pay 20 percent of that $100, which is $20. You keep $80.

But, if I pay you that $100 as salary, you get a paycheck. You can authorize me, as your employer, to move $10 a paycheck, for example, into a retirement account such as a 403(b).

That leaves $90 left to be taxed by Uncle Sam.

20 percent of $90 is $18. So, you pay $18 in taxes, instead of $20. You pay fewer taxes and keep more of your own hard-earned money.

Now, think about how much bigger your paycheck is than $100 and realize that these percentages add up.

You’ll pay the taxes much later, when you withdraw the money from the account, once you’re retired. Because you’ll be retired, your annual income will be drastically reduced, so you’ll be taxed at a lower rate than you would be today, once again saving money.

Each year the contribution limits change, for 2020 you can contribute up to $19,500 in your employer-sponsored retirement savings accounts between your traditional and Roth, not including anything your employer saves.

If you’re offered a match through your employer, they will automatically place it into the traditional, or pre-tax, account. This is because the employer wants the tax benefits now, not when you retire. Even if your contribution is 100% sent to the Roth account, the match will be added to the traditional account.

Roth 401(k) and Roth 403(b)

The Roth 401(k) and Roth 403(b) are just like the traditional employer-sponsored retirement account, except it has different taxation rules.

Savings in a Roth are added after you’ve paid taxes, or after-tax. However, once money gets into a Roth you don’t have to pay taxes on it again and it grows tax-free.

The same contribution limit applies for a Roth as it does for a traditional account, however, there is not currently a limit on how much you can convert into a Roth through a Roth conversion.

After-Tax 401(k) and After-Tax 403(b)

This type of employer-sponsored account is rare. This account acts like a Roth, but also like a brokerage account.

You save after-tax money into it, however, unlike the Roth the growth from investing is taxable.

Unlike a brokerage account, where you pay taxes on the growth each year, an After-Tax 401(k) or 403(b) is tax-deferred, meaning you only pay taxes on it when you go to withdraw it.

Reading Investment Menus in Your 403(b) Plan

The savings in your 403(b) can be invested in mutual funds. You typically choose these funds by reviewing the investment menu which lays out the options for your particular 403(b) plan.

The 403(b) isn’t a scam, and it’s important to understand how this retirement savings vehicle has changed over time.

Prior to 2007, the majority of 403(b) plans were invested in annuities, however, there was never a restriction limiting them to do so. Some 403(b)’s today can be designated as “retirement income accounts” and can invest in annuities as well as mutual funds.

The use of target-date funds, investment funds that change your asset allocation based on your target retirement year, has grown from 1% of 403(b) funds in 2005, to over 33% as of 2017 according to this Aon Hewitt study.

Before diving into your investment menu, ensure that you have reviewed your personal Investment Policy Statement and mapped out your ideal asset allocation.

Once your asset allocation is set, you can begin mapping this allocation to the asset classes available in your 403(b). For example, if your asset allocation mix required 15% in Large Cap Equities, you would allocate 15% of your 403(b) contributions to a fund that matches this asset class.

This can require some research to do properly, however, the time invested in researching your options can pay off in the long run.

If your 403(b) investment menu offers a mutual fund with the symbol ABCD, you could type this fund into Google Finance, Yahoo! Finance, Morningstar, or other investment research websites to see the history and breakdown of this fund.

Solo 401(k)’s

If you’re self-employed, you probably don’t have access to an employer-sponsored account such as a normal 401(k) or 403(b). Luckly, you’re not without options. A Solo 401(k) was created for self-employed individuals.

It’s often called a one-participant 401(k), because unlike normal 401(k)’s there’s only one person using this 401(k) – you.

If you have full-time employees, you can’t use a Solo 401(k). However, your spouse isn’t subject to this rule and can be covered by your Solo 401(k) if they earn money from this business as well.

To open a Solo 401(k), you’ll need an employer identification number, or EIN.

Each year you can save up to $57,000, plus an additional $6,500 if you’re 50 or older. This is broken out by employee and employer contributions – even though you are technically both.

As an employee, you can contribute up to $19,500, plus $6,500 if you’re 50 or older.

As an employer, you can contribute up to 25% of your net self-employment income up to $285,000 in compensation.

Net-self employment income = your net profit – (half of your self employment tax + the plan contributions you made)

Combined, the employee and employer contributions are subject to the overall contribution limit of $57,000, plus an additional $6,500 if you’re 50 or older.

If you’re an employee at a W2 job, and save into their 401(k) or 403(b) as well, the overall contribution limit stretches across all of your 401(k)’s.

Just like a normal 401(k), a Solo 401(k) can be a Traditional, pre-tax, or Roth, after-tax. The taxation rules are the same for a Traditional Solo 401(k) and a Roth Solo 401(k) as they are in a normal 401(k).

Individual Retirement Accounts – IRAs

The other type of account you can use to save for retirement, outside of your employer, is an Individual Retirement Account (IRA). Between a Traditional IRA and Roth IRA, you can save up to $6,000 each year.

Traditional IRA

Traditional IRA’s are pre-tax retirement savings accounts. The money you save into is not subject to income taxes, however, when withdrawn you’ll pay taxes on the amount you saved and on the growth.

Traditional IRA’s are a great tool for those looking to save pre-tax money for retirement outside of their employer-sponsored account.

Roth IRA

Roth IRAs are popular retirement savings accounts because of their tax-free growth benefits. Money saved into a Roth is after-tax, however, once in the Roth it grows tax-free.

Roth IRAs are not subject to required minimum distributions once you are 72, meaning you’re able to control when and how much to withdraw from this account once in retirement.

