This is Part 2 of our Trusted Guide: Mastering Personal Finance for Nurses. In Part 1, we touched on the importance of putting money into retirement accounts because of their tax-saving implications.
Now that we’ve established that retirement accounts are awesome, let’s talk about what you really need to know.
In this article, we’ll cover:
Disclaimer: I’m not a financial advisor and don’t pretend to be one online. (I’m a nurse!) I suggest consulting with your tax and accounting professionals for personal advice. This post is for informational purposes only.
What are retirement accounts? They come in various types, such as a 401k, 401a, 403b, and Roth IRA, to name just a few. We know, all the jargon can be confusing. But it doesn’t have to be.
Think of the retirement accounts as an investment "vehicle" for your money. Even if your car is loaded with cash, you still have to figure out which direction to drive.
But how do you decide which vehicle to use and which direction to drive (invest) in?
These two accounts are effectively the same thing. The primary difference is that an organization with a 401a plan must be a non-profit in order to offer it. Therefore, you’ll likely have access to one or the other depending on the type of hospital or health system in which you work.
When you make contributions to a 401k or 401a account, the money is taken out of your pay check pre-tax, which has multiple benefits.
When you make pre-tax investments, you reduce your total taxable income for the tax year. For example, if you make $80,000 a year and you contribute the maximum amount of $19,000, you will only be paying income tax on $61,000 for the year.
You’re technically deferring paying taxes on that $19,000 contribution until retirement age when you withdraw the money, but at that time you will be taxed at a much lower rate because the money you gained is classified as “long-term capital gains,” which are much lower than the income tax rates that you’re paying on your income right now.
So, if in 2019 you made $80,000 and were a single filer, half of your salary will be taxed at 0-10% and the other half will be at 22%.
Conversely, with $80,000 in long-term capital gains income, $39,375 will be taxed at 0%, and any money all the way up to $434,550 will be taxed at 15%.
The difference between 15% and 22% on $40,625 is $6,094 vs. $8,938 respectively, a tax savings of $2,844!
What would you do with an extra $2,800 in your pocket?
Once you put your money into a 401a/401k it is very hard (or painful) to get it out before you’re age 59 ½ without receiving a stiff early withdrawal penalty. It’s best to contribute as much money as you can while still ensuring that you have enough money in your liquid (on-hand) accounts to continue covering all your expenses.
A 403b is pre-tax, and it’s also exclusive to non-profit organizations with a shared contribution limit of $19,000 with a 401a/401k plan. So if you contribute $15,000 into your 401a, you would only be able to contribute $4,000 to your 403b and vice versa.
403b plans will most likely be a factor for you if your organization offers “employee matching” programs. For example, some hospitals will match your retirement contributions, up to 3% of your salary. In my retirement plan, the hospital put their matching funds into my 403b account, but I had additional contributions outside of the employee match going into my 401a, so I had money in both types of accounts.
If you have access to both types of accounts at your organization and you are able to invest in the same types of index funds, there is no difference which you choose to make contributions to. Just make sure that you are maximizing your employer match if you have one!
If your employer offers matching contributions, you should plan to contribute the maximum amount they will match. It’s typically somewhere between 1-3%, but whichever it is, should definitely be maximized if it still leaves you with enough cash to cover your short-term expenses.
Otherwise, you are essentially leaving free money on the table if you don’t maximize your employer match. If you’re not able to maximize this, it might be wise to reconsider your finances and where you can cut spending (or increase earning potential), whether it’s moving to a cheaper place, selling some stuff on Craigslist, or picking up extra shifts.
Also, if you’re in a pinch, you can take out a loan collateralized by the money in your retirement account; however, I would only explore this option if you had no other choice. Missing out on tax-advantaged investment gains can be very expensive when it comes to your retirement.
It’s possible that the available investment options within the 403b may not be as great or robust as those offered through 401a/k's. Additionally, there may be a difference in the maintenance or management fees associated with some of the different options, depending on which you choose.
Roth IRAs are a type of retirement account where your contributions are made with post-tax money. Contributions post-tax means that the money you are putting into this account is money that you’ve already been taxed on – i.e. your paycheck hits your bank account (post-tax) and you then transfer that money into your Roth IRA.
Hang on, this will make sense in a minute!
Tax-Free Gains. Because your original contributions were taxed already, all of your gains can be withdrawn tax-free and penalty-free at age 59 ½. Ideally, your Roth IRA investments will balloon into a much larger amount, so the taxes you paid on the original contribution could be a small amount of money compared to the total sum of your Roth IRA nest egg.
Another benefit with a Roth is that you can withdraw your contributions without penalty. For example, if you contributed $5,500 and later down the road the account grew to $10,000, you could withdraw your original $5,500 without paying a tax or penalty because you already paid taxes on the contribution. *See the "Important" note below!*
Because your Roth IRA isn’t tied to your organization, you are free to invest in any index fund you want. I’ll save you time and just link to Vanguard’s website. They are world renowned for their low fees and index fund options (more on this later).
