As a young professional who is trying to build wealth, I invest money. Although there are a myriad of different investment accounts and strategies, I invest in index mutual funds through my employer-sponsored retirement plan and through my own Roth IRA. Yes, I have both types of accounts. Let me tell you why.
I invest in my employer-sponsored retirement plan (which is a 403b, that is very similar to a 401K) because:
1. I get a match from my employer to invest in their plan. Back in the day, many jobs offered their employees a “pension” when they retired. This pension would guarantee an employee a certain percentage of their salary even after they retired and stopped working. Although these pension plans were great for the employees, they were extremely expensive for many companies. Thus, most jobs today no longer offer pensions. They instead, want to encourage their employees to save for their own retirement and give them an incentive (in the form of a retirement match) to do so. Through this retirement match, your employer will match what you contribute to your retirement plan. My employer, similar to many other employers, offers a retirement match if I contribute to my work-sponsored retirement account (aka a 403b). Since I don’t want to forgo free money, I contribute to my work retirement plan to get their “match.”
2. It saves me money in taxes. As an unmarried physician with no children, I pay quite a bit in taxes. Although I don’t mind contributing money to ensure that our government can run smoothly and fund things like education, infrastructure, and national defense, there are certain incentives in the tax code that can help reduce the amount of taxes I’m expected to pay. One of the incentives is contributing to a retirement plan. By contributing money to my employer-sponsored retirement plan, I am able to defer paying taxes on the money I contribute which decreases my tax rate. I also have the option of contributing to my work retirement plan via a 403b Roth, in which I can choose to pay taxes now and shield the income and profits from taxes when I withdraw the money later. So, whether I choose the pre-tax 403b (to help me save money in taxes now) or the 403b Roth (to help me save money in taxes later), either way I get to save money in taxes. Thus, either option is a win-win.
3. It decreases my student loan payments. Like many college graduates, I have student loans. In fact, the amount of student loans I acquired from medical school is so high that I had to consolidate my loans and enroll into an income-based repayment plan to make the payments more affordable. This plan, called REPAYE (revised-pay-as-you-earn), caps my student loan payments at 10% of my discretionary income which makes my monthly student loan payments much more affordable. As a resident physician who works for a non-profit hospital, I am also considered a “public servant.” Through a program called Public Service Loan Forgiveness (PSLF), after making 10 years of student loan payments, public servants who work for non-profit companies can get the remaining balance of their student loans forgiven, tax-free. Since the student loan payments I need to make are based on my taxable income, the more I lower my taxable income, the less money I have to pay in my student loans. One way I lower my taxable income, and thus lower my monthly student payment, is by contributing to my work-sponsored retirement account.
In addition to my work 403b, I also invest in a Roth IRA because:
1. I can make other types of investments that I can’t make in my employer retirement plan. Unlike my 403b or 401K, a Roth IRA is not set up through my employer. Because it is not connected to my employer, I have more options in the way I want to invest my money. Instead of being limited to certain mutual funds or index funds, I can expand my options. Through my Roth IRA, I invest in REITs (real estate investment trusts). By investing in REITs, I am able to make money via real estate, since these REITs invest in a variety of real estate deals and syndications. Adding real estate to my investments helps diversify my portfolio in a way that can make me even more money overall.
2. It gives me more flexibility whenever I want to withdraw the money One of the things I really like about the Roth IRA, is that because I contribute to it with “after-tax” dollars, there are fewer restrictions on when I can take the money out of the account. Although it is supposed to stay in the account until I retire, I can withdraw my contributions at any time, with no penalty (as long as I keep all the earnings/profits in the account). Thus, if I contributed $5,000 and made $500 in profits, I can take out the $5,000 I contributed at any time as long as the $500 I made in profit stays in the account. This means that if I ever run in to an emergency or decide to use some of the money to pay off student loans or purchase a home, I can withdraw some of the money from this account when I need. A Roth IRA is like a retirement account that I can technically use as a back-up emergency fund if I absolutely needed to.
3. I don’t have to pay taxes on the money in retirement when I take it out. Unlike my employer-sponsored retirement plan, I contributed to this Roth account with after-tax dollars. This means, when I withdraw the money in retirement, I don’t have to pay taxes on the earnings I made or the money I contributed. Because of this fact, a Roth IRA helps me keep more money! For example, if I retire with $1,000,000 in a pre-tax 401K and $1,000,000 in a Roth IRA. I will have to pay 20-30% in taxes on the money in the pre-tax 401K. So even though there is $1 million in the account, I will have to pay $200,000-$300,000 in taxes on that money. With a Roth IRA, I will owe no taxes and will get to keep it all.
4. I can leave all the money in my Roth IRA to my children without them having to pay taxes on it. Another thing I love about the Roth IRA is that I can give it away to my [future] kids. Instead of trying to leave them a separate inheritance, I can simply leave my Roth IRA to my kids and their kids. Doing so, will help the money keep building overtime and allow me to set future generations of my family up for financial success.