Because of the level of control you have and the option to withdraw money tax-free in retirement, a well funded Roth IRA is favorable in retirement. However, having a mix of various types of accounts with different taxation creates opportunities for withdrawal strategies in retirement.

Once you’re contributing enough to your retirement accounts, you might wonder where else you can save to invest your money.

Types of Investing Accounts

Outside of saving for retirement, many investors look for additional ways to invest their money. Brokerage accounts are the primary method to accomplish this goal.

Health Savings Accounts

A Health Savings Account, or HSA, is a saving account where you can use pre-tax funds for qualified medical expenses.

Individuals can contribute to a Health Savings Account if you have a high-deductible health insurance plan (HDHP). High-deductible health insurance plans include any plans with deductibles over $1,400 for individuals and $2,800 for family plans.

To open a Health Savings Account, check to see if your employer offers one. If not, or if it has high fees, you can open one yourself through companies like Lively.

Each year you can contribute up to $3,550 as an individual or $7,100 as a family. If you’re over 55 you can contribute an extra $1,000.

Unlike an FSA, money saved in a Health Savings Account doesn’t go away at the end of each year.

The funds in your HSA can be used for a variety of medical and health-related expenses including paying towards your deductible, dental, and vision care, as well as uncovered medications.

If you use an HSA or withdrawal funds that are not qualified, you’ll typically need to pay taxes on the contributions as well as the growth on the investments – plus a 20% penalty unless you’re over age 65.

Education Savings

Saving for college is a monumental task. The savings aspect alone is enough to warrant questions, debates, and discussions with your family and financial advisor.

The questions are plentiful. How do you know how much to set aside? How much higher can the cost of college continue to climb? How do you know for sure your child will even attend college? These are all valid questions as you start to make real decisions for your child’s future.

And for physicians, the decision is just as difficult.

Sure, you will be making a great salary (if you aren’t already) and have a steady income. By the time your kids go off to college, you’ll presumably be well-established in your practice with a consistent, dependable salary to match.

But this doesn’t mean you want to “wing it” when it comes to saving for such a big milestone in your child’s life either. You’re wondering what you can do right now so you can be in the best position possible in 5, 10, or 15 years down the road.

How Much To Save for College Expenses

There are plenty of different calculators out there and tools out there to understand this question where you can go in and punch in numbers about how old your child is and what your aspirations are for what type of school they would go to and also how much of the college education you would like to aspire to fund.

Here are a few of the college savings calculators we like:

• CollegeBacker’s College Savings Calculator
• Savingforcollege.com’s College Savings Calculator
• Fidelity College Savings Calculator

Once you determine the amount you need to save to reach your goal, you’ll want to review your budget to see how much you can afford to save.

Some parents worry about over funding the account, luckily, there are some flexibilities built-in with a 529 plan already.

If your child gets a scholarship, you may be able to still withdraw the funds from the 529 plan. 529 plans are actually designed to be supportive of scholarships. If your child earns the scholarship, you can withdraw the amount of the scholarship without any penalties. You can go ahead and spend that money on another purpose.

Of course, there’s a lot more to college costs than just tuition. You can also use 529 funds on room and board, on books and even computers. Even if your child gets a full-tuition scholarship, you still might want to use that 529 money for something else.

But then the other question is, even with the scholarship rule, what if I just have extra money left over after my child has completed their four years of whatever school they went to? Am I stuck and what do I do with that? So first I would say, congratulations, you’re a great saver and so that’s a very good problem to have, but you still have options.

You can also use 529 funding on other forms of higher education. If your child is considering graduate school or something else, you can use that money for other forms of higher education.

You can also change the beneficiary on 529 plans. If you have a second child who is going to school, then you can transfer the 529 funds into the second child’s name. If you want to go back to graduate school or get some other education, you could even transfer it back to yourself and use that money on some form of higher education.

It is true that if you don’t use the money for anything that is higher education-related, then you will have to pay taxes on the gains and a 10% penalty on those non-qualified withdrawals. But remember, that like a Roth IRA, you can actually always withdraw the principal of that account without any taxes or penalties. So there is quite a bit of flexibility built into the 529.

Types of Accounts for College Savings

There are several ways to save for college, you can even technically use a general savings account. Here are the various places you can invest for college in a tax-advantaged way.

529 Plans

529 plans are a tax-advantaged investment account for college, you can think of it as a Roth IRA. You put in post-tax money and then the growth is completely tax-free and the withdrawals are tax-free as long as you’re using them for higher education.

State-by-State Options

California has its own 529 plan, New York has its own, Illinois has its own, every state has its own 529 option. There are a ton of different options out there, however, even though each state has its own 529 plan, you don’t necessarily have to choose your own state’s plan.

This means that you have a lot of different options, of course, some states do want you to use their in-state plan and so they may offer an incentive for you to be saving for college and that incentive usually comes in the form of a tax deduction.

So for example, if you are an Illinois resident and I use the Illinois 529, then I can take an income tax deduction on my state income tax for any contributions made to that plan. But it varies state by state, so this can get pretty confusing. Our recommendation is to first, check out whether your state has an income tax deduction. If they don’t, then it means that you can choose any plan and you should basically just go out there and figure out what the best plan for you is.

If they do have a state income tax deduction, then ask whether that income tax deduction is only for your state plan or for any state plan. So for example, if you’re a resident of Pennsylvania, there is a state income tax deduction, but you can take that deduction on contributions to any state plan. So if you live in Pennsylvania, you could be using the California,Texas, or Utah 529 and still take that income tax deduction.

