Thursday, August 1, 2013

Investing Your Money While in Medical School

So you’ve worked hard at your part-time job during undergrad – or maybe you’ve taken some time off to work at a “real job” – and now you have what seems like more money than you know what to do with. In reality, perhaps, it’s not much – but you’ve never had this kind of money before. So what to do with it? Invest it, you say? That’s an easy way to make a buck, right?

But how the heck do you do that?

Well, for starters, before you ever come close to purchasing your first mutual fund or opening up an IRA, stop. Stop and think about the big picture. You have successfully saved up a few grand. Perhaps you’ve worked really hard and have $15,000 or so and are feeling quite good about yourself. Or maybe you have even more.  That’s great. It really is an accomplishment, but that doesn’t mean it’s time to go find the best and brightest stock picks and start wheeling and dealing.

First, if you are about to start the medical school application process, you have a lot of costs ahead of you. Your AMCAS application, secondaries, a suit, airline tickets, taxis, food, hotels – all of these things cost money. Quite a chunk of change, actually. If you’ve made it through the process, awesome – but don’t forget you probably have to move to medical school. Moving is expensive. You’ll probably have to buy new furniture, put down a security deposit, and perhaps even your first month’s rent – all before your loan money arrives in your bank account. Once all that is taken care of, what if your car breaks down? What if you trip, fall, break your ankle, have terrible insurance, and get slammed with a huge medical bill? What if [insert unlikely but costly scenario here]? Obviously – hopefully – none of those things will happen. But it’s smart to be prepared. Which leads me to the first step you should take with your grand riches – allocate some of it to an emergency fund.

An emergency fund is for…umm…emergencies. You probably guessed that. But not the “Oh darn, I really need that cool new computer/car/video game/whatever” kind. More like the, “Oh darn, my car just gave up on life and now I need a new one” or “Oh darn, something bad happened and now I need to support myself from my savings for a few months.” It’s generally recommended that you have enough money in your emergency fund such that, if needed, you could support yourself for about 3-6 months. Once you build it up, you put it in your savings account (or higher-interest online savings account, such as Ally Bank, or perhaps put two-thirds of it in a CD ladder with reasonable early-withdrawal penalties) and leave it there until it’s needed. If Mr. Murphy strikes and finds you with your pants down (or at least without an adequate emergency fund), that could be financially catastrophic for you.

In addition to having a solid emergency fund that you can fall back on to cover unforeseen expenses, you should also have a handle on your budget. Live below your means. It’s often said that it’s best to live like a student now so you can live like a doctor later, instead of the opposite scenario. That doesn’t mean you will be eating Top Ramen for the majority of the next decade, but it does mean that you should be financially wise with your resources. Figure out your emergency fund, figure out how much you can spend each month to stretch your loan money for the year, factor in rent and utilities, figure out how to cut costs in certain areas if needed, and don’t spend more than your monthly allowance. It’s really not all that difficult to figure out. The hard part is sticking to it.

Ok, you say. I’ve done all that. I’ve got a great emergency fund, I’ve developed a picture-perfect budget spreadsheet in Excel, and I follow it to the letter. I’ve got money left over, and I still want to invest. Now what?

The first step is learning about the world of investing. I’ve posted before about some resources that you could read to learn a bit, but I’ve reposted some relevant links below for your convenience, and added a few new resources.

This is a great resource for medical students and residents in particular, but also for anyone interested in investing. It is written by an emergency medicine physician, and has a lot of great info about all sorts of things. I would highly recommend reading all of the articles linked in his “First-Timers!” section from top to bottom.

What is the difference between a Roth IRA and a traditional IRA? What’s a 529? How do mutual funds work? The answers to these questions and more can be found here. I recommend reading at least through all of the articles under the tabs “How to Invest” and “Retirement” to get a general idea of what’s going on. One word of caution: This site offers a lot of great free content, but has to make money somehow. This often comes in the form of “hot stock tips” newsletters and what not. Ignore these.

Don’t be thrown off by the strange-sounding name – this wiki and the associated forum are one of the one of the best resources online for learning about investing and finance. Spend some time here – it will serve you well in the future. If you have any questions, ask away in the “Help with Personal Investments” subforum – you can get answers within minutes from many wise individuals, including those who have authored some of the most common-sense investment books available today.

If you really want to learn the nitty-gritty details about stocks, mutual funds, bonds, etc., this is the place to go. It takes some time – I’m still not done yet – but going through their free classes is an excellent way to learn some of the finer points of investing.

In addition to the above websites, I recommend getting your hands on some quality books.

