Resident/Student Resources: Personal Finance

A Resident's Guide to Money
Effective Strategies on Debt, Investing, and Money Management

- Mark Reiter, MD MBA -
University of North Carolina Emergency Medicine

Written for EM residents by an EM resident, this guide will offer you straight talk on a variety of strategies to help you take your financial future into your own hands. It is not written to give an exhaustive review, but rather to introduce you to these opportunities and to dispel many of the misconceptions that deter many from maximizing their money. Please note that the relevancy of the following information will be affected by changes in the economic and political climate.

Student Debt and Salaries

The average resident finished school with $115,218 in student loan debt in 2003, with 25% carrying > $150,000 in debt (AAMC). At the same time, many residents have huge expenses as they enter the next stage of their life, such as purchasing a home and starting a family. The average 2004 EM PGY-1 salary is $39,291 (FRIEDA), which barely covers living expenses and leaves little for loan payments, investing, or meeting your lawyer friends for drinks.

Sure, there is a light at the end of the tunnel. The average 2001 starting salary for an emergency physician is ~ $162,000 and rises to an average of $219,960 later on (AMGA). And when you look at your hourly wage, you'll be happy to see you'll only have to log 10 minutes of clinical work to earn enough to fill up your car's gas tank as an attending, rather than the 3 hours you need to log as a resident (yes, housekeeping earns more per hour than housestaff). However, future (inflation-adjusted) salaries may fall significantly if current trends such as decreasing Medicare reimbursement and rising medical liability premiums continue uninterrupted.

Regardless, in order to best achieve your future financial goals, it is essential that you set the framework for intelligent financial decisions NOW.

Loans

Most of your student loans have an interest rate equal to the 91-day T-Bill yield just prior to June 1st each year, plus an additional 1.7% while in school, grace, and deferment periods, or an additional 2.3% during repayment. The government, never one to leave anything on the table, will round up to the nearest 1/8th %. For 2004-2005, this works out to:

This rate is .05% less than 2003, and is the lowest rate in the history of the student loan program.

When you consolidate your loans, you effectively lock in the current rate set each May 31st, which then goes into effect on July 1st. A popular misconception is that you must race to lock in what are historically very low rates for fear that they will rise significantly. However, the rate will not effectively change until July 1st rolls around each year, allowing the wise resident to consolidate their loans before this period if interest rates have risen over the preceding year, or to hold off on consolidating after the new rate goes into effect if interest rates have fallen. If you get palpitations when you open the newspaper's financial section, you're better off asking your friendly local medical school financial aid officer when May rolls around whether the loan interest rate will be rising or falling for the following year, as it is widely publicized. Don't wait until the very last minute to make your decision, as you should leave several weeks for processing time.

If you are eligible for deferment, the best time to make your decision on whether to consolidate will be in early June each year. If rates will be rising significantly, consolidate before July. If rates will be falling significantly, delay your decision to consolidate for one more year. If rates will be stable or fall a small amount (less than .1%), you should (as long as you aren't very risk-averse) delaying your decision to consolidate for another year, in the hopes that rates will fall significantly a year from now.

If you are not eligible for deferment or if your eligibility period is ending, you'll want to take a different strategy. Your effective consolidated rate will be .6% lower if you consolidate during grace period or deferment, rather than during repayment. Therefore, you will want to consolidate towards the end of your grace or deferment period, unless interest rates are on track to fall by significantly more than .6% between the end of this period and June 1st of the following year. In other words, consolidate at the end of your grace/deferment period if rates have risen, stayed firm, or have fallen by significantly less than .6%. Delay consolidation if rates have fallen by significantly more than .6%. If rates have fallen by about .6%, it's up to you if you want to roll the dice and delay consolidating, hoping that rates will fall further.

Loan consolidation allows you the opportunity to simplify your payments and if done correctly, will save you a significant amount of money in the long run. Some consolidators, such as Sallie Mae (www.salliemae.com) offer such treats as a 1% rate reduction after 36 to 48 consecutive monthly payments on time, a further .25% reduction for automatic payment from your checking account, and the possibility to lock in the .6% lower grace period rate (this effectively ends your grace period, so make sure to have this go into effect right before the six months end, so you maximize your advantage). Taking advantage of each of these perks, would allow you to knock your interest rate down to as low as 1.625%, compared to 3.375% without consolidation (using 2004-2005 interest rates).