*IMPORTANT*: You can only withdraw your contributions without penalty if it’s been at least 5 years since you’ve opened the account. This potentially won’t be super clear upfront. I learned this very painful lesson when I withdrew contributions to help pay for my wedding after the account had only been open for 4 years and 6 months… ouch. That mistake hurt.
So the sooner you open a Roth IRA, the sooner the funds will be available for you.
As of 2019, it has an annual $6,000 contribution limit. Since this is the absolute max amount you can contribute to a Roth IRA every year, it can take awhile to collect a significant amount.
These aren’t offered through employers, but can be set up through banks you already use. There are also income limits on high earners that may limit your ability to have a Roth IRA.
If you are single, you must have a modified adjusted gross income (MAGI for short) under $135,000 to contribute to a Roth IRA.
If you are married filing jointly, your MAGI must be less than $199,000, otherwise you will be ineligible for Roth IRA contributions.
Essentially, contributing to a Roth right now is betting on higher tax rates in the future and/or your income increasing to a level over $135,000/year. If you like these two bets, then you should consider maxing out a Roth IRA.
Traditional IRAs and HSAs are two key accounts that we are going to cover in more detail in the Advanced Strategies post in this series.
Avoid trusting money managers without doing your own research!
Once you have figured out which type of investment account you have access to, and which style meets your needs (i.e. pay tax now or pay tax later), deciding what to invest in can seem like a confusing and daunting task.
You may be familiar with the terms mutual funds, wealth managers, or financial advisors. These types of companies are also known as active managers. While they may seem like a convenient and safe bet when it comes to managing your money, they’ll charge a pretty (and deceptive) penny to do it.
They may come at the recommendation of family members who think they’re giving you great advice for “smart investing.” You’ll hear things like:
“Mutual Funds are a safe investment, you should put your money there!”
“My friend has been managing our family money for years, and we’ve done great! They only charge 1% in fees, that’s nothing!”
“What do you know about investing anyway? You’re a nurse, probably best to leave it to the professionals.”
Based on the type of account you have, you may even be automatically enrolled in things like “target date mutual funds” or "free financial advisor seminars." Be skeptical, very skeptical!
Here are a few problems with financial advisors and the products they recommend for you. Financial Advisors aren’t required to act in your best interest.
“In 2016, the U.S. Department of Labor issued its fiduciary rule, which would have required any advisors who offer retirement advice to act in their clients’ best interest. But that fiduciary rule was challenged, overturned in court and appears to be dead.” -Nerdwallet
Yikes. Imagine if that was the case for us nurses and our patients? Not cool.
That would be synonymous with healthcare providers being paid more for prescribing more expensive medication and doing more expensive procedures, irrespective of patient outcomes. In fact, bills have been passed across the United States banning pharmaceutical companies from giving gifts to doctors in order to avoid situations where healthcare providers may be benefiting at the expense of their patients.
Yet, for some reason it’s totally legal for financial advisors to recommend products that earn themselves more money over products that are cheaper and better for you.
But don’t worry, not all financial advisors are created equally; good (and great) ones do exist!
You can find a good advisor by specifically looking for fee-only advisors, or by asking an advisor if she abides by a fiduciary standard (kind of like the Hippocratic Oath).
Fee-only advisors charge a flat rate for managing your investments and don’t make commissions on any trades. This helps eliminate the possibility of an advisor making a bunch of trades when they didn’t have to in order to generate more commissions for themselves.
John Oliver has a fantastic and hilarious segment on financial advisors that’s a must watch.
If an advisor confirms they abide by a fiduciary standard, that means they commit to acting in your best interest, which is great. Having a professional doing their best to guide your investments sounds awesome, right? The problem is their best may still not be good enough for your hard-earned money… 93% of actively managed funds don’t beat the market.
In 2016 Standard & Poor’s released a report that examined a complete database totaling thousands of actively managed funds over the last 15 years and concluded that 92 – 95% of them didn’t outperform an S&P 500 Index Fund. Would you take a medication or undergo a procedure that had a 5-8% efficacy rate? Would you recommend it to friends and family? I certainly wouldn’t! So don’t do the same to your money.
Conclusion? If you want to make sure you’re maximizing your retirement investment results, you’re probably better off managing it yourself. If not, do your due diligence when choosing a managed fund.
You don’t have to be an entrepreneur or super wealthy to own a percentage of a company. This is where the magic of index funds comes into play. Index Funds will take your contribution and combine it with other investors into a big pool of money. Then the fund takes the entirety of the money and buys shares of every company in a category.
