Personal Finance for Healthcare Professionals
Whether you are a young professional, busy professional, or health professional, many of us did not take a personal finance for professionals course in high school or college. Myself included, I had no personal finance foundation after starting a career in the health field other than what little information was passed on from my parents.
Although saving money and staying out of debt is a good first step to personal finance, it was not enough to pursue financial independence or know what to do with money after starting my career. So I compiled this personal finance guide for busy professionals to build financial literacy and share what I have learned with you about personal finance and the importance of investing ASAP.
By the end of this guide you will know where to put your money, the differences between types of investment vehicles (401k, IRA, HSA), the difference between ROTH vs Traditional accounts, index fund investing, why you need to start taking advantage of these investment options now to reap the benefits later, and what the costs are if you wait.
Fair warning this guide cannot be completed in one or two days and may take months to reach your goals. It took me 8+ months so do not be discouraged you can do this! The important part is getting started and referring back whenever needed. Ok, let’s dive in!
Why financial knowledge and compound interest are so important.
Have you ever asked yourself, am I saving enough for retirement? Am I leveraging my finances to the best of my ability? What should I invest in? Then you are not alone.
It is no secret Americans are known for having horrible savings rates. This compiled with our materialistic consumer society does not leave many with excess funds to put towards retirement and forget about other investments outside of retirement.
But what if I showed you the real cost of waiting to invest and not having financial goals?
The cost of waiting to invest:
For the sake of demonstration, let’s say you invest $250 a month ($3,000 per year) into a tax deferred 401K each month with a 7% return without factoring in inflation from age 25 up to age 65 or for 40 years.
Starting at age 25 with $0 investing if you stuck to this plan you would have $617,886 invested.
What if you started investing this same way at age 30 instead of 25? You would have $427,853. That’s missing out on -$190,033.
We can apply this same principle for delayed investors, like myself, if we start investing at ages 35 we miss out on -$325,523 and 40 we miss out on -$422,126.
What is compound interest?
Compound interest results in your investments growing at an exponential rate. This doesn’t look like much when you start investing but over time you can see your investment growth start to curve upward. To look at this from the other side of the same coin, you are exponentially losing money by not taking opportunities to invest today.
This is why increasing your financial knowledge to leverage your finances and start compounding your investments as soon as possible is vital to having enough money at retirement, financial independence, or building generational wealth.
To see this in action let’s look at a couple of examples:
Here is a simple investment calculator that demonstrates the point of your total interest earned, money earned by your money working for you, actually exceeding your initial contributions when setting years to growth of 20 years or more!
Here is a more detailed retirement retirement growth calculator.
Do not worry about the Roth or Traditional growth right now. This will be covered below.
You can see the more you contribute and the greater the initial investment, the faster this compounding exponential growth effect can be seen on the bar graph! Which is why putting your money in investment vehicles today is so important.
Passing this knowledge on by teaching our children about financial responsibility becomes just as important for us as for them.
How to prioritize money allocation – Your financial flow.
You have probably asked yourself, “where should my money go?” at some point in your life. Below is what I call a priority step ladder of money allocation.
- Emergency Fund – 3 to 6 months of living expenses.
- Company 401k – Up to company match typically around 4% of your annual wages.
- Tackle Debt – Paying off highest interest rate first.
- Roth IRA or Traditional IRA – total max contribution to IRA(s) is $6,000 if below max contribution limit.
- Invest more in 401K – Max contribution is $20,500.
- Health Saving Account (HSA) can be used as an investment vehicle. With max contribution of $3,650.
- Savings and investing – If you have money left to invest, create a non-retirement or taxable investment account at a brokerage such as Vanguard, Fidelity, etc and start investing.
Personal Finance Checklist
Three to six months of living expenses may seem like a high number but when uncertainty strikes, you will be happy you built this fund. This money should be easily liquidated, meaning you are able to pull it out quickly with no penalty or fees, such as in a high interest savings account.
401K or IRA?
The 401K and IRA (traditional or ROTH) are all tax advantaged retirement vehicles to invest money.
With a 401k:
- You choose from a list of investment options from your employer.
- You have until the end of the calendar year to contribute for that years contribution.
- Your maximum contribution as of 2022 is $20,500 if you are under 50.
- If you are 50 years old or older you can contribute $27,000.
- There is no income cap for this investment vehicle.
With an IRA:
- You have access to a wide variety of investments.
- You have until the next year, when you do your taxes in April, to contribute to the previous year. For example I can contribute to an IRA for 2022 in March of 2023.
- Your max contribution as of 2022 is $6,000 if you are under 50 if you qualify.
- If you are 50 years old or older, you can contribute up to $7,000.