Most medical school financial aid offices will advise you to pay off your loans in the shortest possible amount of time. Do NOT listen to these misguided persons. You should pay your loans off over as long a period as possible, usually 30 years. As previously mentioned, with proper planning you can reduce your loan interest to well below 2%. This is an incredible deal that the rest of the world isn't allowed in on. If anyone could get a loan at this rate, everyone on Wall Street would be tripping over each other to sign up for the largest loan possible, realizing they could be virtually guaranteed to earn a rate of return considerably higher by putting the money to work in safe investments over a 30 year period (see Investing section). So, since we can no longer increase the amount of our loans, we should do the next best thing; pay our loans off over as long of a time period as possible, so we do not prematurely give back our great deal of a rock-bottom loan rate. In the future, when loan interest rates rise to higher levels, such as 6%+, the different between what you expect to earn on the money versus what you will be paying in interest narrows quite a bit, so you should re-evaluate whether extending the loan period is the best choice.

Furthermore, the best payment plan to maximize your financial future in the face of dramatically low interest rates is the "graduated repayment" plan, whereby your payments are lowest early on (only covering interest) and increase over time.

For similar reasons, you should defer your loans whenever possible. Subsidized loans will continue to have interest payments paid by the government during deferment, making this strategy a no-brainer. Also, you will still be eligible for deferment if you choose to consolidate your loans during the grace period (despite a popular myth).

Please note that this strategy is only successful if you have the financial discipline to use the extra cash flow you are saving by "backloading" your loan payments, in a manner that will allow for a rising income stream by smart investing (See Investing and Roth IRAs). If you blow all your cash on cheap booze and pretty women (or men), you'll just be digging yourself into a hole, and may be better off following the traditional financial aid dogma of paying off loans as soon as you can.

Credit Cards

High interest rate (>10%) debt should be avoided at all costs. Incredibly, the typical U.S. household at the end of 2002 owed an average of $8,940 (CardWeb.com). This is a big no-no. Most credit card debtors will pay between 10 and 30% interest on the balance, which can add up to thousands of dollars wasted each year. If you're not in a position to use dollars bills as toilet paper, now is the time to wisen up. You must pay off your credit card debt ASAP through belt-tightening, and if necessary, using the extra cash flow from deferring student loans or extending the repayment period for student loans or home mortgages, which each have dramatically lower interest rates.

If you have the discipline, you have another option to reduce your interest charges. Many credit card companies are now offering promotions where they will give you 0.0% APR for a year or longer on balance transfers. I would recommend you take advantage of these offers rather than paying high rates on your existing balance. Of course, you'll need to save the money you would otherwise be using to make payments on the high-balance credit card, and make sure you'll be in position to pay back in full within a year or risk costly penalties. Your next move would be to put the money to work in a conservative, liquid investment such as a money-market fund. So, if you're paying 15% interest on a $10,000 credit card balance, if you transfer the balance to a 0.0% card, and conservatively invest the money you would be using for payments, you'll save $1500-$2000 a year. Remember, if you instead decide to use your payback money on that "can't lose" roulette system your buddy told you about, you're digging your own coffin. Granted, if you're "that guy," few companies are going to offer you a decent deal anyway.

If you've got decent credit, make sure you are using the best credit card for you. If you're currently paying an annual fee, stop reading, pick up the phone, and cancel your card immediately. Paying an annual fee on a credit card is worse than paying for scrubs. Likewise, there are dozens of credit cards that offer 1% + awards towards cash, flights, etc., that would love to have the business of a fine, upstanding citizen like yourself.

It is also important to take steps to protect your credit rating. With a good credit score, you may be able to get better rates on home loans, car loans, credit cards, insurance, etc. There are many factors that favorably influence your credit score, such as an on-time payment history, a long history with a lender, and staying well below your credit limit. Unfortunately, despite your good intentions, a staggering number of credit reports have errors that can hurt your credit score. Since it is unlikely that the ex-McDonalds workers that work at the credit reporting agencies will ever thrive in an environment without hamburger pictures on the computer buttons, you need to protect yourself. Even the federal government has thrown its hands up in the air on this one, and as a result has passed legislation entitling you to one free credit report each year from one of the major credit reporting agencies (Experian, TransUnion, and Equifax). So, each year, get your free credit reports, check for the inevitable errors, and file for a correction.

