When thirty-somethings are asked about the things they wished they had done in their twenties, many invariably state that they wished they had saved more, or at all. As it takes 3 - 10 years after medical school to become a full-fledged attending physician, residents often put off saving for retirement, reasoning that there will be enough money coming in as an attending to make up for the difference. However, this disregards the effect of compounding has on saving earlier; those 3 - 10 years of PGY training are years that your money has to significantly compound. For example, say you maxed out your 403b (we'll cover this later) at $18,000 for a 5 year residency. If that sat in an investment account with a ~6% return, you would have around $1,000,000 in about 30 years.
Medical school and residency together take at the minimum 7 years and medical training often extends 10+ years after undergraduate education. This equates to lost years of income and saving/compounding ability that those in other professions can take advantage of. To put real numbers to it, an engineer can start working straight out of college at 22 years of age. A doctor, if going straight through school and training, will have to wait until they are at least 29.
Most medical students and residents have science-related bachelor degrees and know very little about finance or personal money management. Many went straight through school, from kindergarten to medical school, with the odd TA or research assistant job and never had to significantly management money. Many have not had any formal education in money management or investing. As such, it is all the more imperative for the young physician to self study.
I didn't know much at all and spent the latter half of my fourth year of medical school reading and learning about saving and investing. I've tried to condense below the key points of what I've learned for those those who know very little about the topic.
Set aside an emergency fund
People recommend setting aside 3 to 6 months of expenses aside to be used if needed for emergencies. Other than your standard savings account, you can consider putting this in a high interest rate savings account such as with Ally bank or in a CD ladder if you feel particularly savvy.
Set up a Roth IRA
This is the single most important thing you can do as a resident to ensure, as much as you can, financial freedom in the future. IRA (Individual Retirement Account) is essentially a retirement account that you can set up, by yourself, to save money for retirement. There are 2 different types of IRAs, traditional IRAs and Roth IRAs. In traditional IRAs, you put in "pre-tax" dollars; in the Roth IRA, "post-tax" dollars. What does this mean to the unknowing resident? It means that in a traditional IRA, you will put money into the account and then get a tax deduction. However, when you withdrawal the money (when you're 59.5 years old), you'll get taxed on it as income in the tax-bracket that you are sitting in. For doctors, this is usually going to be a substantially higher tax bracket than the one you're in as a resident. As such, the Roth IRA is a better option for residents: you'll put in "post-tax" dollars, essentially money from your paycheck, and, when you're 59.5, you won't be taxed on it when you withdraw it. Because you're in a lower tax bracket as a resident, Uncle Sam takes less of your invested money.
The maximum contribution for a Roth IRA is $5,500 a year. You can invest this in one lump sum or every month, however you like. You're not just putting money into this account, however. This is an investment account — you can buy stocks/bonds/funds to put in here. To prevent this article from getting too long, I recommend purchasing low expense ratio index mutual funds. Let's break down what that means.
"Low expense ratios" refers to the amount of money that brokerages take from your account to run your account/manage your funds. These ratios range from as low as 0.03% to more than 1 or 2%. The higher the expense ratio, the more money you lose to managerial costs. You want this number to be low; shoot for expense ratios below .50%.
To understand "index funds," we should briefly talk about mutual funds. Say each different stock is a different pizza topping — Disney is a mushroom, Apple is a pepperoni, and Tesla is a mushroom. Take these toppings and put them together on a slice of pizza; to simply the topic for all intents and purposes, that pizza slice is a fund — it has a bunch of different stocks within it. Each "bite" of that pizza with all of its different toppings can be thought of as a share of that fund. A mutual fund owns a bunch of stocks from different companies within it. When you buy some shares of that fund, you indirectly own a bit of each stock that is within the fund, kind of like how a bite of pizza has a bit of each different topping in it. Hopefully that illustration helped.
Continuing that area, what does "diversifying your portfolio" mean? It means not having everything in one thing—not having all of your money in Apple stock or all in bonds. Index funds are, in and of themselves, diversified — they have a bunch of different stocks or bonds in them and by buying a share of that fund, you own a bit of each stock.
As such, "index funds" are mutual funds that have a composition of stocks within that match different market indexes — things that you may have heard about like the S&P 500. Index funds have very low expense ratios because there really isn't that much management that is needed to take care of an index fund; they just aim to match the market.
Because the market goes up, when looked over many years, about 7% a year, index funds should go up about 7% a year when averaged over long periods of time. This is contrasted to actively managed funds where fund managers cherry pick which individual stocks/bonds they want in their funds. This is riskier, because you're counting on one guy or a bunch of guys to dictate what is in the fund you are buying. Because they are "actively" managed, they also have higher expense ratios. A study done by the S&P Dow Jones Indices showed that, over 10 years, 82% of large-cap managers, 88% of mid-cap managers, and 88% of small-cap managers did worse than their index benchmarks on a relative basis. What does this mean? It means that the vast majority of actively managed funds do worse than their index counterpart. Lesson for young physicians? Stick with index funds and worry about actively learning medicine instead of figuring out which actively managed fund to pick.
