Do you know what most financial advisors say about doctors and how they manage their money?
It is not pretty.
I have been in those conversations, and stereotypical doctor stories come out.
Impulsive purchases, lack of knowledge, and easy to manipulate into poor investments are just a few of the things I have heard.
Now, in our defense, we spend ten or more years studying to become a doctor and, one day after residency, are often handed a nice bonus and a large annual salary, and it is easy to fall into the trappings of living the lifestyle of a “rich doctor.” Societal pressures push us to live in a nice house, drive nice cars, and have a few flashy toys.
How do we avoid this trap?
No, it does not mean you cannot have nice things. It means recognizing that investments are the only tangible way to build wealth and having the income from investments adds to what is likely a good income. When you combine strong earnings with a growing portfolio, you have both the ability to retire early and can enjoy more luxury while in your working years because the power of compounding growth and tax-deferred or tax-free investments create financial stability for doctors.
So how do you do that?
Compounding growth: a long-term strategy
Compounding growth is a fundamental principle that every doctor should be well-acquainted with. The earlier you start investing, the more time your money has to grow exponentially. Let us consider a hypothetical scenario for a 30-year-old doctor named Dr. Smith, who invests $6,000 per year for 20 years in a Roth IRA with an average annual return of 8 percent.
After the first year, Dr. Smith’s investment of $6,000 grows to $6,480 (8 percent return). However, in the second year, the return will be calculated on the new total of $6,480, not just the initial $6,000. Over 20 years, this compounding effect will lead to an impressive final balance of approximately $288,000, solely from annual contributions of $6,000.
Tax-free investments: the benefits of municipal bonds
High-earning doctors often face significant tax burdens, making tax-free investments like municipal bonds an attractive addition to their portfolio. Municipal bonds are issued by state and local governments to fund public projects. The interest earned from these bonds is typically exempt from federal taxes and may also be tax-free at the state level if you invest in bonds from your state of residence.
For instance, if Dr. Johnson, a successful cardiologist, invests $50,000 in municipal bonds with an average yield of 4 percent, he could earn $2,000 in tax-free income annually. This means Dr. Johnson’s investment would be shielded from federal income tax, offering an advantage over taxable investments, especially in higher tax brackets.
Dividend-paying investments and the power of DRIP programs
Dividend-paying stocks can be an excellent addition to a doctor’s investment portfolio. These stocks provide regular cash dividends to shareholders, offering a steady income stream on top of potential capital appreciation. Doctors can capitalize on the power of compounding growth by reinvesting these dividends through Dividend Reinvestment Plans (DRIPs).
For instance, Dr. Martinez, an established orthopedic surgeon, invests $100,000 in a dividend-paying stock with a 3 percent yield and enrolls in the company’s DRIP program. With dividends reinvested, he would earn an additional $3,000 in the first year. In the second year, assuming the stock price remains constant, he would earn dividends not only on his initial $100,000 but also on the $3,000 in dividends from the first year. This compounding effect could significantly enhance his wealth over time.
Doctors can create financial stability by understanding the power of compounding growth, utilizing tax-free investments like municipal bonds, and taking advantage of dividend-paying stocks with DRIP programs.
It is important to remember that investing involves risk, and seeking advice from a qualified financial advisor is essential. By combining a good financial advisor with your own financial education, doctors can be empowered investors in their own financial future.
Amarish Dave is a board-certified neurologist with over 20 years of experience in both neurology and active stock investing. In addition to his medical career, he holds a background in business from the University of Michigan and has successfully passed the SIE exam administered by FINRA. Dr. Dave is founder, FiscalhealthMD.com, a website dedicated to educating doctors at all stages of their careers, ranging from residents to retirement, about financial planning.