This is an excellent starter book that outlines a basic philosophy of investing that I believe will serve any reader who is in it for the long haul very well. I highly recommend getting your hands on a copy of this book and reading it. Once you are done here, you might want to grab a copy of their next book…

This excellent work details the various nuances of planning for retirement, including the various kinds of vehicles you can use to stock away tax-advantaged cash. Honestly, if you read the above links you’ll probably get a pretty good handle on most of the basics, but you might want to consider adding this one to your collection at some point. That said, I do highly recommend their Guide to Investing


Some general main points of the sources above are summarized below:

Avoid Individual Stocks
You are not an expert stock-picker, and the market is smarter than you are. You can’t beat it consistently. No one does. But if you try to time the market, you will underperform it. And you will likely do that fairly consistently.

If You Can’t Beat ‘Em, Join ‘Em
Why limit yourself to a few poorly-chosen stocks? Why not just buy them all? This is where index funds come in. These are mutual funds that attempt to replicate a market index, such as the S&P 500 – a fund that is composed of stocks of many of the larger companies in the U.S. You can take that even further and buy an index fund such as the Vanguard Total Stock Market Index Fund, an index fund that essentially covers the entire spectrum of the domestic market – big companies, small companies, and everything in between. If you buy this fund, you are essentially buying over 3500 different stocks. Try doing that on your own. Round out your portfolio with funds like the Vanguard Total International Stock Index Fund and the Vanguard Total Bond Market Index Fund. Do that, and you’ll essentially own the entire market.

The beauty of low cost index funds is that, over time, you will get at least market returns. Actively managed funds (mutual funds that are essentially run by a single manager or group of managers) try to beat the market by buying and selling certain funds according to where he/she/they think the market is going. Which might sound good in theory. But in reality, in any given year, actively managed funds underperform the market over two-thirds of the time. Of course, that means that one-third of actively managed funds are beating the market. That’s great, but those funds are changing every year, and there’s no way to know who will be the next winners – or losers. Investing is not a game of winning and losing, though – it’s a game of not losing. By getting at least market returns, you are guaranteed to not lose.

Determine Your Asset Allocation
Your asset allocation (AA) is essentially how much of your money you put in different areas of the market. For example, you will have to decide how much money you will invest in, say a Total Stock Market index fund versus a Total Bond Market Index Fund. A good general rule of thumb here is that your 110 minus your age equals your equity (or stock) allocation. So, a 30 year old investor might invest 80% of his money set aside for investing into stocks via index funds and the remaining 20% in fixed-income securities, perhaps via a Total Bond Market index fund. It’s generally recommended to have at least some type of fixed income allocation. Over time, this acts as a hedge against market downturns and can even increase your overall returns as stocks might go one direction and bonds in another in varying market environments.

An easy way to choose and maintain your asset allocation while also investing your money wisely (especially if you could care less and would rather have a hands-off approach) is to simply buy a Target Retirement fund, such as the ones that Vanguard offers here, or a LifeStrategy Fund, which can be found here. These funds invest in all of the funds I mentioned above, thereby allowing to you cover the entire market in one fell swoop that you never have to think about again, if you don’t want to.

Invest for the Long Term
Investing your money in the market comes with a certain degree of risk – namely, at certain times, you might actually lose money. But the general trend of the market is up, and if you keep your head on straight and don’t sell your investments in a panic (thereby locking in your losses), you will, over time, regain your lost money and then some. All that takes time, though. Don’t invest any money in the stock market that you will need in the next 7-10 years. Short-term goals are better suited to CDs and high-interest (relatively speaking…) savings accounts.

Now what?
So how do you buy these funds? I won’t go into too much detail here about the different ways you can invest (e.g. via Roth IRA, Traditional IRA, 401(k), 403(b), taxable accounts, etc. – that’s what the above resources are for!) except to say that, for someone just entering medical school, the best investment option (if indeed it is appropriate to invest in the first place) is probably via a Roth IRA. Think of a Roth IRA (or any of the vehicles mentioned above) as a bucket in which you hold various types of investments, such as stocks, bonds, etc. A Roth IRA is not an investment in of itself. Each different bucket has different benefits. In this case, you contribute to a Roth IRA with post-tax money, but all of the money you earn within that “bucket” will be available to you in retirement tax-free. Additionally, the money that you contributed can be withdrawn without penalty, which may prove helpful in a time of extreme need.

The catch, of course, is that you need earned income to be able to qualify for contributions to a Roth IRA. That means that if you haven’t earned at least as much money as you plan you contribute in the past tax year, you are out of luck. But don’t let that stop you. Spend time now pouring over the resources above and learning about all of this now. Becoming familiar with sound investing principles now will pay off in a huge way later. Good luck to you in your journey, and feel free to post any questions you might have in the comments section below.

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