- No matter your age, you may not qualify to contribute if your income is to high. Refer to ROTH vs Traditional below for details.
According to the priority step ladder of money allocation above, we should at a minimum, match our employers 401K contribution and max out our IRA if possible. It is important to at least match your employer contribution because this is FREE money from your employer.
Employer vesting period
Note there may be a vesting period where you have to work for your employer a certain number of years before you own 100% of the 401K employees match given to you.
For example, the company I work for has a vesting period of 20% for every year I work for the company. So I would have to work for 5 years at this company before I own 100% of the company 401k match they gave me. At this time I could change companies and keep all of the employers match. However, if I left after the first year, I would only own 20% of the match they gave me that first year and the other 80% I would not receive.
The IRA provides more flexibility with your preferred choice of investments and the ROTH IRA offers some perks that the traditional IRA does not. Refer below to ROTH vs Traditional for details.
For a comparison that includes limitations and potential penalties refer here 401k and IRA Comparison.
Refer below to investing for guidance on choosing investments.
The priority money allocation puts tackling your highest interest debt at number three after having an emergency fund and matching your company 401k. This is a great starting place but what if you are a type A personality, like myself, who is asking yourself, is this the best way to leverage my finances and make my hard earned money work best for me? Great question, let’s look at an example to determine if we are making the most out of debt.
How much money should I put to debt?
To know if you should tackle debt 100% before moving on to the next money allocation step, you have to look at two factors:
- What are your loan interest rates vs your investment return rates?
- How much money do I have working for or against me?
Knowing these two factors will give us an ideal picture of our money flow.
So let’s look at an example.
Say you have a car or student loan that has a low interest rate of 4% and you have some money in a low cost index fund in the stock market which provides an average return of 8%. If you add these together to get your net money flow then the 4% debt going out plus 8% return coming in gives you a net return of 4%.
Based on this alone you may think it makes more sense to pay the minimum on your car or student loans while contributing more to your investments. However, to fully understand your money flow picture, you have to look at the amount of debt vs investments you have.
Let’s say you have $200,000 in student loan debt with 4% interest rate that compounds monthly. Resulting in $8,148 of added interest that has to be paid annually. This is money working against you. Let’s now look at a $25,000 investment that provides a 8% return every year. This results in $2,000 of money working for you.
In this example your net flow of money is $8,148 – $2,000 = $6,148 going out or working against you. You may ask yourself then how much do i need in investments to meet or surpass this negative cash flow?
You would have to have an investment of $101,850 that returns 8% every year to break even and that is not taking into account any fees or expenses that may be associated with this investment.
There is no wrong way to do this other than not doing anything at all and there maybe other factors here to take into account that apply specifically to you. But the point is to establish a strategy to reduce your debt, preventing the added loan interest from snowballing while still allocating some to investments so your wealth can start compounding!
Roth vs Traditional
ROTH accounts require you to pay taxes now and Traditional accounts are tax-deferred which means you do not pay taxes today but you will pay taxes when you pull those funds out later in retirement.
There is quite a debate about which to invest in. The general rule of thumb in the personal finance community is if you are in a low tax bracket now and expect to be at a higher tax bracket later in life to invest in ROTH accounts. Where if the opposite is true and you are in a high tax bracket now and expected to be at a lower bracket later in life to invest in Traditional accounts now.
This general guide was too vague for my liking. So I dug a little deeper and found some unique properties of Roth IRAs.
The difference between Roth and Traditional IRAs
- If you do not contribute to a 401(k) then there is no income limit if you contribute to this IRA.
- Contribution restrictions single: If you do have a 401(k) (Roth or traditional) and earn $68,000 to $78,000 then your contribution is “phased out” (limit contributions based on a sliding scale) and you cannot contribute if you earn more than $78,000.
- Contribution restrictions married: If you contribute to a 401(k) (Roth or traditional) and earn more than $129,000 then you can not contribute. There is a sliding scale for contribution from $109,000 to $129,000.
- If only one married individual is eligible for a 401(k) at work then the IRA tax deduction is phased out for incomes from $204,000 to $214,000.
- Have to wait until 59 ½ to withdraw penalty free.
- Contributing to a 401(k) plan does not affect your contributions.
- Contribution limits start to phase out for singles with incomes of > $129,000 up to $144,000 and for married couples who earn > $204,000 up to $214,000. If over these amounts, you are not eligible.
- Refer to the IRS guidelines for how to determine Your Reduced ROTH IRA Contribution for 2022.
- Conversions of traditional IRA to Roth IRA do not count towards contribution limits.
- *Can withdraw contributions, anytime, tax-free, and penalty free 5 years after your first contribution. The interest earned you cannot withdraw, only your contributions.
