1) Physicians provide a valuable service

Most importantly, what doctors do is valuable.  In all the whining about the high cost of health care, few people would argue we should just bag the whole thing all together.  The day to day work of a doctor is valuable.  Worries are extinguished, lives are lengthened, and quality of life is improved.  Does medicine have lots of problems?  Sure.  Are there some bad doctors out there?  Of course.  But overall, physician services have a high economic value.  Those who provide them deserve appropriate compensation for the value provided.  We don’t think twice about plunking down $200 for an iPhone, but balk at $200 to get a specialist’s opinion on treating a serious condition?  Where are our priorities?

2) The Lost Decade

The 20s and early 30s are the prime of life.  You typically enjoy good health, can run on little sleep, can bounce back easily from a hard day, and are often free from burdensome family responsibilities.  Many physicians come out of residency feeling as though they checked out of life for 5-15 years.  They’ve lost friends, missed opportunities, and often times suffered through the loss of important romantic relationships.  They’ve missed weddings, funerals, vacations, reunions (I was in my first month of internship during my 10 year high school reunion) etc.  If there is no financial compensation for this loss (i.e. a light at the end of the tunnel), the intelligent people you want to go into medicine won’t.

3) A Difficult Job

When I was growing up in Alaska, everyone understood that you had to be paid well to do a difficult job.  Commercial fishermen didn’t risk their lives on the Bering Sea for minimum wage.  Oil men didn’t work a two-weeks-on-two-weeks-off schedule on the North Slope for lower middle class wages.  If your corporation wanted to send you to Alaska, it had to pay you a lot of money to do so.  There was a well-known relationship evident in everything people did.  If a job required hard work, long hours, odd hours, and/or a great deal of stress, it paid more.  Enter medicine- long hours, constant stress of not diagnosing or treating someone properly (leading to the patient getting sick or even dying), and the bureaucratic hassles imposed by government and other payors, and you’ve got a hard job that deserves to be paid well.  How many times have you been told by friends and family “I could never do that, I can’t stand the blood.”  (Or the rectals and pelvics, or sick people, or the stress, or the call, or the crazies.)  More importantly, it’s a hard job that requires compassion, difficult decision-making, leadership, intelligence, continuous learning, and decades of dedication.  That deserves appropriate compensation.

4) Constant Liability

I never thought about this much as a pre-med, or even a medical student.  Becoming involved in two suits during my first two months of residency (I was dismissed from both thankfully) really opened my eyes.  Ever since then I constantly think about and worry about legal liability for my actions.  I worry more about doing the right thing for my patients so they actually get better and don’t die, but you better believe I never fill out a chart without thinking about how I would defend it in court.  You think your grocer worries about that?  Or your mortgage broker?  How many times a day do you suppose a teacher worries about getting sued for $5 Million?  Don’t you think having to deal with that constantly hanging over your head deserves a little bit bigger paycheck?  I do.  I used to think I’d be a doctor even if it only paid $50K.  Now?  No way.  And the constant liability is a major part of it.

5) Long, Costly Training

If it takes a few months of training to learn to do something, it should pay more than something you can pick up in 10 minutes on the job.  But what if something takes more than a decade to learn?  And requires you to take on levels of debt that many wouldn’t consider for a mortgage they plan to pay off over 30 years.  Isn’t that worth something?  It’s gotten to the point where the typical graduate of many medical schools simply cannot afford to go into the lower-paying specialties.  That’s just not right.  Some argue that the problem is that other specialists are paid too much, stealing part of the income of a lower-paid specialist.  Having worked in a system where no specialists are making more than the very low six figures, and watching people quit that job at the first available opportunity, I just don’t believe that lowering the pay for all physicians to the lowest common denominator is the solution.

If our society demotes doctors from their status as professionals and business owners to that of unionized workers, our society is going to get what we deserve.  The medical training pipeline is long enough that it will take a while to see the effects, but in the end, we’ll rue the day we decided quality health care wasn’t worth paying for.

Quit buying cars on credit. Pay this one off ASAP and then keep putting the payments into a “car account.” When it comes time to buy your next one, you can use cash. There’s no reason for anyone, much less a physician, to buy a car on credit.

Another poster responded:

I disagree with the “no reason for anyone… to buy a car on credit” advice. Rates are currently low enough that some people could get a car loan, pay a relatively small amount in interest for the car, but end up saving much more come mortgage time because they were smart enough to build credit history. Since the OP [original poster] has no student loans, he probably has no other installment accounts, so the car loan is probably benefiting his credit score.

In response, I came up with 15 reasons why buying a car on credit probably isn’t a great idea.

1) You buy too expensive of a car

Basic transportation is available very cheaply. You can get a 10 year old economical commuter for less than $2K. The availability of credit encourages too much consumption.

2) Interest costs

Given that cash-equivalent investments are paying 1% or worse these days, even financing at 2 or 3% is costing you something, especially after-tax.

3) Finance charges

Cash buyers don’t pay them.

4) Smaller selection of cars to buy from

Guess what? If you want to come buy my car I’m not going to finance it nor wait while you dink around with a credit union. You better have cold hard cash. So that leaves you to go deal with those who are willing to either finance it or mess around with whoever you’re going to finance it through. That’s fewer cars to choose from.

5) Higher price

On the same reasoning as above, you can get a great deal from me if you wave twenty $100 bills in front of my nose. If you have to go down to Low Book Sales down the street, you’re going to pay more.