So, putting it all together, which funds should a resident put into their Roth IRA? Everyone has their own approach to their "ideal" portfolio. Some people have multiple funds covering different individual sectors of industry. Some endorse a "three-fund portfolio" where you purchase a total market index fund (American stocks), a international total market index fund (international stocks), and a total market bond fund (American bonds) which further diversifies your portfolio by giving you bonds and international stocks. There are others whose whole portfolio consists of just one total market index fund.
It all depends on how "risk-adverse" or not you are. If you're very risk-adverse, as in you want to minimize losses as much as you can, you should consider buying a total market bond mutual fund as well in addition to a total market stock index. To put it simply, bonds fluctuate less with the rise and fall of the market as compared to stocks. To figure out what percentage of your portfolio should be bonds, a general rule of thumb is to subtract your age from 100. That number gives you the percentage to allocate towards bonds.
If you're young and not that risk-adverse, contributing 100% into a total market stock index fund such as Vanguard's VTSMX or Fidelity's FSTMX is reasonable. As time goes on, you can add bonds in there as well.
Which brokerage should you use? If you have $3,000, Vanguard is the way to go as their expense ratios are exceptionally low for their index funds. They have, as noted, a $3,000 minimum on purchasing index funds; if you can't do that, Fidelity is a great second option.
Set up an institutional 403b
A 403b is a 401k for non-profit organizations, such as most academic hospitals. The maximum contribution per year is $18,000. It's the same idea as IRAs — you take money and use it to buy stocks/bonds/funds. There are Roth 403bs and Traditional 403bs which follow the same idea as Roth and Traditional IRAs; the Roth 403b option, is not as prevalent as the traditional 403b and your institution may only have a Traditional 403b option.
403bs work by taking money out of each paycheck that you receive — you can't just dump money that you've had saved up in your savings account into a 403b; figure out what percentage of your income you are able to put aside. Also, fund choices are dictated by the institution you work at so they may be good or terrible. Look for total market index funds; if that fails, look at those with the lowest expense ratios. Again, anything below .50, and preferably under .20, is pretty good. Not all academic hospitals offer 403bs for residents so consider yourself fortunate if you have access to one.
Should you fund your Roth IRA first or your 403b? This is dependent on a number of factors but often requires a longer discussion. To put it briefly, if your institution matches contributions, put enough in to get that match—essentially free money first. If your institution has good quality mutual funds, better than that of your Roth IRA, consider investing in that account. However, because you can only contribute to a Roth IRA if you earn less than $116,000 (single) or $183,000 (married filing jointly), and as most physicians will be earning higher than that number as attendings, you should take full advantage of the Roth IRA option while it is on the table before contributing to a 403b (Traditional 403b here, for the sake of comparison and argument).
Live within your means
This is probably the most important point of this whole article, and something I'm sure you've heard repeatedly. Without living within your means, none of this really matters. As a resident, our paychecks are relatively small and our free time is relatively limited; it shouldn't be too hard, in that regard, to "live like a resident" and limit excessive spending.
For each month, figure out how much money you make and subtract from it your known expenses including your rent, monthly loan repayments, internet/television/telephone/water/electricity bills, average gas usage, food, and insurance payments. Determine how much you want to save and appropriate money for your Roth IRA, institutional 403b, or savings account; just as a ballpark, most experts recommend saving 15%+ of your income when possible. Compare your wanted purchases with the remainder of this final bit of the equation before splurging on that new television.
Understand the overall context
All of this is not to say to bury all of your money into savings and investment accounts and wait until retirement to truly "live." To put it mildly, medical school is rough and residency is challenging. Within the context of cognizant budgeting, take full advantage of your days off and use your spare change to make the most of your time with your friends and family and help facilitate real, memorable experiences for the betterment of yourself and others. Human rights activist Grace Lee Boggs has the following quote which I find ties well within the scope of finance and medicine:
“When you read Marx (or Jesus) this way, you come to see that real wealth is not material wealth and real poverty is not just the lack of food, shelter, and clothing. Real poverty is the belief that the purpose of life is acquiring wealth and owning things. Real wealth is not the possession of property but the recognition that our deepest need, as human beings, is to keep developing our natural and acquired powers to relate to other human beings.”
All the best to your medical training and financial future.
Peter Han, MD
Otolaryngology-Head & Neck Surgery Resident
Suggested Reading:
White Coat Investor - James Dahle, MD
A quick read that focuses on saving and investment principles for physicians.
The Bogleheads' Guide to Investing - Taylor Larimore
An easy to read, general overview of personal investing.
A Random Walk Down Wall Street - Burton Malkiel
Overviews the basics behind stocks, bonds, and funds.
The Intelligent Investor - Benjamin Graham
Warren Buffett's favorite book that overviews investing principles.