My point? Both my employer-sponsored retirement plan and my Roth IRA have advantages. Instead of choosing one over the other, I contribute to both accounts to maximize the benefits. Tell me, do you contribute to your work-sponsored retirement plan AND a Roth IRA?
5 Lessons GameStop Taught Us About Investing
Over the last few weeks there has been a great deal of buzz about GameStop. In case you missed it, GameStop is a retail company that sells video games and associated equipment in shopping centers across the country. Due to the recent pandemic, many Wall Street Investors noticed that people are shopping in person less and thus predicted that the GameStop and its stock would go down in price. Some of those investors even made bets that this would happen (by “shorting" the stock).
Many individual investors on an internet forum disagreed with this prediction. In an act of defiance, they decided to buy large shares of GameStop stock and encouraged everyone on the forum to do the same thing. As more and more people bought the stock, the price of the stock increased drastically. The stock price increased from around $20 at the start of the year to over $400 at one point proving the Wall Street investors wrong and causing some of the largest investment firms to lose millions of dollars in the process. Conversely, many of these individual investors who were on the internet forum made thousands of dollars. Many people realized how much money they had made and began to sell the stock to realize their profits. As more people sold their stock, the price of the stock began to decrease. As I’m writing this article, the stock is around $60.
Here are 5 lessons we can learn from GameStop:
1. Sometimes buying individual stocks can make you a lot of money. The GameStop stock price increased from $20 to over $400 at some point. People who purchased shares of the stock around that lower number and sold it around the higher number made a substantial profit. There have been reports of people making thousands of dollars and beyond.
2. If you purchase a stock when it is already near its peak you can lose a lot of money. While many people on the internet forum who bought the stock when it was around $20 made a huge profit, many people who purchased the stock when it was near $300 or $400 were not as fortunate. Because the stock went down in price and is now around $60, anyone who bought the stock higher than this price lost a substantial amount of money.
3. Making money buying individual stocks relies on good timing and good luck. Some people made a lot of money by purchasing the stock and some people lost a lot of money by purchasing the stock. Which group you may fall into if you choose to buy individual stocks depends on many factors, but two of the biggest factors “good timing” and “good luck.” None of us can predict the future, so despite how good we think our guesses may be, making money by purchasing individual stocks has a great deal of risk. Who could have predicted that people on an internet forum would buy stock in a struggling company and cause the price to increase over 600%? Who could have predicted that the price would decrease to $60 less than 2 weeks later? A lot of the profit people make buying individual stocks requires them to buy the stock and sell the stock and just the right point and timing these two things can be challenging to say the least.
4. The prices of stocks can change drastically. In this situation, the price of GameStop stock ranged from $20 to well over $400 and the change happened in the span of weeks. Although changes to stock prices don’t usually have this wide of a range, this situation was a good illustration of a key investment principle: prices of stocks can change and some stocks are more volatile, and likely to have these types of changes more frequently than others. This can be great news for investors who are able to “time the market” and happen to buy the stock at its low point, but this can be hard to do. Stock prices change for myriad of reasons that you can’t always predict.
5. Stock prices aren’t always based on the company’s financials and overall value. GameStop prices changed a lot over the past few weeks, but this change wasn’t based on something that the company itself did. In fact, nothing about the actual business of GameStop or its financial outlook changed. Yet, despite this, the stock price fluctuated a lot. Although this worked out well for investors in GameStop who made profits, the fact that stock prices can change may not be so good for other companies who are more successful. In fact, it isn’t uncommon for successful companies to experience a drop in their stock price despite increasing their revenue and doing good from a “business sense.” Since a company’s stock price isn’t always based on the company’s financials, this makes it more difficult to predict which stocks will earn you a profit and which will not.
My point? Buying individual stocks is risky. You have the potential to make a lot of money, but you also have the potential to lose a lot of money. What actually happens for you depends a lot on luck. To avoid having to rely on good luck, I invest in index funds. This means I own a little piece of all the stocks. This strategy gives me steady profits and also minimizes risk.
Think twice before you buy individual stocks
I don’t actively trade or buy individual stocks, much to many of my friends’ surprise. I mention several reasons why in another blog post, but the main reasons are that:
It takes a lot of work to try to do it correctly
Accurate, timely information on individual companies can be difficult to find
It requires a substantial amount of research on various companies and industries.
The market is volatile and the purchase of individual stocks is too risky
I keep my investing simple by purchasing well-diversified index mutual funds. The index funds lower my risk of losing money and increase my chance of making money. They also increase the odds that I will make a substantial return on my investments over time.
However, I had a few people reach out to me and question this strategy. They asked “if investing in index funds means you purchase all the stocks, then that means you own both good companies and bad companies. Why not just purchase all the good companies individually?”
My answer was that “It’s not that simple.” Let me explain why.
Good company does not mean good stock. In other words, just because you hear of a “good company” like Apple or Microsoft that does not mean buying stock in that company will make you money.
You make money by purchasing stock in a company and having that company’s stock increase over time. Unfortunately, even if a company is good and profitable, that does not mean buying stock in that company will make you money over time.