6) Credit Scores Are Stupid

A good credit score is so easy to get without doing dumb financial things that it is no reason to take on debt. How about buying your gas on a credit card and paying it off at the end of each month? That’ll give you a credit score you can get the best mortgage rates with after a year or two. Not enough credit lines? Get two cards and alternate them.  Too many of us worry about our credit scores anyway.  I hope to never need mine again.

7) Cash Flow Constrained

So you decide to borrow the money to buy your car so you can leave your cash invested. Guess what? You still have to service the debt. You’ve got to come up with a few hundred bucks a month. If your income drops or another opportunity comes up or whatever, that cash flow isn’t available. It’s best to have low fixed expenses and high variable expenses. Buying things on credit reverses that.

8) Living On Credit Mindset

If you finance your car, why not your TV, and your furniture, and your house, and your vacation and your kid’s college and borrow from your 401K etc etc etc.

9) Screw-ups

One missed payment not only hurts your credit score, but also tacks on additional fees. It might not even be your fault. Maybe your employer sent the paychecks out a day late.

10) Satisfaction of Living Without Debt

You don’t get to call in and scream “I’m debt-free!” on the Dave Ramsey Show.  Seriously though, talk to someone who has paid off their mortgage and ask if they’d take out another mortgage on the home at a very low rate.  Most won’t because it is so satisfying to live without debt in this world.

11) Insurance costs

If you own it you can go liability only. The bank wants you to fully insure it. And a more expensive car has higher insurance too. That cheap beater you could have paid cash for is dirt cheap to insure.

12) Registration fees

More expensive cars (the kind you go into debt for) cost more to register each year.

13) Sales Tax

Same drill. Paying cash encourages you to buy less. Less car, less tax.

14) Cars depreciate

It’s one thing to buy a house that you expect to keep up with inflation on credit. The longer you wait to buy a car (while you save the money) the cheaper that car gets.  In fact, the terms on auto loans are getting so long these days (5-8 years is not uncommon) that many buyers actually find themselves upside down on their loan.

15) Leverage Goes Both Ways

Many argue that they prefer to keep low interest loans and invest and hopefully earn on the spread.  It’s great when it works for you. But it works both ways. Here’s what Warren Buffett says about it:

By being so cautious in respect to leverage, we penalize our returns by a minor amount. Having loads of liquidity, though, lets us sleep well. Moreover, during the episodes of financial chaos that occasionally erupt in our economy, we will be equipped both financially and emotionally to play offense while others scramble for survival. That’s what allowed us to invest $15.6 billion in 25 days of panic following the Lehman bankruptcy in 2008.

Now I’m not a Dave Ramsey-esque extreme anti-debter.  I do understand that forgoing 401K contributions to pay off your 0.9% student loans might not be that wise.  But far too many people who plan on investing the money they would have used to pay down loans or buy a car never get around to it.  It’s a behavioral finance thing, and it’s an easy trap to fall into.

If those 15 reasons aren’t enough to convince you, feel free to buy your cars on credit. There are dumber financial things that most Americans do every day. But for a physician, who likely makes $10-30K a month, to have to take out a loan for a car, is what I call a negative status symbol. It tells me he has no idea how to manage money. He should be able to save up for an average used car in the same amount of time it takes to shop around to buy one.

What do you think? When is it okay to buy a car on credit and when is it folly?

Photo Credit: Stephen Hannafin, Via Wikimedia, CC-BY-SA

More importantly, these pages have been viewed over 385,000 times, by over 69,000 people.  There have been 22,500 comments (okay, I admit 21,000 of them were spam, but that still leaves 5 a day.)  Judging by the email and comments I get, there are a lot of people benefiting from the free, unbiased advice here.  That was the whole point of starting the site, so I’m very pleased with that.

A website is a tough business to start, since there is little barrier to entry, and limited ways to monetize it (at least if you feel some obligation not to sell your soul).  Financially, the site hasn’t been a total bust, but it certainly is not a significant source of income to me.  Emergency medicine is a far better way to trade my time for money.  The gross income on the site in the last year was a little over $3000 (of course I’m working hard on keeping the net income very close to zero).  Most bloggers will tell you that’s a pretty good first year.  But when you divide that income by the 255 pages/posts written, it works out to about $11 a page.  It’s passive income going forward, but it certainly was an active process researching, writing, editing, and putting them together in the first place!  But the research benefits me as well, and the writing seems to be helping a lot of other people, so I’ve recently re-upped my web hosting agreement for another year.

I hope you all have enjoyed the journey as much as I have.  I figure there are nearly a million doctors and dentists out there just in the US (not to mention similar professionals), and at least 25,000 or so new ones every year, so there are plenty of people left to rescue from the clutches of Wall Street.  Please share the word with your friends and colleagues.
Now it’s your turn.  What subjects would you like to see covered on The White Coat Investor in the future?

Too Much Information

People worry about Google and Facebook knowing too much about their personal information.  That’s nothing compared to the hundreds of questions that SurveySavvy will ask about you in order to “personalize the surveys they send to you.”  After a while I just got uncomfortable with the invasiveness of the questions and figured they had enough to personalize the surveys adequately.