Let’s examine the S&P 500 Index Fund, which tracks the Top 500 American companies. I like Vanguard’s S&P 500 Index Fund, because of the low fees, however as you’ll see in my examples below, you can find equally great S&P 500 index funds with companies like Fidelity. It all depends on what company your employer uses to manage their retirement accounts.
Say you had $500, and I asked you to invest in stock markets, choosing the best companies in America. Who would you choose? Apple? Amazon? Netflix?
Unfortunately, it can be challenging to buy partial shares of a company, so buying a share in a company like Apple which has a share price of ~$166 at the time I am writing this would eat up most of your $500. You could only buy a share in one or two of the top companies before using up all your money.
Additionally, while household names like Facebook, Amazon, Apple, Netflix, and Google are the top companies in 2019, just a few decades ago they didn’t exist.
For example, if we did this stock picking exercise in 2001, you could have just as confidently invested in companies like: Compaq Computers, Sears, and Enron.
These were dominant companies back in the day that were generating huge returns for their investors... and now they’re all gone.
This kind of unpredictability and volatility is why picking stocks (active investing) is so hard. Who would have guessed that Apple would invent a phone that would replace the personal computer for most people… or that this little online book company called Amazon would start delivering all of your products and put pressure on the retail stores that dominated for the past 100 years?
Remember, we are planning your retirement accounts to secure your future 30-100 years down the line and beyond. As such, we should invest in a way that will be safe no matter who the top companies are. How do we do it?
The index fund decides how much to buy based on the value of the companies relative to each other. Let’s say the combined value of the Top 500 companies is $100 Trillion. If Apple is worth $1 Trillion, then the fund will invest 1% of its big pool of money into Apple stock.
Let’s say Elon Musk’s new crazy product that links our brains to a computer causes people to stop buying iPhones, causing Apple’s stock value drops to $500 Billion, while Tesla’s stock rises to $1 Trillion. At the end of the year, the S&P 500 Index Fund will sell some Apple stock and buy some Tesla stock so that 1% of the fund is invested in Tesla, and 0.5% of the fund is invested in Apple.
The beauty of this system is that no matter what happens in the world, you will always be investing in the Top 500 companies, so you will always win (over the medium-long term, at least).
Yes, they could. The problem with paying someone to actively invest for you are the fees. On average, active managers will charge you 1% of your assets that they manage in fees every year.
Don’t be fooled by advertisements and sales pitches that say things like, “$0 in management fees up to your first $10,000, then only 1% after that.” We established in the first article that on a nurses salary, a 1% difference in return can lead to hundreds of thousands of dollars later in life.
Also, in order to justify the 1% in fees they are charging you, they most likely won’t be investing in index funds, since that requires zero work. Instead, they may start picking stocks and assets in an effort to give you a better return on your money. However, as we’ve seen from the data, more than 90% of the managers that try to beat the S&P 500 index fund fail. And of the 10% that don’t, an even smaller percentage are able to continue beating the index fund each year, which indicates that most of the top performers in any given year were just lucky.
Does this sound like a product worth $500,000? How much is your future-self worth?
If you didn’t set up your accounts when you first started employment, now is the time to reach out to someone in the organization to find out how to access your accounts. The setup process will be different for each organization. Once you are able to login to your retirement benefits account, select your 401k/a, 403b, or Traditional IRA and look for the investments tab.
Here is how it looks for my hospital’s retirement plan, which is through Fidelity. Yours may look different, so just look for similar tabs to click on:
If this is the first time that you’re putting money into a retirement account, you should click on “Change Investment Elections” under the Future Investments section.
If you’ve already been contributing to your retirement accounts through an employer matching program, OR if you were already contributing to your accounts and want to make sure you’re invested in the right things, you will be able to select one of the “Exchange Investment” options. Afterward, you will come back to the Future Investments section to make sure all of your future contributions go to the correct investment.
Once you are in the “Buy” section, type “Index” into the search bar, and hopefully there is an available index fund you can purchase shares in. Of the 23 available investments I can choose from in my retirement account… only one is an index fund:
Luckily, the available index fund for me is the Fidelity S&P 500 Index Fund (FXAIX) which has low fees that rival any other fund, including the gold standard Vanguard 500 Index Fund.
If you don’t have an index fund option, send an email to the person in charge of your organization’s retirement accounts and ask them why you’re getting ripped off! (Just kidding, don’t be that mean… though it would be good to ask what it would take to get your employer to offer a proper index fund.)
The next step will be comparing all of your available investment options to see which one has the lowest fees.
You want to look for the expense ratio, which consists of the fees charged to investors in order to “cover the fund’s total annual operating expenses. Expressed as a percentage of a fund’s average net assets, the expense ratio can include various operational costs such as administrative, compliance, distribution, management, marketing, shareholder services, record-keeping fees, and other costs.” -Investopedia
To show the massive difference in fees between an actively managed fund and an index fund, I took some screenshots of my retirement account investment options:
Notice the difference in expense ratios: 0.9% vs. 0.015%. That means the fees for the actively managed fund are SIXTY TIMES HIGHER than the index fund. Now look at the performance section: 13.92% for the actively managed fund vs. 14.99% for the index fund. You would be paying 60x the fees for 1% less performance… cha-ching??