A company’s stock price is not determined by that company’s value. Some well-run companies can have low stock values and some poorly run companies can have high stock values.
Stock prices are volatile and change quickly based on a variety of factors. If investors think an industry will do poorly over the next few months, their stock price may go down, even if the company itself is doing very well. If investors think a company’s stock is overpriced, they may start to sell that stock which may drive the price down, even if the company itself is still doing well and making huge profits.
Plus, even if a company is doing well and its stock price has increased recently, that does not mean its stock price will continue to go up in the future.
Sometimes a bad company can have its stock price go up (making you money) and a good company can have its stock price go down (losing you money).
It’s hard to predict what will happen.
Picking the right stock relies too much on luck. It is not dependent on skill, intelligence, having the “right” advisor, or extra knowledge. Because it’s so hard to know which companies will have stock prices that will go up over time, buying individual stocks is like gambling in a casino. Although you hope to make money, you can’t predict what will happen. Even if you got lucky and made money initially, that does not mean you will continue to be lucky and make money in the future.
It’s too risky. I’m not sure about you, but I don’t like to lose money. I want to invest in a safe way that will still give me a good return on my investment over time.
I invest in index mutual funds. By purchasing funds like the Vanguard Total Stock Market Index, I am nearly guaranteed to make about 8-10% profit on my money each year. Each year, this return on my investment will continue to increase and compound. This will build my net worth.
4 Reasons I Don’t Buy or Trade Individual Stocks
Over the last few months, many of my friends have started investing. Because they know I love talking about personal finance, they will often ask me advice on which stocks to purchase. I tell them all the same thing: “I don’t buy individual stocks, I only buy index funds.” They usually seem a bit perplexed and want to know why. Here’s my answer:
1. It takes a lot of work and timely information is difficult to find. As a busy doctor, I don’t have a lot of free time. Some weeks I work 80 hours in the hospital or have over 20 patient message to review. I barely have time to fold my laundry on a regular basis let alone do extra work, outside of work. When I do get a free afternoon or “golden” weekend in which I’m not on call at the hospital, the last thing I want to do is be productive. Most of the time, I just want to relax with friends and family eating good food or enjoying quality time. Trading stocks or researching companies to invest in, isn’t on my priority list.
Even if I did have the desire to learn more about various companies, finding good, timely, information can be quite challenging. Most of the time when information about a company is finally published it has already been known to Wall Street investors beforehand. This means it’s almost too late to make an investment decision that could make you money. For example, if I turned on the news and heard that Facebook was acquiring another company that could increase its profits, chances are the price of Facebook stock would have already increased to reflect this change. By the time lay people like you or I tried to capitalize on this potential increase in stock value it would be too late.
2. It requires substantial research on each industry and company. Although apps like Robinhood and Akorns have made purchasing individual stocks easier, they haven’t necessarily made it more profitable for the consumer. In order to actually make money when you purchase stocks you need to purchase companies that will increase in value and do so in a way that you will still make money even after you pay the taxes on your profits. This may sound easy to do initially. You may be thinking that you’d just purchase stock of Netflix and Facebook or Tesla and Apple then call it day. Unfortunately, it’s not that simple. If it were, everyone would do that.
There are some companies that seem to grow exponentially in ways we could never expect and other companies that seem to implode overnight. It’s difficult to predict which ones will make money over time and which ones will not. In fact, Wall Street companies spend millions, if not billions, of dollars each year on market research to help provide more information to help them make better predictions and investment choices. Even they still struggle to choose the right companies year after year.
3. The market is volatile and things change quickly. If 2020 taught us anything, it’s that life can be unpredictable. Random unforeseen events that happen in other parts of the world can affect us in ways we could never have imagined. These effects not only impact our daily lives, but they can have drastic effects on our economy and the success or failure of certain businesses.
Before the coronavirus, many of us would have assumed that airlines and travel industries would do remarkably well in the summer. The weather is great, kids are out of school, and most people have time off of work to go on vacation. We all got a rude awakening in March when the coronavirus pandemic put a drastic halt to almost all leisure travel and many airline industries found themselves on the brink of bankruptcy. Past performance isn’t always indicative of the future valuations and this makes picking and choosing individual stocks to purchase quite risky. Which leads me to my last point…
4. It adds too much risk and I don’t like losing money. When you buy individual stocks you’re essentially rolling the dice and hoping that the company’s stock you purchased will increase in value over time. As we mentioned before, stock prices are volatile. A company’s stock could be worth $20 today but then drop to $5 tomorrow due to some global tragedy or company scandal that you had no idea about. They best way to mitigate risk and decrease your chances at losing money (and increase your chance of making money), is to diversify your investments.
This means purchasing stocks in a variety of different companies from a slew of different industries. Since it would be too cumbersome to individually purchase all the stocks, most people such as myself, just buy index mutual funds. An index fund does the work of buying all the stocks for you. That way, your investments are diversified in a seamless, stress-free, risk-averse manner.