Screen-Outs

I signed up for SurveySavvy about 6 weeks before I wrote this post.  Since that time I’ve been invited to take 29 surveys.  I was screened out of 27 of them.  That means I wasted at least a couple of minutes on each of those surveys.  You’d think with all the personal information I provided up front, they wouldn’t send me any surveys that I wasn’t already pre-selected for.  But no, that’s not the business model.  The business model seems to be send the survey to everyone, screen most people out after they start the survey, and then don’t pay them.

Ridiculously Low Pay-Outs

Guess how much I’ve accumulated in my account after starting 29 surveys?  $2.  That’s right, a dollar a piece for the completed surveys.  In fact, most of their surveys (which they estimate will take 10-15 minutes) are for $1.  I’m pretty cheap, but I’m not that cheap.  Even their really good surveys are only $5 or so.  Sorry, my time is worth more than that.

In conclusion, if you’re interested in doing online surveys for cash, you need to look for something that is physician-specific.  SurveySavvy is a joke. I’ve signed up for a couple of others, but surveys are pretty rare from them. Have you tried any of these? Any of them you can actually recommend? Leave a comment below.

I was at Home Depot picking up some sprinkler system parts.  I’ve been meaning to get a leaf blower to blow off the walks, driveway, and decks, especially after mowing and to help with fall clean-up.  Cheapskate that I am, I took a look at their refurbished stock, where they sell returns for about 50% off.  An inexpensive blower, but adequate for my needs, was selling for $50.  Now, I’ve had blowers before, and I know you can really only expect them to last 1-3 years.  No one repairs them because it’s cheaper to get a new one than to pay for a single part to be replaced.  The part that needs replaced is usually the engine anyway.  My last blower, of better quality than this Ryobi, lasted only two years of moderate use.

So when I go to check out, the check-out dude offers me a two-year full-replacement warranty for $10.  I asked him if that meant I got another refurbished one, and he assured me that no, I would get a brand new one.  I told him there was no way this blower was going to last 2 years, and it had already been used for who knows how long before I got it.  He didn’t care, his job is to sell warranties on everything he can.  So I took him up on his deal.  This was a bet I was willing to make, especially since I get to control how much the blower gets used, how hard it gets used, and how much bad gas I put in it.  I can assure you, it will not last two years.  So for $60 I get a blower that’ll die in a year or two, then I get a brand new one.  I even got a full tank of gas thrown into the deal.  I think I’ll use it to blow snow off the driveway all winter now.  And maybe leave it out there in the snow when I’m done.

Our 4-in-1 printer died a couple weeks ago and my wife is shopping for a new one.  She found one with a 3 year full-replacement warranty.  I’ve had 3 or 4 printers in the last 10 years and I don’t think one of them lasted more than 3 or 4 years.  I don’t think they were charging for this warranty, but even if they were, I’d probably take them up on it.  Those printers at the hospital get changed out every 6 months it seems.  These things just aren’t built to last.  They make all their profit off the ink anyway.  I assume they make their warranty money back on people who buy the warranty but then forget to use it, or perhaps people who are a lot nicer to their stuff than I am.

We just had the roof replaced.  It came with a 50 year warranty.  What kind of a roof lasts 50 years?  I’m confident I’ll get a chance to use this one too, at least for a patch job or two.

Some of the unconditional warranties for smart phones seem like a pretty good bet too.  I mean, if you’re getting near the end of the warranty period and you still haven’t dropped it into the toilet or off a cliff I’m sure it can be arranged.

We made the people who sold our house to us buy a pretty standard 1 year homeowner’s warranty.  That was good for a new $1600 gas range.

So when offered a warranty, you should probably usually say no, unless it’s free or if you can get someone else to pay for it.  But every now and then, when they make a dumb bet with you, take them up on it (and keep the receipt.)

What do you think?  Which consumer warranties are a good deal?

Image Credit:  Chicoutimi, via Wikimedia, CC-BY-SA

This post falls into the category of “that’s interesting.”  For all but the medical students reading, there isn’t a lot of actionable information here.  But it is difficult to find this information out there.  Physician income information is relatively easy to find, but work hours information is notoriously difficulty to find.  The only information that combined physician work hours with their income is from a survey in JAMA published in 2003, and obviously using even older data.  Here’s the “money shot”:

There’s a lot of information there, but I’m just going to use the 4th column, the average hours worked.  I’m also going to adjust the column for the trends we’re seeing in medicine of decreasing hours.  Over the last 15 years or so, physicians have been cutting back on their work hours.  Part of this is decreasing compensation and increasing practice burdens, part is a greater focus on lifestyle issues, and part is due to increasing numbers of women in our ranks who are more likely to work part-time and/or take off significant time due to pregnancy/child-rearing issues.  At any rate, it works out to about a 2 hour per week decrease since 2003.

Now, let’s find some reasonable salary data out there.  Medscape has a survey using 2009 data.  I’ve used that data and combined it with the hours in the table above adjusted for the decreased work hours I’ve noted.  I’ve also made the possibly erroneous assumption that all physicians work 48 weeks a year.  Also, where I don’t have the data, I’ve tried to fill it in from other, less reliable sources.  Those figures have an asterisk next to them in the table.  Here’s what we end up with:

Now, I’m sure there are plenty of inaccuracies in this table.  For example, in my specialty (emergency medicine) there is a great survey I participate in every year, the Daniel Stearns Survey.  It showed the average emergency physician in 2010 made $278,000 in 1700 hours, for an hourly rate of $155, significantly more than this analysis shows.  But nonetheless, there are some useful trends to analyze.  For example, among specialties with three year residencies, hourly income ranges from $78 (FP) to $121 (EM).  Specialties requiring four years of training show a range from $94 (Psych) to $146 (Derm).  Five year specialties range from $117 (Gen Surg) to $187 (Ortho).  The only six year specialties I’ve included pay $179, although I know others tend to be relatively poorly paid such as many internal medicine-based and pediatric-based subspecialists.  I’ve always found it interesting that emergency doctors do a two year fellowship to specialize in pediatric emergency medicine only to make less money than they made before specializing.  Many other subspecialists, especially academicians, are in the same boat.