Remember, with retirement accounts we are playing the multi-decade game where small differences matter. Big differences in fees, like reducing them by 60x, can lead to colossal gains on your money over the long term.
Fight for every dollar… you’ve earned it! Go through your retirement account investment options and compare the expense ratios. Which option has the lowest fees?
With personal finance strategies there is always a risk to everything. Anyone that tells you they have an investment or strategy that is guaranteed to give you a return is either misinformed or a liar.
The biggest risk when following the playbook in this article is a major economic downturn happening right when you’re ready to retire.
The Great Recession is the most recent example of horrible timing for retirees. In less than two years, between October 2007 and March 2009, the S&P 500 went down by a whopping 56.4%.
Imagine if you busted your ass your entire life, did everything right, invested intelligently, and were turning age 59 ½ in 2007. You may have seen your entire net worth cut in half... 30 years of work gone in an instant!
That’s the brutal situation that retirees found themselves in during The Recession, and the massive drop in stock prices led to a lot of panic-selling. People were thinking “This thing can just keep going down and down and down, I’m going to cash out now before I lose it all.”
None of us know how our future selves will react if we are in that unfortunate situation ourselves. The best thing we can do is ask ourselves how much risk we are REALLY willing to stomach. Just know that if the people who sold their investments during the recession just held on instead, they would have completely recovered in 5 years and even had some significant gains after 10 years.
Despite these risks, maximizing your retirement account investments in low-cost index funds will always be the safest thing you can do with your money.
The easy - but expensive - strategy.
The Good:
Wealthfront is a new company in the personal finance space with a mission to automate retirement investing. Think of it like nixing a travel agent when booking travel (or like nixing recruiters as a travel nurse!). Remember that wealth manager we mentioned a while ago? That’s who we’re nixing here. Wealthfront is super popular with us "young people" because they have great technology, a simple interface, and they automate all the boring stuff.
Basically you decide how much money to automatically deposit from your paycheck every month, decide how much risk you are willing to accept with your investment mix, and Wealthfront technology will do the rest. Buying and selling assets that their software suggests is the best mix for your needs.
Unlike other active managers, Wealthfront’s software actually does invest in low-cost index funds and seems to be acting in your best interest. They also automate some fairly complicated things like portfolio rebalancing and tax-loss harvesting, which we will cover in our Advanced Strategies blog post.
The Not-so-Good:
That being said, there’s no such thing as free lunch. Though robo-advisors like Wealthfront advertise their service is free up to $10,000, if you invest anything over that, then you’ll be charged an annual advisory fee of 0.25% on top of the expense ratio fees from the funds they invest in on your behalf.
We know that the real value in our retirement accounts will be in the hundreds of thousands or even millions of dollars. So their “great deal” is saving you from fees when the amount you’d pay is small, but charging you a premium when the amount you invest is high. Not such a great deal when you think about it.
Compared to our self-managed investment example from earlier, the Fidelity 500 Index Fund (which has a .015% expense ratio), Wealthfront’s fees start to look a little steep. You’ll have to decide if the "set it and forget it" convenience and tax-loss harvesting offered by companies like Wealthfront are worth paying 16x higher fees than self-managing your funds.
If you haven’t invested in your retirement accounts because it’s too complicated, then it might be worth going with a service like Wealthfront, since the most expensive option is not investing at all! I’ve tried the product out and had a really positive experience with it.
Mint is an app by Intuit, which also owns the popular finance apps Quickbooks and Turbotax. Mint allows you to keep track of all of your retirement accounts and bank accounts in one convenient place.
The Good:
Super clean interface and having things all in one place help keep you on track.
The Not-so-Good:
Anytime a product is free, you, and your data are actually the product, and the customer is whoever is purchasing your data. By connecting your retirement, bank account, and credit cards into one place, you are giving up highly sensitive information like your debt and spending habits. Additionally, in the past I had to disable two-factor-authentication on one of my bank accounts in order for Mint’s app to successfully connect to it.
Given the recent track record of big tech companies handling sensitive data, I decided that for me, privacy and security were more important than convenience. Plus, the downside of easily seeing your investment accounts is the anxiety that comes with seeing ups and downs in the market. I prefer setting things up and forgetting about them until I need to access the funds decades from now.
In the Part 3 of our personal finance series we are going to go over a topic that is preventing many nurses from investing in their retirement accounts: DEBT.
We’ll cover student loan debt, credit card debt, and my personal experience getting rid of a soul-crushing amount of debt.
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