Private Options

CollegeBacker is the most popular private 529 plan on the market today. The best feature of CollegeBacker is how easy they make it to invite others to gift to the account. When it’s time for gifts, I have told my family to make a small contribution to the account instead of getting them toys that they will break or stop using within a few months.

College Backer was kind enough to give all listeners a $25 match into the account. I encourage you to sign up for an account today.

The crazy part CollegeBacker is that they really do want to stick to their mission of helping all families save for college. The way that they set up their fees and structures is represented in that. It’s a donation-based payment system, so you pay what it’s worth. That’s right. You literally could pay them nothing, or if inclined you can give anywhere between $0 and $10 a month.

Expense Ratios of 529 Plans

In the world of 529 plans, there is a wide range of expense ratios. The best-in-class out there typically are charging around 0.2% on the assets, whereas some of the more expensive plans can easily be over 1%. The typical advisor-sold plan is around 1.3%.

Having a high expense ratio could have significant impacts on the amount that is in the account when it’s time to pay for college. A 1% difference in fees might not seem like much, but 1% on $30,000 is $300. That’s enough to pay for a textbook, just one textbook though.

Here are some other benefits of a 529 plan:

• • Federal Tax Breaks – Your money grows tax-free and you are not taxed when it’s taken out if used for college
  • State Tax Benefits – Over 30 states offer residents a tax deduction for contributing
  • You Have Control – The funds are yours for the entire life of the account. (The beneficiary has no legal right to the money in the 529 plan.)

• Low Maintenance & Quick and Easy to Set Up

• • High Contribution Limits – Assuming you’re married, your family can contribute up to $28,000 per year per child without any tax consequence.
  • Automatic Investment Options
  • Professional Money Management – If you have a financial advisor.
  • Simple Tax Reporting – There is nothing to report on your taxes until you make a withdrawal.

• You Can Change Your Investment Options Twice a Year

• Everyone is Eligible – There are no restrictions with regard to income, employment, or age.

Coverdell Accounts

Formally called the Education IRA, the Coverdell Education Savings Accounts is another way to save for college. Just like a 529 plan, Coverdell accounts offer tax-free investment growth and tax-free withdrawals for qualified education expenses.

Coverdells can be used for K-12 education including books, supplies, equipment, academic tutoring, and special needs services.

If you are primarily saving for college and not for K-12 private school, then a Coverdell might be too limited for you. A 529 plan, in contrast, is going to have a lot more flexibility and it’s going to not have those income limits and contribution limits.

UGMA (Uniform Gift to Minor Act)

The Uniform Gifts to Minors Act essentially is a trust account or a custodial account that you can set up for your child that is not necessarily focused on education. You’re basically just putting together a group of assets that you’re gifting to your child.

There are some significant drawbacks to this though, because that gift is going to automatically be transferred to your child’s control upon age 18 or 21, and that means that the child is going to have full control of those assets. They might spend it on education or they might spend it on something else.

It’s also going to have some negative financial aid consequences, compared to other accounts used for college. For financial aid purposes, assets in a UGMA are going to be considered student assets and that’s going to have a really significant impact on financial aid.

Using a Roth IRA for College Expenses

While you can use a Roth IRA for college expenses, it’s one of the least tax-efficient ways to accomplish this goal. Whatever you contribute to a Roth IRA can be withdrawn tax-free, because you already paid taxes on it, the earnings are taxable and could incur an additional 10% fee for early withdrawals.

Not only is a Roth IRA not tax-efficient when used for saving for college, but you’re limited on how much you can save in it each year by the annual contribution limits and income thresholds. You can, however, convert a pre-tax or traditional retirement account into a Roth IRA through a Roth conversion to save more into a Roth over the annual limitations. By doing this however, you could pay heavy taxes on the growth in your account and be further limited by the 5-year rule. The 5-year rule stipulates that you must wait 5 years to withdraw the earnings that were converted from a traditional account to the Roth. There are situations where the 5-year would not apply, such as if you are older than 59 ½.

Using Life Insurance for College Expenses

As a financial advisor, I’m asked a great deal about the right way to save for college. A common question is whether to tap into a whole life insurance policy or set aside funds for a 529 college savings plan.

We want to consider the pros and cons of using whole life insurance versus a 529 college savings plan for future education. Let’s see how these two options compare to one another.

If you have already chosen a whole life insurance plan, then you need to know your options available with your policy. Tapping into a whole life insurance policy could be a consideration if the policy has been in place for several years.

But be warned. If you choose to use the cash value of your policy to help fund a college education, you need to make sure you understand the fees associated with withdrawal. There could also be a potential tax penalty if you withdraw from your policy prior to age 59 ½.

Borrow Against the Death Benefit

There is a way you can borrow against your death benefit with your whole life insurance policy, in order to fund college. Your whole life policy may have built up a cash benefit, depending on how many years you’ve had the policy.

By using the money against the death benefit, you can either choose to pay it back or your agent can simply deduct what you need to withdraw from the payout upon death.

Policy Is Not Factored in Earnings

If your child is applying for financial aid, whether it’s in the form of a scholarship or student loans, then a whole life policy will not be used to calculate parental assets. This is where the 529 differs because a 529 will be taken into consideration with the applications.

Will Not Incur the Penalty If Child Doesn’t Attend a Post-Secondary School

As mentioned earlier, with a 529 plan, you will be subject to a penalty if the funds end up not being used and you choose to withdraw them for non-educational purposes. Obviously, if your plan is to use your whole life policy and you end up not using it, then you don’t have to worry about incurring a penalty.