You can also see that if you want to get into the $100 an hour club primary care is pretty much out.  Procedures are where the big bucks are, not only as a general rule among specialties, but also within a specialty.  I find it embarrassing how much higher my reimbursement per time spent is from reducing a phalangeal dislocation or suturing a facial laceration compared to dragging a history out of an 85 year old demented patient and her family and reviewing her records.  If only I could get an entire clinic full of patients with nursemaid’s elbows then maybe I could break into “The 1%”.

Lastly, if you go to the trouble to calculate out your hourly wage (and especially if you do it on an after-tax basis), you can see what services you’re currently paying for that might be worth doing yourself.  For example, if you’re an FP, making $78 an hour, let’s say $52 after tax, and you’re paying someone $40 to mow your lawn, but can do it yourself in a half hour, then you might want to consider doing it yourself and making twice as much as you make at work.  On the other hand, if you’re an orthopedist, and have cut back on your hours to allow time to build on an addition to the house, you might want to consider hiring it out.  As I’ve mentioned before, managing your own finances and investments is still one of the highest-paying activities you can do, on an hourly basis.

Sticker Shock

There’s nothing quite like that first 5-figure paycheck when you get out of residency.  Of course, no one cares about “good” sticker shock.  What you notice is what appears to be a very high tax bill accompanying that 5-figure paycheck. Whether you see it as a withholding on your monthly statements, as quarterly estimated tax payments, or as a big check in April (with associated penalties and interest), the shock of realizing your tax bill just went up by over 10 times is one that drives doctors to make dumb financial decisions, like running into the arms of a commissioned salesman offering a product that promises to lower your taxes.

Tax Breaks Are Not All Equal

There are dozens of tax breaks available in our ridiculously complex tax code.  But they are not equal.  Many docs simply don’t understand that some are extremely valuable, while others contribute minimally, or even not at all, to lowering your tax bill.  This causes them to mistakenly skip the really useful ones, and focus instead on the ones that are much less valuable.

The biggest tax break I see attendings missing out on is maxing out their retirement plan contributions (or not starting an appropriate one in the first place.)  Every dollar you put into your 401K is a dollar you don’t pay taxes on.  And since that dollar is saved at your marginal rate, it may be worth up to 35 cents (plus another 3-9 cents in state taxes) in tax savings.  The best part about this is that you don’t have to spend anything at all.  All that money is still yours, you just don’t have to pay taxes on it.  I’m continually amazed to see docs putting large chunks of money into cash value life insurance and annuities when they haven’t even maxed out their 401K. A related mistake is not having access to enough retirement plan “space.”  If you are a business owner/independent contractor, you ought to have a 401K/profit-sharing plan/SEP-IRA/Solo 401K that allows you to shelter up to $50K.  You can add on another $10-50K into a defined benefit plan each year and up to $6250 into an HSA (Stealth IRA).  If you’re an employee, and these options aren’t available to you, it’s time to go to your employer and demand them.  When interviewing for a new employee job, this is the most important benefit to ask about.  The difference between being able to shelter $17K and being able to shelter $80K every year over your career will make a huge difference in taxes paid and the retirement stash available to you later.

Yes, you’ll have to pay taxes on that money eventually, but if done wisely, you’ll pay at far lower rates later.  Most docs don’t realize that the first $12K ($6K single) of your 401K withdrawals are tax-free each year, the next $17K are taxed at only 10%, and the next $53K are only taxed at 15%.  A retired married doc not yet getting social security can take out $82K and only owe $10K in taxes, an effective rate of 12%.  Saving money at 35% and spending it at 12% is a winning formula.  If you relocate for retirement to a state without income taxes, you may save up to 9% more on those withdrawals.  And that doesn’t even include the wonderful benefit of tax-free growth between the time of contribution and the time of withdrawal.

The next step down in the tax-break pecking order after tax-deferred retirement plans are other savings plans, such as the backdoor Roth IRA and 529 plan contributions.  Yes, these breaks are valuable, since you get the break, still have the money to spend, and get tax-free withdrawals.  But the amount of money saved on taxes for an attending isn’t nearly as significant.

Even less significant are the tax breaks you get for spending money.  This includes things like mortgage interest, property taxes, CME and other business expenses, alimony/child support, and charitable contributions.  Yes, it’s nice to have Uncle Sam subsidizing your lifestyle, business, and preferred charitable organizations, but it doesn’t necessarily make sense to spend a dollar in order to save 33 cents.  Better than a kick in the teeth, yes, but not the biggest bang for your buck.

Last on the pecking order are instances where you trade one tax break for another.  For example, annuities grow tax-free.  But when compared to a taxable investing account, you’re trading tax-free growth for a lower capital gains/dividends tax rate and a step-up in basis at death.  The difference just isn’t very significant, and may very well be negative for your particular circumstances, especially after fees.

