Welcome to a short guide to kick-starting your personal finance journey. When you begin learning about these topics, the fundamentals are critical. Key topics include why early planning is invaluable, the importance of paying yourself first, various investment strategies, and the ins-and-outs of retirement accounts (Roth IRA vs. 401k/403b)—all of which are covered in this guide.
Why invest early as an ophthalmology resident?
Does making money with little effort sound like something you’re interested in? If so, having a high early savings rate and maximizing compound interest is for you.
“Starting early, in terms of saving for retirement, means you harness the power of time.”
It is an established fact that time in the market is the key to wealth-building because it allows compound interest to work for you. Compound interest is interest on your interest that is added back to the original amount.
By having a high savings rate early on in your career, aka right now, you contribute to either a retirement account such as a Roth IRA or 401K (~5-7% interest rate from investment return with luck). You then sit back, relax, and allow your investment to grow over time.
Examples always help me put things into perspective, so here’s an example of two people saving at different time periods in their life. In this example, they both are contributing to a retirement account where they get a 7% annual investment return.
- Jenny saves $5,000 a year at age 18 and stops saving at age 28. Her total investment is $50,000. From the 7% investment return during those ten years, she gained an extra $23,918. She feels accomplished, lets her $73,918 sit for the next 30 years, doesn’t save a penny more, and retires at age 58.
- Lewis was late to the game and started saving at age 28 (when Jenny stopped saving). He saves $5,000 a year until he retires at age 58. He saved a total of $150,000 over those 30 years. Sounds great, right?
Who wins the compound interest game at age 58? Lewis saved over 30 years, Alice started early but only saved over 10 years. Final totals: Jenny—$562,682.67 and Lewis $505,365.21. Jenny wins despite only saving for 10 years because she started early.
That is the power of compound interest! Making up for the lost time is harder later in life because you have to save more and do not have as much time for compound interest to work.
“The more you delay savings, the more you will have to save in the future to make up for it.”
And as we are already starting later in the game as post-graduate students, it is even more important to start saving with our first paycheck.
What is a recommended savings rate?
There are different thoughts on this, but in general, a person should be saving at least 20% of their take-home (i.e., post-tax) pay.
A great article by the Physician Philosopher discusses “wealth accumulation rate” or WAR. His recommendation is a rate around 30%, in which one would be saving 20% and then putting 10% toward student loans.1
What does it mean to pay yourself first?
If there is chocolate in the house, I find it and eat it. If there is more money in my checking account, I am much more likely to spend more liberally. This is where paying yourself first is key.
Paying ourselves first is also called backward budgeting (good apps for budgeting include YNAB or MINT). This is because you put money into mandatory expenses, and then you “pay yourself first” by putting money away for saving/retirement before allocating money to non-mandatory expenditures.
For example, after making a budget for the month and putting in your mandatory expenditures (mortgage, HOA fee, water, electric, etc.). You can then give a slightly overzealous estimate of what you want to save regarding emergency fund/retirement/money toward student debt. You then allocate the remaining categories into dining out, fun money, other gifts, and such.
Example:
1st paycheck: Mortgage or rent, bills, and utilities
2nd paycheck: First, you can transfer money to our high-yield savings or retirement fund. Use the residual money to pay the credit card statement, and then roughly $500 sits in your account until the next paycheck. Repeat.
As a student, this concept works too, you would just transfer your student loan money to an account that is not your primary account and then transfer in money as you need. This is awesome because you spend less overall and don’t max out your loans unnecessarily. You mustn't overspend on your credit cards because you do not want to incur credit card interest on purchases if you cannot pay them off.
What are different investment and debt strategies?
Investment strategies
- Dollar-cost averaging: you invest over regular increments of time regardless of what the market is doing (e.g., you have $1000 and invest $84 every month throughout the year.)
- Lump Sum Investing: you invest all $1000 at one time.
Dollar-cost averaging is often better in a bear (downgoing) or volatile market. Lump sum investing tends to do better in a bull (upgoing) market. Regardless, it is good to devise your investment plan and rebalance each year.
Debt paydown strategies
There are two methods people refer to when paying down debt. One is called the snowball method, and one is referred to as the avalanche payment method.
- Snowball method: paying off the smallest debts first and then progressing to bigger ones.
- Avalanche payment method: making minimum payments on all debt, then using any remaining money to pay off the debt with the highest interest rate.
Both payment methods can be justified, and which you choose can depend on where you are in the debt repayment process. If someone is beginning to pay off debt, the snowball method creates positive feedback in that you actively watch a small amount be eliminated. This is more satisfying than chipping away at one large loan that requires a longer time period to pay off. The avalanche method makes the most sense financially, because you are paying off the highest interest rate loan first.
Both are great options. The nice thing is you can do one or the other, or a little of both. The world is your oyster.
Roth IRA or 401k/403b . . . what’s the difference?
The alphabet soup is how I felt about this topic before starting my finance journey. In actuality, it’s not too complicated like most personal finance.
| Account: | Roth IRA | Traditional 401K or 403b* |
|---|---|---|
| Eligibility | Single head of household or married filing separately: Annual income less than $122,000 for max contribution. Married filing jointly: Annual income less than $193,000 | Anyone whose employer offers a plan to contribute |
| Taxes | Post tax dollars: You get your paycheck and then contribute; when you pull out at retirement you don't pay taxes on it. | Pre tax dollars: Withheld from your paycheck and is is not taxed going in (you choose how much. When taken out at retirement, it is taxed at your retirement tax rate, which lowers your AGI (Adjusted Gross Income) |
| Contribution limit | $6,000 | $18,000 |
*These are the same essentially, but one is for private employers and one is for non-profit, respectively.
Note: These numbers were for 2019, each year, it changes slightly.
Essentially pre-tax or post-tax contribution is how they are most easily separated.
Roth IRA is a retirement account that you contribute to after taxes. This means I get my paycheck, land in my bank account, and transfer my money to TD Ameritrade, Vanguard, Charles Schwab, or whomever I choose to open my Roth IRA account with. Because I was taxed on my paycheck, the money I contribute to my Roth IRA is post-taxation. It will not be taxed when I pull it out after age 59½.
Now, why is this beneficial in residency for ophthalmology residents?
Eventually, you will receive a significantly larger paycheck when you become an attending. This means you will be over the annual income contribution limit for a Roth IRA. Technically residency is the only time you can contribute in the normal way to a Roth IRA. (Although there is a Backdoor Roth IRA for when you have this problem).
Now on to a 401k or 403b; this is money that you choose to be withheld from your paycheck.
You set this up by going to your employee portal and choosing how much you want to be withheld from each paycheck. I withhold $200 from each paycheck, so around $400 each month. At the end of the year, that is $4,800 I contributed.
In this hypothetical scenario, if I only contribute that amount and it grows by 6% for the next 30 years, in the end, I will have $27 570. After age 59 ½, I can start withdrawing from that amount at my retirement tax rate (which varies by state).
“Another great benefit of a 401k/403b is that any contribution I make lowers my adjusted gross income because I don’t pay taxes until it is pulled out.”
This can be useful if you want to increase the REPAYE interest subsidy you receive since it is calculated off 10% of your adjusted gross income. Since I never received the money I contributed, it lowers my AGI and thus my minimum payment for REPAYE. Cool hack.
Personal finance is personal, but I hope this guide helped you get excited about your journey and explained some of the basics of starting your journey.
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References
Turner, J. “Saving Money. How Much is Enough? The 30% Rule” thephysicianphilosopher.com. https://thephysicianphilosopher.com/third-decree-30-rule/