But giving advice on how you can use whole life insurance to help finance education shouldn’t be perceived as an endorsement for obtaining whole life insurance. As a fee-only financial advisor, we always advise our clients to consider a term-life policy instead of whole life insurance. However, it’s likely some of you already have a whole life policy in place and you are wondering what your options are for post-secondary education.

Time is on your side when it comes to saving for college, so it’s important to get started as soon as you can. Even a $25 a month contribution can turn into $10,000 by the time an infant reaches college age.

Where to save for college will depend on your goals and your unique situation, however, there are rarely times where a 529 plan isn’t the best option.

Brokerage Accounts

Brokerage accounts do not have favorable taxation rules like retirement savings accounts, however, they are still a good place to invest extra cash.

Growth on your investments isn’t tax-deferred in a brokerage account, so you’ll pay capital gains taxes each year if you sell your investments.

Brokerage accounts are opened at custodians, such as Vanguard, Charles Schwab, and apps like Acorns or Robinhood.

Most have low or no fees, especially if you have account balances over a certain limit.

Apps & Firms

All of the apps mentioned below are easy to use. They each offer an affordable way to get involved in saving and learning about investing. They each provide options for moving around smaller amounts of money so you get experience investing without needing a lot of money to get started.

With any app, the basic principles of investing hold true:

• Start early
• Diversify your holdings, and
• Be in it for the long haul.

Anyone can get started investing with these apps, given how little money it takes to open an account. Diversification is your friend, and because these apps only require the little bits of money you can probably spare pretty easily (the equivalent of the spare change in the couch cushions), you’ll be able to use your online account as a great complement to your more strategic investing portfolio.

The bottom line is that no one teaches you how to invest when you’re in school. No one teaches the principle of save early, save often and how impactful it can be when you follow this simple strategy. So, we at Financial Residency are here to share that saving early and often really is possible, even if you don’t have a lot of money to invest. These apps can help you find ways to learn and have fun with saving and investing without risking losing large amounts of money.

Acorns

Acorns is among the best-known apps for saving and investing. Their tag line sums up the focus of this app: Investing. Earning. Growing.

Ideally, with this app, you will be able to grow your saving and investing knowledge over time with little bits of money, much like how a small acorn takes time to slowly turn into a mighty tree. Grow your money steadily over time and you’re winning. There are no get rich quick schemes here. This app – just like with investing – is all about starting small and using time to your advantage.

The big picture philosophy of how this app works is that it uses small amounts of money to add up slowly over time. This is a great strategy for saving money because those small amounts really do add up, and because the pieces are small, you don’t miss them. You do reap the benefits when they make up the bigger whole, however.

To use Acorns, simply download the free app, and link your bank account or credit card. You then authorize the app to round up your daily purchases and use those bits of change to buy shares in investment funds of your choice.

Think about the money that’s rounded up like your pocket change. For example, say you buy $34.96 worth of gas. The extra four cents that would make this purchase an even $35 goes to your investment account.

That doesn’t sound like much, does it? That’s the genius of this strategy. You are saving amounts of money so small that you won’t even miss them, yet those bits and pieces add up so quickly that the compounding effect really does make a difference, especially over time. This is how you find the money you never knew you had. This is how you take that small seed of pocket change and help it grow over time into a sturdy, full-grown oak.

Acorns is a great option for anyone new to investing who doesn’t have a lot of money to invest or doesn’t think they have a lot of money to invest.

The upside is that you pay a much lower fee to use this app than you would pay a fee-only or Asset under Management financial advisor. The downside is that, while they do have customer service representatives to help you, that is not the same as having your own financial advisor who knows your entire portfolio and can guide you toward your long-term goals. This makes Acorns a cost-effective way for someone new to investing to get their feet wet with the stock market with relatively low risk and without much start-up capital.

Stash

Stash is similar to Acorns in that both are apps designed to help those new to investing get their feet wet in the stock market, so to speak, but with Stash, you get more choice in where and how you invest your money with a wider selection of funds. Stash only requires $5 to start an account and charges $1 a month as a fee. Like with Acorns, little bits of money add up quickly, and also like Acorns, you have the opportunity to learn about investing with relatively little risk. Rather than rounding up your change, with Stash, you decide how much to invest at any given time, and those amounts can be very small. This allows you maximum flexibility with minimal risk.

While you won’t have the personal advice of a fee-only financial advisor, the app does provide guidance towards funds that work well as foundational funds versus greater risk. You will also have the opportunity to buy shares of stock in addition to funds.

Stash is great for visual learners, offering a synopsis of your portfolio in chart form, as well as other visuals, like the ticker symbols and bar graphs showing the level of risk for each fund or stock. There are enough funds and stocks available for you to make some choices, but the app provides information to help you make informed choices without being overwhelmed. Funds are named thematically so you can choose where and how to invest based on your own personal interests.

TD Ameritrade

Perhaps you are not comfortable sharing too much personal information with apps you maybe haven’t heard of before and don’t particularly want to link your bank account or invest in a company that is not familiar. No worries, there is also an app by a reputable financial services company that you have most likely heard of: TD Ameritrade. Their app is designed to complement their financial advising and investing services.

With TD Ameritrade you can go big if you want and invest larger amounts of money, or you can dip your toe into the investing waters with individual trades. This app requires a bit more know-how and comfort with investing in the stock market than Acorns or Stash, and so isn’t as great for true beginners, but could be a terrific next step if you have some basic investment experience, or if you are comfortable with a higher level of risk and would prefer to jump right in.