Marginal Rates Are Not Effective Rates

Most of us are familiar with the tax brackets.  I’ll reproduce the 2012 tax brackets here for a married doc.

For some reason doctors think that if they make $300,000 they pay 1/3 of that in federal income taxes.  It just isn’t true.  The marginal tax bracket just means that they pay 1/3 of their final dollar in taxes.  This chart shows the effective tax rates for a married, single-earner, with two kids taking the standard deduction (most docs itemize so rates would be lower) and contributing 20% of his salary to retirement plans.

Yes, this neglects Medicare/Social Security taxes, state/local income taxes, property taxes, and sales taxes.  Rates would also be higher if you were single, had no kids, or chose not to save 20% of your income in tax-deferred accounts (which gets progressively harder to do as you get above $250K, usually requiring a defined benefit plan.)  But the rates are certainly much lower than you’d be led to believe if you didn’t understand the difference between marginal rates and effective rates.

Liability Phobia Compounds The Problem

As physicians, we’re also paranoid about being sued- by our patients, our employees, or our neighbors.  Physicians fail to appreciate how rare these suits are.  They also fail to appreciate how rare it is that the cost of one of these suits, if successful, isn’t paid by a reasonable malpractice, business, or umbrella insurance policy.  Beyond that, they fail to realize just what a small part of their assets is actually at risk by a successful suit that exceeds the insurance policy limits.  Although laws are state-specific, most states provide significant protection for your retirement plans and home value.  With simple asset protection plans (such as putting toxic assets such as businesses and rental property into an LLC), you can reduce that risk even further.

Tax-O-Phobia and Liability Phobia causes doctors to make dumb investments without consideration of the actual after-fee, after-tax return on the investment.  The most common ones are annuities, cash-value life insurance, limited partnerships, and accounts in overseas tax havens.  These are generally investments made to be sold, not bought, and are avoided by those who can get a grip on their Tax-O-Phobia.  The complexity (with associated scams), fees, poor returns, and illiquidity general outweigh any possible tax benefits.

In the Millionaire Next Door, Stanley and Danko have an entire chapter entitled “You Aren’t What You Drive.”  They note that only 23.5% of millionaires own a car from the current model year.  In fact, 55% of millionaires own a car older than 2 years old.  Most doctors aren’t even millionaires.  In fact, a large percentage of doctors in their 30s still have a negative net worth.  If most millionaires don’t drive new cars, why should a doctor?  Stanley and Danko write about what buying habits among used-car buyers reveal:

What factors explain variation in wealth accumulation?  Income is a factor.  People with higher incomes are expected to have higher levels of wealth.  But note again that members of this group of used-vehicle buyers have a significantly lower income than the average for the other groups of millionaires….Occupation is another factor.  We have noted many times that entrepreneurs account for a disproportionately large share of the millionaires in America.  Conversely, most of the other high-income-producing occupations contain disproportionately smaller portions of high-net worth types.  These include physicians…dentists….attorneys….

But there are exceptions.  For example, each of these non-entrepreneurial occupations is represented in the used vehicle-prone shopper group we are profiling.  Used vehicle-prone shoppers are unique even among their millionaire cohorts.  Note that, on average, they have the highest score values on all seven measures of frugality.  Behind their frugal behavior is a strong set of beliefs.  First, they believe in the benefits of being financially independent.  Second, they believe that being frugal is the key to achieving independence.  They inoculate themselves from heavy spending by constantly reminding themselves that many people who have high-status artifacts, such as expensive clothing, jewelry, cars, and pools, have little wealth.

Being frugal is a major reason members of the used vehicle-prone group are wealthy.  Being frugal provides them with a dollar base to invest.  In fact, they invest a significantly larger portion of their annual income than do any of the other types of vehicle buyers…the used vehicle-prone shopper group also contains the highest percentage of prodigious accumulators of wealth [those with a high net worth to income ratio.]

The majority of people do not have the ability to increase their incomes significantly.  Yet income is a positive correlate of wealth.  What then is our message?  If you cannot increase your compensation significantly, become wealthy some other way.  Do it defensively….They successfully innoculated themselves from contracting the high-consumption lifestyle that many of their neighbors adopted.  More than 70 percent of their neighbors earn as much or more than they earn.  But fewer than 50 percent of their neighbors have a net worth of $1 million or more.

You can save a lot of money on automobiles in two ways.  First, buy used.  New cars cost far more than it takes to maintain a used one.  Second, drive the car for a long time.  Even a new car buyer can get a great value if he drives the car for at least a decade.  Older cars also save you money on insurance and taxes.  They can even save you money on maintenance.  Who needs to fix a broken electric window or fix a little dent on a car with 150K miles?  But on your brand new one, you’re going to pony up some cash to keep everything working and looking sharp.