Mortgages

Many residents will buy their first home during or shortly after residency. Since most can barely afford a haircut, let alone a house, you'll need a mortgage. First, decide between a 30-year or 15-year repayment plan. A 30-year repayment plan makes the most sense as long as interest rates remain relatively low, especially since you are able to tax deduct your mortgage interest. Next, decide between a fixed rate and an adjustable rate mortgage (ARM). The 30-year fixed is the most popular mortgage, however, for most residents, an ARM is a better choice. Most ARMs are at a fixed rate for 1, 3, 5, or 7 years (ie. 1/1 ARM, 3/1 ARM, 5/1 ARM, 7/1 ARM). After this period expires, the ARM interest rate will go up or down depending on the bond market. ARMs offer a lower interest rate than fixed mortgages, since you are assuming part of the interest rate risk after the fixed period expires. You can think of a 30 year fixed mortgage as a 30/1 ARM. Typically, the shorter the fixed period, the lower the initial interest rate, and the higher the eventual risk. Still, many residents will be buying a "starter home." If you plan on moving to another home in five or so years (as you'll have more income and perhaps a larger family, or may move to another area), you would benefit from paying the lower rate on a 5/1 ARM, and won't be taking on any extra risk since your mortgage will end if you sell the home after five years, and you won't be affected if the interest rate rises.

Many lenders won't offer a mortgage to residents because of a lousy debt/equity ratio due to massive student loan debt. Some lenders won't count your loan debt if you can supply a letter from your financial aid office detailing that your loans are in deferment, and you do not have to make payments until a later year. Some lenders won't work with you no matter what you do, especially if you have lots of debt and are not eligible for deferment.

Unless you can come up with a 20% down payment, most lenders will require you to buy private mortgage insurance (PMI) which adds to your monthly payment. An alternative option is to cover some or all of the down payment with a "piggyback" loan, which is an additional home equity loan on the house you're about to buy. The piggyback loan will be at a higher rate than the original mortgage loan. You'll have to run the numbers to see whether a piggyback loan will offer a better deal than PMI. In some areas of the country, lenders such as Wachovia and Bank of America have a physician loan program, whereby they allow you to make little or no down payment without having to purchase PMI. These programs recognize the unique circumstances of residents, while the majority of lenders think we're deadbeats. If you have access to such a program, it's almost certainly going to be the best deal available.

Tax Deducting Loan Interest

The Economic Growth and Tax Relief Reconciliation Act of 2001 (H.R.1836) increased the income limits for which student loan interest payments are tax deductible to $65,000 for single filers and $130,000 for married persons filing a joint return. It also eliminated the 5-year time limit and the restriction against voluntary interest payments. You can deduct up to $2,500 a year. This change in the tax code will put a little money in your pocket, but won't be a huge windfall. As a resident, you'll be able to take the full $2,500 deduction if you've got tons of loans and you've got tons of spare cash to start paying. However, since you'll be in a low tax bracket due to your pathetic salary, you'll likely save less than $700 a year. A few years later as an attending, you'll have the spare cash to be able to easily afford loan payments and will be in a higher tax bracket allowing you to benefit more from a tax deduction. Unfortunately, at this point, your salary will be above the income limits and you'll not be eligible for the deduction, a classic Catch-22. The AMA and other groups are fighting to remove the income threshold, so keep your fingers crossed. Meanwhile, you'll benefit much more from plowing your extra cash into a Roth IRA (see Roth IRA section) during your residency years, rather than grabbing a few hundred bucks in extra tax deductions.

Roth IRA

Opening and fully funding a Roth IRA is the most important financial move you can make as a resident. You can open a Roth IRA in minutes at virtually any online broker. As you can see in the chart below, fully funding your Roth IRA each year is going to take quite a bit of cash, which won't be easy on your laughable salary. Still, do everything in your power to come up with the money: cut your expenses, defer your loans, check the hospital vending machines for loose change. Why the hurry? As you can see from the other chart, by the time you've earned your first full year's salary as a full-time attending, you'll be over the income threshold and will no longer be able to contribute to your Roth IRA. So, you only have about 3 or 4 years to plow a significant pile of money into your Roth IRA…for most physicians, it's a one-time chance. Note that you can fund your yearly contribution up until tax day (April 15th) of the following year.

Now you're probably thinking, "Why should I live in squalor for several more years just to throw ~ $15,000 of my hard-earned cash into a Roth IRA?" The answer: an expected retirement nest egg of over $340,000 thirty years later for your troubles (assuming 11% annual rate of return), about triple the return you would have by investing the same amount of money if you were paying taxes on your profits each year. You'll likely never have as favorable an opportunity to safely make so much money on a small investment, so make sure you take the chance.