They charge a per-trade fee of $6.95. You can make trades with as little money as you want, but to invest in funds, you will need at least $2000 in your account. This gives you a goal to work toward, if you are so inclined, and does require some tolerance for risk to get to that point (or, a $2,000 chunk of cash you’re comfortable investing. Note: Do not invest that much money as a beginner unless you are comfortable with the fact that you could lose every penny of it).

Robinhood

The Robinhood app was designed to allow users to buy and trade stocks for free. If you have been reading this blog for a while, you know that we generally advocate for professionals being paid a fair wage for services rendered, so if something seems too good to be true, it’s important to ask yourself why. Robinhood is reputable, but it is important to note how they use your money and how much of it they keep. Robinhood is paid is by investing the interest earned in investor (your) accounts.

Let’s say you invest $100. Every month, that $100 or more earns a tiny bit of interest. In a traditional savings account, you would keep that interest and essentially re-invest it, because the following month, your interest would be calculated on the new capital. With Robinhood, they keep that bit of interest as their fee. If you are comfortable with Robinhood using your money in this fashion, it can make saving pretty seamless for you.

As long as you know what you’re giving up and are making an informed decision, this may not be a bad thing. If your money is in a traditional savings account, it’s earning a little bit of interest but not growing very much. It’s safe there. It’s comfortable. You might be comfortable, too. Except no one ever got rich by being comfortable, at least not in the world of personal finance and investing.

There is some criticism of the app because it makes investing in the stock market, otherwise known as day trading, very easy to do, which is great. However, that can be a risky thing for people who are new to investing and don’t fully understand the risks.

Stockpile

Go to Stockpile.com and you are presented with a simple proposal: “Start investing with just $5.” Sounds easy, doesn’t it? Sign up for free. No monthly fees. And really, investing in the stock market is and should be easy. Stockpile works buying stock and selling you a small piece of it (known as fractional shares). You can buy physical gift cards for stock in well-known companies such as Facebook, Tesla, Amazon, and Disney.

Stockpile was designed by CEO Avi Lee, who was concerned less than a third of people aged 18-29 own stocks, largely because they don’t have the capital to invest but also because they weren’t sure how to get started. He wanted to make investing fun and easy and a little bit tangible, so that investing wasn’t some fancy thing you hired a professional to do, but so you could roll up your sleeves and get involved in your own investing.

The idea was to make investing in the stock market accessible for everyone and teach Americans the “fundamental rules of the stock market.” When you’re ready, you can up your game by making trades for $0.99 a trade.

Etrade Mobile

Etrade Mobile is not the cheapest option in an app, but is user-friendly and will help you learn more about investing, should more education be your goal.

Like TD Ameritrade, you’ll pay $6.95 per trade (or cheaper if you meet a certain threshold of the number of trades per quarter). You’ll know exactly what you’re paying for and there are no hidden fees. The app is designed also to help you learn how to research stocks, review available data, and make informed decisions. With close to 9,000 available funds from which to choose from, you have a tremendous opportunity to learn.

The app provides an overview of each stock of the fund, which is full of information yet admittedly can be overwhelming for the beginning investor. This app is great if you’re really looking to learn about investing, but can slow you down if you simply want a reasonably safe way to get involved in investing and start learning with minimal risk.

Investing Lump-Sums of Cash

If you received a large bonus, a modest inheritance, or a large sum of money from some other source – you may be asking yourself what to do with it. Most people will tell you to invest it, but give little guidance as to where or how.

For this example, let’s assume you received $25,000.

Your first step in deciding how to invest $25,000 is to determine how much time you are willing to spend to get returns on your investment. Are you looking for a quick return or is more of a long-term impact acceptable to you?

Your next step is to consider what type of returns you are looking for. Do you want to grow the money so you have more money? Or would you prefer to use the money to pay down debt? What about a less tangible return on your investment, such as if you invest in yourself and further your education or enjoy some life experiences?

Then, consider your tolerance for risk. Any investment comes with a bit of risk, but there are ways to invest money while playing it safe, as well. An informed investor is a happy investor.

As you begin to consider which investment options might be right for you, start by going over your budget. If you don’t yet have a budget, now is a great time to get one going.

Whatever you decide to do with your windfall, remember to seek options that keep fees low. It never hurts to touch base with a financial adviser, especially if you are considering investing the money in a way that is new to you, such as with a REIT or a mutual fund.

Regardless of how you choose to invest your money, remember that there is no such thing as a sure thing. There is only risk and your tolerance to it. Even putting money into a savings account has risk, albeit a small amount. To truly invest the money and help it grow, you will need to consider letting go of it in some way.

As you figure that out, we recommend keeping your investments quiet. Telling others about your investment decisions opens a door into conversations about your financial situation that you may not wish to have. Large sums of money also attract attention, and not in the way you might wish.

While there are a lot of options listed here, the best part is that you get to decide what to do with your money. This is a wonderful problem to have. If you do happen to have a five-digit chunk of change ready to be invested, don’t decide overnight as to what you’ll do with it. Keep the money somewhere safe, like a traditional savings account, until you decide what’s next.

Invest in yourself

We’ll start with the obvious: pay down your student loan debt. With medical students owing an average of $173,000, an extra $25,000 might seem like a drop in the bucket. Taking a $25,000 bite out of your overall student loans can help you significantly over time, primarily by reducing your interest that compounds over time. Make sure to check with your financial adviser and accountant before simply throwing a chunk of change at your loans. The last thing you want to do is take action that results in the bulk of that money going towards interest or taxes.

Hire a personal coach, or create a plan to incorporate coaching with complementary medicine such as acupuncture or a fitness plan with a trainer. As a physician, you know better than most that health and wellness are about more than medicine.