How much can you save?  Consider this.  Physician A buys a $30,000 car.  He drives it for 3 years, then sells it for $15,000 and repeats the process.  He will also pay more in sales taxes, registration fees, insurance, possibly maintenance, and most likely finance charges.  I’d estimate his cost of ownership at $7000 per year.  Physician B buys a $3000 car.  He drives it until it dies after 10 years.  Then he buys another one.  He paid cash for it (no sales tax), didn’t fix any of the little things, and paid minimal registration fees and insurance (liability only.)  I’d estimate his cost of ownership at $800 per year.  After 30 years, what is the difference between spending $800 a year on transportation versus $7000?  Invest the difference at 8% and you’ll get $702,000.  Yes, you read that right.  Is driving a new car worth $700K to you?  Most Americans retire with far less than $700K.  Multiply that by two, or even three cars, and you’ll quickly realize the sum of money available to the frugal driver.  The example might be a little extreme, but run your own numbers and see what you get.  I’m convinced that many Americans are kept in the poorhouse simply because of their automobile choices.  No consumption item, except a house, will make as much of a difference in your accumulation of wealth.

Now I realize full well that I’m a bit of an extremist on this subject. My parents have only bought two brand new cars in their entire life, and neither was bought during the 18 years I lived at home. I rode in beaters and I drove beaters, including a true Flintstone-Mobile due to a rusted out floor.  But they were able to raise 6 kids, own an airplane, and retire early on a middle class income.

I learned early on that you’re not what you drive (although I confess that in high school I was jealous of those guys with the jacked up little Toyota pick-ups.) In fact, my “first car” was an old Geo Prizm my parents sold to me for $3K as a college senior. I was just happy to get an interest-free loan from them. Prior to that time I rode a bike or got a ride, so this was a huge upgrade.

I sold it after 2 years for $2100 and we got another one for $6K.  I totalled it after 3 years, and the insurance company gave us $5500, which we put toward the next car.

My third car cost $8K.  It was totalled after about 3 years and we got about $7K for it from the insurance company.  Before it was wrecked we bought a second car for $1850, which was sold 4 years later for $1500.  We took the insurance money from the totalled car, and added it to our savings to buy the car we really wanted, which we bought 3 years old for $18,900 and are still driving.

Most recently, I bought a car a couple of years ago for $4350.  According to the blue book, I could sell it today for $6000.  As you might guess, I got a great deal on most of these cars, but even if you just pay the sticker price at a used car lot, you’re still going to be far better off than getting a deal on a brand new one.

Initially, I thought I was just saving money now so I could drive whatever I want to drive later.  After a few years driving beaters, I’ve realized I no longer care what I drive around in as long as it runs well, is comfortable to sit in, and can carry what I need to carry and pull what I need to pull.  I do like driving the $20K car better than the $5K car, but not 4 times better.  I probably won’t buy any more cars that cost less than $10K.  I simply no longer need to.  I’m 6 years out of residency, have no non-mortgage debt, have got a good chunk of equity in my home and rental property, have started college savings for the kids and have a portfolio on track to allow an early retirement.  Can you say the same?  Then what’s with the Lexus you share with the bank in your driveway?  I’d much rather have the ability to walk into a Lexus dealership and pay cash for a brand-new, top-of-the-line Lexus than actually have one in the driveway.

Some complain that they can’t drive an inexpensive used car because they need something reliable.  I just don’t buy it.  I haven’t commuted in a car with less than 100K miles….ever.  I’ve had to get a jump once on a cold morning after a night shift.  Replaced the battery that afternoon.  That’s it.  Even if you add on the cost of a AAA membership, you’re still not going to get anywhere near the cost of driving new cars.  Others worry about the cost of repairs on older vehicles.  It’s a rare car repair (not a collision) that costs more than $1000-2000.  Most are a few hundred dollars.  It doesn’t take long to pay for that when you don’t have a $500 a month car payment.  Even if you insist on having one nice car for road trips and driving the kids around, you can still buy a cheap commuter and save thousands.  Who says your car has to be as nice as your spouse’s?

In the end, spend your money on what makes you happy.  Do you need to drive $3K cars to be financially successful as a physician?  Certainly not.  But you do need to save and invest 20% of your income a year.  If you can’t do that AND buy an expensive car then you’d best line up your habits with your true priorities.  Just keep repeating “You aren’t what you drive….you aren’t what you drive” until you believe it.

1) Taxed at Ordinary Income Tax Rates

If the chief upside of investing in a VA is tax-deferred growth (i.e. the investment isn’t taxed each year on its capital gains and dividends), then the chief downside is that when you pull the money out it is taxed at your ordinary income tax rates rather than the lower capital gains/dividends rates a mutual fund would get.  Consider two investments with the exact same after-fee return (stop laughing and just IMAGINE for a minute), one is a mutual fund and the other a VA.  How long would it take before the benefit of the tax-deferral would make up for the lower tax rate at withdrawal?  Let’s assume a 33% tax bracket, a 15% capital gains/dividends rate, and an 8% after-expense return.

Variable Annuity- Grows at 8% per year, then at the end gains are taxed at 33%

Mutual Fund- Grows at 7.7% per year (assume 2% yield each year is taxed at 15% before being reinvested), then at the end gains are taxed at 15%.

When does the after-tax return on the VA first exceed the after-tax return on the mutual fund?  After 86 years.  What?  You don’t expect to live another 86 years?  Exactly.  Tax-deferral is valuable, but not that valuable.  Doctors, as a general rule, are paranoid about taxes because they don’t understand them very well.  This causes them to dive into “tax-shelters” that they never really needed anyway.