- **There is no Required Minimum Distributions (RMDs) for this account.
- RMDs force you to withdraw from your retirement accounts (any 401(k) and the traditional IRA) starting at age 72 or you will be penalized. This does not apply if you are still working for your employer sponsoring your 401(k).
Here are a couple references comparing the two:
Brandon, aka madfientist, makes a good argument to use the Traditional Tax-deferred Approach to compound your investments faster.
Nerdwallets take on Roth IRA vs Traditional IRA.
These are additional reasons why I chose to invest in Roth accounts:
- Historically we are at a relatively low taxation period in the US.
- You can predict taxes in the future, but there is no guarantee and they are something that typically does not go down.
- Roth accounts cannot be touched by bankruptcy.
- Whoever receives your Roth account after you pass away, will not have to pay taxes on the withdrawn funds. However, they are subjected to required minimum distributions.
- “Stealth taxes” (from 2020):
- At age 63 The Medicare part B premium and drug coverage premium are increased after adjusted gross income is above $85,000 for single people and $170,000 for married filing jointly. This will vary depending on how high medicare premiums will be when you enroll.
- 3.8% Net Investment Income tax that impacts those making more than $200,000 for single and $250,000 for married filing jointly. Due to the lack of inflation indexing over 10% on the medicare premium adjustment and the complete lack of inflation indexing on the 3.8% Net Investment Income, it can be difficult to predict expenses in the future.
- Social Security Income is taxable if your adjusted gross income + nontaxable interest + ½ of your Social Security benefits are more than $32,000 married or $25,000 filed jointly, then you will pay taxes on your social security.
- The Required Minimum Distributions forcing you to withdraw from traditional IRA, 401k, 403b, TSP, may force you to pay higher tax rates and medicare premiums (the more income you have the higher your medicare premiums).
Health Savings Accounts (HSA) for DIY investors
Most HSAs provide an opportunity to invest these funds. This gives us another vehicle to invest! There are some points to make about HSA investing:
- This money is tax deferred, taken out before taxes, and can only be used for health expenses until we reach 65 age. We can use these funds for non-medical expenses at age 65 or older without any penalties but you will have to pay taxes on the withdrawals. Similar to a traditional IRA account.
- One caveat though, most HSA investments are self managed and have rules that need to be met or maintained to be able to invest.
- For example my HSA account requires a minimum of $1000 that has to be maintained in the account before I can invest.
The maximum HSA contribution for 2022:
- For single coverage is $3,650.
- For family coverage is $7,300.
- These contributions include any employer contributions as well for the year.
- If you are 55 or older you are allowed another $1000 catch up contribution for either single or family coverage.
I am going to share with you the simple long term strategy that I use recommended by Warren Buffet which is perfect for busy professionals who don’t have time to daily trade looking up P/E ratios, quarterly earnings, etc all day.
A simple long term investment strategy
The simple long term investing strategy is low cost index fund investing. Warren recommends investing in an index fund such as the S & P 500 which is 500 of the largest publicly traded companies in the U.S. This Index has diversification within it as you are infesting in 500 companies at once by contributing to this one index.
His advice comes from a large percentage of mutual funds, advisors, and traders not able to beat the average market returns so instead of paying someone to invest your money but not beat the market why not just invest in the market yourself. Very logical advice thanks Warren!
There may not be an exact index fund called S & P 500 in say your 401k plan for example due to limited investment options. However, they will likely provide an equivalent. For example, in my 401K plan they offer a “State Street S&P 500 Index” plan which is equivalent to the S & P 500 that I invest in.
Why don’t I just hire a financial advisor?
This is a great question. The fact that financial advisors do not have to do what is in your best interest steers me away from them. You have to remember, the only person who has your best financial interests at heart is yourself. Which is why improving your financial knowledge pays for itself!
If you currently use a financial advisor or want to hire one, then I recommend the following:
- Make sure they are a Fiduciary advisor which means a trusting advisor who puts your interests first.
- They are a fee-only advisor. Charging a flat fee for their services.
- You can find fiduciary fee based advisors at the National Association of Personal Finance Advisors
Suggested order of money allocation is emergency fund (3-6 month expenses), contributing to a 401K at a minimum of your employers match, tackle debt with highest interest rate first, invest in an IRA, invest more in 401K, invest in HSA for DIYers, and finally if you have money left over invest in a taxable brokerage account.
Strategy I use for investing, as recommended by Warren Buffet, is low cost index funds like the S&P 500 index with low expense ratio percentages to invest in.
Disclaimer: Financial decisions you make are yours alone at your own risk. Rehab Rebels holds no responsibility nor liability for your financial decisions. Refer to full Disclaimers & Terms and Conditions for more details.