Take a sabbatical. It’s not often in life that we have the opportunity to take a break from, well, life. Perhaps you are at a point in your career where you can take a break, let your partner run the practice, and write the book you’ve been dreaming about writing.

Of course, one of the best things you can do with a windfall is to pay down credit cards. The high-interest rate and ease of use make credit cards alternately a curse and a convenience. More than half of Americans carry credit card debt that they can’t afford to pay off, with the national average around $6300.

Fund a health savings account. As a physician, you know all too well how quickly medical bills can add up. If you know you’ll have a lot of upcoming medical bills, funding a health savings account could offer you some relief from the stress of paying expensive medical bills.

Invest in education. Medical school takes a lot of time and money, to be sure. You may finish medical school and never want to see the inside of a classroom again. But depending on your interests and your specialty, a Master’s of Public Health (MPH) degree or a Master of Business Administration (MBA) degree could help you considerably in your medical practice. There are countless certifications as well that may be better suited to your specialty and career interests.

If a full degree program is not your preference, look into other professional development opportunities. Project management, personal coaching, or a certificate in your specialty are good options to advance your career long term.

Travel. Fund that dream vacation. Take a trip around the world. Bring your family on that cruise you always promised them.

Simply save it. Take that chunk of change and put it in a good, old-fashioned savings account. Keep it there, safe and comfortable, for your life happens fund. Because life will happen, and now you’ll be ready.

Invest in the Financial Space

We have one word for the single most important part of your financial plan, after paying down debt: retirement. It’s pretty hard to go wrong when you save extra money towards retirement.

This option is not sexy, and it doesn’t give you anything in the short term (other than perhaps an extra bit of peace of mind that you’ll have what you need to be cared for in your old age), but the long-term benefits of this option can be significant.

Consider funding a taxable brokerage account. The same financial adviser who handles your retirement accounts can help you open a taxable account. This is similar to a savings account, only your money is invested in the stock market instead of being loaned to a bank. There is risk associated with this option, but a potentially high rate of return, as well. A nice upside to this option is that, unlike your retirement accounts, this money remains liquid so you can access it at any time.

You can also invest in the stock market directly. Using trading apps like Etrade, you can buy and sell shares of stock as you like. This is a very high risk, particularly if you have little to no experience with the stock market. This option will also require a higher than average level of attention, because, unlike a taxable brokerage account, where a financial adviser or brokerage house is watching the account for you, the stock market fluctuates daily and you are solely responsible for making decisions to buy or to sell.

Buy a franchise. It’s more affordable than you think to buy a franchise. While some franchises are quite expensive to get started (think McDonald’s), others can be purchased for less than $10,000. Don’t get too excited, though – the money you save on the purchase price will be needed for various fees that come along with opening your own store. While you’ll need to spend that $25,000 carefully, this amount of money can definitely serve as the capital you need to start your own franchise.

Become a lender. Microloans are small loans, typically well under $25,000 so you can spread that money around. You invest what is, to you, a small amount of money to help someone else get their business off the ground. Enjoy the rewards of a higher interest rate than you’ll get from any savings account. As an added bonus, microloans are often helpful in particular for women or minorities who have a harder time qualifying for loans due to all sorts of economic and discriminatory factors.

If saving money is your jam, consider investing in certificates of deposit, known as CDs. Interest rates tend to be higher than traditional savings accounts and the risk is low. You can stagger them so that every six months or so, one matures, so your money can be semi-liquid while it grows.

Have kids? Fund that 529 plan. Enough said.

Invest in a mutual fund. If your tolerance for risk hovers somewhere between the low returns of a savings account of CD and the high return but equally high risk of the stock market, then a mutual fund is for you.

A somewhat unconventional though intriguing option is a 401(k) swap. Ramp up your 401(k) contributions directly from your paycheck, and then use the cash from the $25,000 to offset the reduction of money in your paycheck. Once you have depleted the $25,000, go back to your original amount of 401(k) contributions. This is a way to keep your cost of living stable while increasing contributions to your already established retirement account.

Peer to peer lending is another form of micro-lending. Instead of providing small loans to people, you don’t know, with peer to peer lending, you provide small loans directly to someone you do know. The risk here is more to your personal relationship than to your finances, but if you and the borrower go into the deal with eyes wide open, this can be a viable option to strategically grow your money.

Invest in real estate

Perhaps one of the most tried and true ways to grow your money is to invest in real estate. The average rate of return on real estate is 8.6%. Compare that to your savings account, and the value of real estate is clear. Buy a property to use as a rental to generate passive income and if you play the numbers right, you can break even in a matter of a few years.

If you already own a home, use that money to make improvements to increase your home’s value. Need a new roof? How about replacing those windows? Check-in with a realtor to learn how to strategically invest your money in your home so you don’t over-improve.

Invest in a REIT. A real estate investment trust, or REIT, is basically a mutual fund where you invest in real estate instead of the stock market. You buy small shares of large investments, along with lots of other people, and enjoy minimal risk with all of the gains.

Pay down your mortgage. There are different schools of thought on this. There are financial reasons why it could make sense not to funnel a lot of cash into something as illiquid as a mortgage. If the real estate market takes a downturn, you could lose that money without seeing any gains. But generally speaking, paying down debt is typically a gamble worth taking. If a $25,000 bite out of your mortgage helps you refinance for a lower monthly payment, or simply helps you breathe easier, this option could be a good one for you.

Wild card options

Try a combination. $25,000 seems like a small amount when it comes to big changes. You can take a bite out of your student loans or mortgage, but can’t pay them off. On the other hand, when you break down your wants and needs into manageable parts, you can do a lot with that money. Book a vacation and bank the rest. Fund a microloan for someone else and an MBA for you. Hire a personal trainer and invest in a mutual fund. Once you identify your goals, the possibilities to maximize your money are endless.