2) Lack of Flexibility

If I own a mutual fund in a taxable account, I can sell it any day the market is open and buy another one or just take the proceeds, pay taxes on them, and purchase a boat.  It takes far more time to surrender an annuity contract, get your money, and move on.  If you want to exchange one VA for another, you get to go see another agent, sign another contract, move the money etc.  The Etrade baby can’t swap one for another with a couple of clicks of his mouse, like he could with a mutual fund.  You can call and make changes WITHIN a variable annuity, but there’s usually a limit as to how often you can do this without paying additional fees.

3) Poor Investment Choices

Most VAs are chock-full of poor investment choices.  The “sub-accounts” (mutual-fund like investments within a variable annuity) are often poorly-performing, actively managed funds with little incentive to keep fees low.  Although you can get a variable annuity from Vanguard (in cooperation with an insurance company) or other mutual fund house with better choices, most of the VAs sold by annuity salesmen (insurance agents) are composed of inferior sub-accounts.

4) Surrender Fees

Annuities are supposed to be long-term investments.  With a fixed annuity, the insurance company takes your money and puts it into longer-term investments, like stocks and bonds, then pays you each month.  In order to allow it to do so, it needs to be able to hold on to your money for a long-term period, so to encourage you to leave the money there they instituted surrender fees.  When they started offering variable annuities, they carried the rather profitable practice over.  Surrender fees generally start at about 7%, generally decreasing by 1% a year.  Sounds like a load, no?  Would you buy a loaded mutual fund?  Of course not.  So why would you buy a loaded VA?  The company has to pay the salesman somehow don’t they?

5) Mortality and Expense Fees

Since a variable annuity is an insurance product, it has to provide some kind of an insurance function.  Usually this is a guarantee that even if you die your heirs will get the greater of the value of the account or the amount you invested in it.  This is a nearly worthless guarantee at a high price.  Let’s say you had a VA you’d put $100K into.  A typical M&E expense is 1.1%.  So if the value of the VA had decreased by 25% to $75K, and you died, your heirs would get $25K from “the policy” (plus the $75K from the annuity.)  It’s like a $25K life insurance policy.  You pay 1.1% ($1100 a year, and you’re covered for $25K or so.)  You might ask yourself at this point….how much is a $25K policy worth?  Well, for a 60 year old male, a 5 year term insurance policy goes for $249 a year.  So you’re paying over four times as much as you should.  Plus, the chances of you actually needing the policy aren’t that good.  If the account is worth MORE than you paid into it (and it darn well should be after a few years, it’s an investment after all), it doesn’t pay anything.

It’s interesting to compare a Vanguard Variable Annuity to a similar Vanguard Mutual Fund.  Keep in mind that Vanguard runs these things essentially at cost, so this likely reflects the true cost of that policy.

The ER for the Vanguard Total Stock Market Mutual Fund is 0.18%.  The total ER for the Vanguard Total Stock Market VA is 0.50%.  So Vanguard (and the associated insurance company) can do it for about 0.32%.  Why would anyone pay 1.1%, over 3 times as much?  Looks like insurance company profit to me.  I won’t even go into the other fees commonly detailed in the very fine print within the prospectus.

6) No Step-up In Basis

When you die with a mutual fund, your heirs get a step-up in basis.  That means, for tax purposes, that it’s as though they bought the mutual fund themselves on the day you died.  They can immediately sell it and owe no capital gains taxes.  When you die with a VA, all those earnings that have been deferred for years are fully taxable to your heirs, and not at the favorable capital gains rates either.  I can tell you which one I’d prefer to inherit.

7) Rebalancing Isn’t A Big Issue For Mutual Funds

Proponents of VAs frequently cite the fact that you can rebalance your portfolio without any tax consequences if you’re invested in a VA.  While that is true, the tax consequences of rebalancing can be minimized or even eliminated pretty easily.  First, you can do all your rebalancing within your IRAs, 401Ks or other tax-protected account.  Second, within a taxable account, you can use distributions of dividends and capital gains to rebalance.  Third, you can always use new contributions to rebalance.  In fact, studies show that it’s best to only rebalance every 1-3 years.  So far, after 8 years of investing, I’ve never paid taxes in order to rebalance.  I don’t anticipate EVER having to.  That might not be the same for everyone, but it is pretty easy to minimize the tax hit for most.

Also, keep in mind that it takes pretty serious market fluctuation to actually generate a need to rebalance.  Consider that you have a 50/50 stock/bond portfolio and wish to rebalance it if it gets off more than 5%.  How much more does the stock portfolio have to outperform the bond portfolio in a year for you to need to rebalance?  By about 25%.  What percentage of the time are your stock and bond returns more than an absolute 25% different?  Not very often.

8) You Shouldn’t Be Market Timing Anyway

Proponents also argue that being able to swap funds around within the VA without tax consequences is a huge advantage for an aggressive investor.  While ignoring the fact that most mutual fund investors have enough assets within tax-protected accounts to do plenty of tax-free market timing, the truth is that the less jumping around between investments, chasing performance and timing the market you do, the better your returns are likely to be.  Buying and holding a static asset allocation takes the emotions out of investing, and produces better returns over time.  You’re not Warren Buffett.  Get over it.

In short, variable annuities are for the most part an investment made to be sold, not bought.  There may be a role for one in a few, very limited circumstances, primarily for those who mistakenly bought an expensive one and wish to transfer into a less expensive one or for those with little tax-protected space who wish to invest in very tax-inefficient assets such as TIPS or REITs.  You will likely be better off not mixing insurance with investing.  Don’t be so afraid of taxes that you let the tax tail wag the investment dog.  There are far worse ways to invest than in tax-efficient asset classes within a taxable account.

Regular readers know I’ve been tinkering with investments through both of these organizations, but only in small amounts in a taxable account.  As I become more comfortable with the concept, I am considering allocating up to 5% of my portfolio to these consumer loans.  But I don’t want to do that in a taxable account.  So I was pleased to see that both Lending Club and Prosper have made it possible to invest with them through IRAs.  As you might expect, there’s a few catches, and these are predominantly high fees.  There’s no Vanguard or TSP in this realm.

Neither Prosper, nor Lending Club, offers IRAs directly.  They offer them through IRA custodians, Sterling Trust in the case of Prosper, and SDIRA Services for Lending Club.  These are custodians that you might use if you wanted to hold physical gold or other less traditional assets in an IRA.  You can’t currently hold P2P loans in an IRA at a mutual fund company like Fidelity or a brokerage account like eTrade.  These custodians, just like Lending Club and Prosper, want to make a profit, and they do this through fees.  Those, unfortunately, come directly out of your return.  So you have to assess the cost of these fees against the tax savings you get by holding the loans in a tax-protected account.  They advertise these IRAs as “No-fee IRAs” but as you can see, that’s not completely true.

IRA Fees at Prosper

Your fees at Prosper are exactly the same as they would be in a taxable account, 1% of all the payments made by the borrower, plus fees associated with collection efforts.  Sterling Trust, however, has a whole new set of fees you need to be aware of.

• Annual Fee (includes first year) : $200 (increases if > $250K invested)
• Termination Fee: $200 (You pay this when you move assets away from Sterling Trust)
• Wire Fee: $30
• Withdrawal Fee: None

Prosper will cover that $200 annual fee IF you put a full $5K into the account when you open it, and one year later have at least $10K in the account (and keep at least $10K in there.)  You’re on your own for the termination fee.

IRA Fees at Lending Club

Fees at Lending Club are similar, 1% of all payments made plus collection fees.  SDIRA Services has a different fee schedule:

• Annual Fee: $100 according to Lending Club, $300 after the first year according to SDIRA
• Paper Statements Fee: $20
• Termination Fee: $150
• Withdrawal Fees: $25 (wire) $5 (check) $0 (regularly scheduled ACH transfer)

Lending Club, like Prosper, will waive (pay?) the annual fee if you fund the account with $5K, then have $10K in there within a year and keep it in there.

Beware of fees

What kind of impact can these fees have on your return if you’re not careful?  Consider an investor who opens a $5000 IRA at SDIRA in order to invest at Lending Club.  Let’s say he keeps his money there for two years, earning a 10% return, and then decides to roll it over elsewhere to invest in something else.  His annual fee is waived the first year but is $300 the second year.  Then he pays a $150 termination fee.  He also paid a $20 paper statement fee each year.  He earned about $1000, then paid about $490 in fees.  Instead of the 10% annualized return he earned, he now ends up with close to a 5% annualized return.  That sucks.

How can you minimize these fees?  The main way is by starting big.  Make sure you get $10K in there within a year.  The easiest way is to just roll over part of your IRA or Roth IRA from another custodian.  While these guys can probably do a backdoor Roth IRA, I think I’d rather trust Vanguard with that, then just do a rollover.  I saw a per-asset fee for Roth conversion at one of the companies, but it’s unclear how they would treat cash in a conversion process.  You should also make sure you select electronic statements when you open an account at Lending Club/SDIRA.  You can minimize the termination fee by investing more money (so it is a relatively smaller percentage of assets) and by leaving the money there for a long time.  It’s pretty obvious that an IRA isn’t the place to experiment with Peer to Peer Lending.  You should do that in a taxable account first.  When (and if) you’re convinced you want to make it a significant part of your portfolio long-term, then you can look into an IRA.

What about the bonuses?

Lending Club advertises that you get a cash bonus for opening/rolling over an IRA.  Don’t get too excited.  You have to rollover at least $25K to get any bonus at all (0.5%, or $125) and $250K to get the maximum 2% ($5K bonus).  It will take much time (and much hassle) to get that much money invested at Lending Club within 90 days.  Trust me when I say you’ll earn your $125.  You can automate the process somewhat, but I’d still recommend you forget the bonus and move over a smaller amount at a time.  $5K is doable.  $250K would make you a giant on the P2P scene.  According to Lendstats, there are only 25 investors at Prosper with more than $250K invested.

What about defaults?

Defaults are common with peer to peer lending.  That’s why the rates on these loans are generally over 10% and often exceed 20%.  A loss due to default can normally be claimed on your Schedule D.  Not so when you invest in an IRA.  However, that shouldn’t matter. In a taxable account, you offset your losses with your gains and only pay taxes on the gains minus the losses.  In the IRA, you still only earn the gains minus the losses.  You’ll still come out ahead in the IRA, as long as you watch those fees.  In fact, now that you can eliminate the hassle of having to fill out Schedule D for all those defaulted loans, you’ll be much better off.

Would you like to get started?

One of the ways this website makes money is through advertising and affiliate sponsorships.  Both Prosper and Lending Club pay me a small commission if you open an account through links on the site.  If you think you’d like to get into P2P Lending, via a regular account or an IRA, please use the links below:

Prosper Regular Account

Prosper IRA

Lending Club Regular Account

Lending Club IRA