Give to charity. You were making things work before you had the $25,000, so you won’t miss what you didn’t have. In the meantime, that money could make a huge impact to one or more charities. Consider the causes that mean the most to you and reach out to find out just how far a gift like that can go. Consider dividing into smaller parts and make donations to more than one charity. The investment you achieve is not in dollars that go back in your pocket but is huge in terms of the good you are able to put into the world. There are also tax breaks in it for you, so be sure to consult your tax adviser.

The Best Way to Invest Money

There are plenty of options to choose from when deciding where to invest. Whether you’re investing a one-time lump sum of cash or stashing money away on a regular basis – where you save depends on your goals.

If your goal is to fund your retirement, consider if you want to save pre- or post-tax and if you want to use an account through your employer or an individual retirement account.

For those looking to save for education costs, 529 Plans typically are the best place to save – however, Coverdell accounts may be worth looking into as well.

Health savings accounts, or HSAs, are fantastic places to save pre-tax money to use for medical expenses if you qualify.

Brokerage accounts are typically the main place for stock-trading, but can also be used for long-term investing through mutual funds or ETFs.

Remember, no matter where you save – you won’t regret saving money.

How Much to Invest

There are two limits to how much you can invest:

1. What your cash flow allows, accounting for your other goals
2. The limits placed on how much you can save into each account type

If you have $100 extra cash flow each month, you can invest up to $100. This sounds simple, however, many people invest more than they can afford and in the end, they sell some of their investments to support their cash flow needs.

Each year, the contribution limits are updated that tell us the maximum amount we can save in our employer-sponsored retirement accounts and our IRA’s.

The 2022 contribution limits are:

These limits only apply to the amount you save and do not include employer contributions from your match.

Retirement Planning

Saving for retirement doesn’t have to be difficult or overly complex. Once you know how money works in retirement, you might be surprised to find you can actually live off less than you expect.

How Money Works In Retirement

Once in retirement, the “normal” structure of your budget is left behind. Now, your budget includes multiple sources of income and a pot of money that needs to last the rest of your life.

You’ll start considering where your income comes from, and how much you’ll need to pull from your savings in a tax-efficient way. Also, your expenses will start changing and could increase or decrease depending on your new lifestyle.

We’ll review the changes to your income and expenses during retirement, as well as how to figure out how much you need to retire without a high risk of running out of money.

Income in Retirement

Stable Income

Stable income can come in the form of a pension, Social Security, or annuities. This income is predictable and pretty much guaranteed.

For some, their stable income is enough, or more than enough to cover their living expenses. For others, their retirement savings supplement their stable income sources.

As a Financial Planner, I’ve seen several cases where retired doctors are able to not only be able to fully live off their stable income sources but also have multi-million dollar portfolios at their disposal. This combination creates a significantly lower chance of running out of money in retirement.

Required Minimum Distributions (RMDs)

Once you turn 72 (previously 70 ½), you’ll need to take out a portion of your retirement savings. You won’t have to spend it, but the government wants it out of the tax-advantaged retirement savings accounts. RMDs taken from a pre-tax account, such as your Traditional 401(k), Traditional 403(b), or Traditional IRA will be included in your taxable income for that year.

The only retirement savings account that does not have Required Minimum Distributions (RMDs) is a Roth IRA.

Portfolio Withdrawals

If your stable income and RMDs are not enough to cover your expenses for that year, you may need to take additional portfolio withdrawals to fill the gap. These can come from your retirement accounts, brokerage account, health savings accounts, as well as general savings accounts.

Physicians Working in Retirement

Just because you have retired, you don’t have to stop earning money. Many physicians use their skills to consult other physicians, practice owners, or hospitals while in retirement.

Not only does this inject more cash into your savings, or allow for more traveling, it also brings a form of structure back into your life.

If your retirement is already well funded, working in retirement can be optional and done on your terms.

Expenses

A common rule of thumb in planning for retirement is that you need 70% of your current income to live the same or similar lifestyle during retirement. While this will not be the same across all professions, the good news for doctors is that the actual number is probably much less.

Why would the level of income needed be below the common rule? Well for many doctors, your tax burden is likely to be far lower in retirement. The reason is due to several large factors that are discussed below.

First, you won’t be paying Social Security or Medicare tax. Your income will be derived from your retirement accounts and will, for the most part, not be derived from “work” as you will now be retired. If you decided to move to a state without a state income tax, your tax burden could be lowered as much as 12.3% (12.3% in California; highest in the nation).

Federal income tax is likely to be lower as you will be earning an income that is tax-deferred or exempt and scales up as you withdraw more. Money withdrawn from your Roth IRA has already been taxed and is exempt from being taxed on withdrawals. Withdraws from your 401(k) are taxed as ordinary income but are unique due to the fact that the tax rate scales higher as you increase your withdrawal amounts per year.

A more obvious detail that is often overlooked is that you don’t have to save for retirement when you are retired! If you have been saving 20% of your income, as recommended, that is 20% of your current income that you do not need to replace.

Another general assumption is that you have likely purchased a home during your career and that you have paid off your mortgage before retirement. Mortgages are usually 20% of your current income. Many retirees will not only have a home paid off but they will often sell their larger homes and downsize. Not only does this allow them to fund additional money into their nest egg, but will also decrease home maintenance and expenses. Most find that a large home is just too much home and unnecessary once the kids have left the house for good.

Many retirees will not only have a home paid off, but they will often sell their larger homes and downsize. Not only does this allow them to fund additional money into their nest egg, but it will also decrease home maintenance and expenses. Most find that a large home is just too much home and unnecessary once the kids have left the house for good.

Speaking of kids, do you have any? As much as we love them, kids are expensive. The good news is that most of the expenses relating to your children will be gone by the time you retire. You will have saved for college (or most of it) and wedding (if applicable) during your working career. Feeding, clothing, etc. for your kid should be minimal by the time you hit retirement.

Another smaller point to consider is that there will also be a decrease in job-related expenses (mileage, work clothes, training, etc.).

This all sounds great, except we all know that there will be increases in certain expenses at retirement. After all, you are retired and want to enjoy it right?! Traveling expenses are the most common expense increase, as well as medical costs.

While everyone’s situations are different, let’s give a quick example to illustrate the points illustrated in this post. Please keep in mind this does not take into consideration your spouse’s income, only yours. The example starts with the current salary and either reduces or increases expenses in order to determine how much income you will need yearly (in retirement) to live a similar lifestyle in retirement.

Example:

Current Salary: $200,000

Reduction: Elimination of taxes (State, Social Security, Medicare) – 15% – ($30,000)

Reduction: Retirement savings eliminated – 20% – ($40,000)

Reduction: Mortgage paid off – 20% – ($40,000)

Reduction: Home Maintenance and Expenses – 5% – ($10,000)

Reduction: Job Related Expenses – 2% -($4,000)

Reduction: Kids – 5% -($10,000)

Current Salary needed after all reductions: $66,000

Addition: Increase in Travel and Medical – 20% – $40,000

Current Salary after all changes* – $104,000 (52%)

Prior estimated income needed at retirement: $140,000 (70% of current income)

*Note – I have intentionally left out any Social Security benefit for the above example as it is unlikely that anyone under 40 today will see any funds from SS in its current form. If you want to factor in the potential benefit you could receive or if you are above 40, you should reduce your “current salary after all changes” by roughly $35,000. This would change this number down to $69,000 or 39.5% of your current salary.

After reviewing the above example, our doctor friend will only need $104,000 to live a very similar life during retirement as they enjoyed pre-retirement. This resulted in only needing to plan for 52% of their current income, not the general assumption of 70%.

Finding Your Magic Number for Retirement

Now we know that we should be planning to live off roughly 52% of our current income a year during retirement, but how much does one need to save in order to get there?

Great question. Let’s dive a little bit deeper.

First, we need to know how much can our doctor friend take out every year. There is a well-known rule in the financial community known as the 4 percent rule. This rule states that retirees who withdrew 4 percent of their initial retirement portfolio balance and then adjusted that dollar amount for inflation each year thereafter, would be able to create a “paycheck” that would last for 30 years under average market conditions.

If we need to generate $104,000 a year, in today’s dollars, and following the 4% rule, a nest egg of roughly $2.6 million is needed. With the assumption that you are starting right now with $0 in savings, it will take you roughly 24 years until you can retire. If we factor in Social Security, it would allow you to retire in roughly 20 years.

There are two more ideas I want to mention before we finish:

If you were to wait just one more year until you started saving for retirement, it would add almost two years to your overall plan. The power of compounding interest is mind-boggling when allowed to run its course of 25 or more years. The more you delay, the longer you will have to work or the larger the percentage you will need to save of your current salary to “catch up”. Remember, always pay yourself first, save for retirement, and then spend money on other items.

Secondly, think about your savings rate. If you were to save 30% of your salary as opposed to 20%, you would be able to retire in roughly 19 years. That is half a decade earlier than if you only saved 20%! Boost up that savings rate and enjoy “the golden years” way earlier than your peers.

Realities of Retirement

When you think about retirement, it might seem fairly abstract. Maybe you’ve been able to watch your parents or grandparents retire, and observe their actions. What you might notice is a sudden shift to a vacation mode for a few years, then a slow down period, and finally a period of time where all they want to do is rest.

We call these your “go-go” years, your “slow-go” years, and your “no-go” years.

During your “go-go” years, those first few years of retirement, youth is still on your side and you’re able to enjoy traveling, partying, and living life to the fullest. Spending on things like travel and entertainment is typically at its highest during this phase.

However, as we age, we typically enter into the second phase of retirement – the “slow-go” years. During this phase, people tend to slow down. Maybe you don’t travel as far as you once did, and certainly not as often. Your idea of a party might be having a friend over for dinner and TV – but get to bed by 8 PM. Spending on travel and entertainment might slowly decline, but medical expenses tend to start increasing.

Finally, the “no-go” years are during the final stage of life. During this time, most people want to rest for most of the day and might be in an assisted living facility if they need assistance. During this time, traveling and entertainment spending is likely close to $0. Many people’s only expenses during this time are healthcare and long term care costs, however, these costs can be significant.

During retirement, your income and expenses may vary from year to year, and certainly will during the various stages of retirement.

When to Seek an Advisor

Investing your hard-earned money can be complicated, but we hope that by breaking down the foundations for creating and implementing an investment strategy you’re able to craft your own guidelines and investment strategy.

At some point doing the analysis, research, and decision making for your investments may become overwhelming. Unless you are willing to take on the hobby of managing your own money, which can take as much time as a part-time job for one person, it may be time to outsource this task to a professional.

Not only will hiring a Financial Advisor free up the time and energy of managing your investments, but they can also offer a deeper level of understanding and expertise that DIY investors may not possess.

Once you’re ready to find a Financial Advisor, this article can help you navigate the interview and selection process.