Roth IRAs became available for the first time a few years ago, and I consider them the best opportunity the government ever gave the American taxpayer. All profits (capital gains) made on investments held in a Roth IRA are not subject to any taxes. The lack of taxes allows you to earn much, much more money on your investments since a significant portion of your return is not being eroded by taxes every year (you'll likely be in the highest tax bracket). The tax-free rate of return becomes especially valuable when compounding is taking into account (see Investments Section).

You can only withdraw money from a Roth IRA prior to retirement age without significant penalties for a few purposes, such as buying a home and certain educational expenses. However, you'd be a fool to tap into your Roth IRA even for such expenses. You want to use your normal taxable money to pay for your house; the last thing you'd want to do is use up the stash of tax-free money in your Roth IRA. Remember, your top financial goal during residency is to maximally fund your Roth IRA. You don't want to negate that important work by paying for anything with these tax-free funds.

The Bush administration has a plan for a new type of retirement savings account that would replace and improve upon the Roth IRA. Overall, the taxpayer would be able to save up to $15,000 a year in a tax-free account, with fewer restrictions, and most importantly, no income thresholds. This would be a very beneficial for physicians, but only time will tell whether this proposal will become a reality.

Investing and Money Management

Despite the millions of pages published on investing (mostly crap), the subject is widely misunderstood and many potential investors are scared away. Investing is the long-term key to your financial future, with your Roth IRA being the most powerful weapon in your investing arsenal.

For the past 75 years, the most widely followed stock index, the S&P 500 (an aggregate of the 500 largest U.S. firms) has returned an average of 11% return per year. Returns over the past few decades have been even higher. The stock market can be quite volatile from in the short run (the S&P has a standard deviation of ~ 20%), and there will be lows along with the highs (2001 was one of the worst years of the century). However, in the long-run stocks are extremely safe; in the 200+ years of the U.S. stock market there has never, ever been a 20-year period where stocks have not returned a profit.

A common misconception is that cash, CDs, and bonds are safer than stocks in the long-run. For the last 50 years, annual inflation rates have been 4.1%, and have been much higher during certain periods (such as the 1970s). Any time that inflation is higher than your rate of return, you lose money. You're virtually certain to lose money on "real terms" (including inflation) when holding cash, and will likely make paltry profits with some risk of losing money on real terms when investing long-term in low-interest paying CDs and government bonds. Corporate bonds can offer a good rate of return, but the safe, rock-solid companies generally only pay slightly better interest than government bonds, while the good returns are usually just available on small, risky companies. If you're going to take such a risk, you're better off purchasing stock in the company, as stock returns have historically offered almost twice the rate of return of corporate bonds.

However, there is definitely a major role for these instruments in the short-term. If you expect to need access to your money in the short-term (weeks to months), it isn't prudent to have those funds in the stock market, where your fortunes can fluctuate significantly on a day-to-day basis. Keeping the money in a checking account makes sense, but storing those funds in an interest-bearing money market account is a smarter move. Money market accounts, offered by all brokers, invest money in ultra-safe short-term government securities (such as U.S. Treasury bills) and pay higher interest than virtually all interest-bearing checking accounts, and similar amounts to most bank CDs. Still, you can access your money immediately and write deposit and withdrawal checks against the account just as you would a normal checking account. You'll probably still need a regular checking account as many money-market funds charge fees if you write lots of checks each month. You should place any significant amount of cash you'll need in the short term in money-market funds, as they offer a similar rate-of-return and risk profile as CDs and government bonds, but allow much more liquidity and less hassle. In addition, you should always keep a few months worth of expenses deposited in a money-market fund in case you need extra cash for an unexpected emergency.

In the intermediate term (months to years) you should use a mixture of short-term strategies and long-term strategies.

For the long-term (years to decades), you should put any money you can spare into the stock market, as you'd be foolish to pass up on the superior returns and long-term safety of the stock market. To reiterate, use money you can afford to lose, as anything is possible in the short-term. It's important to get started as early as possible, as most of your success will come from the long-term compounding of your investment profits. In the following chart, take a look at the huge difference over a 30-year time period between investing in stocks (expected 11% rate of return) versus investing in government bonds and CDs (expected 4% rate of return). Also note the enormous advantage of a Roth IRA compared to a taxable account, and the impact of prudent tax planning on your long-term profits.

At this point, you may be convinced the stock market makes good sense in the long run, under the assumption that you could achieve such a high rate of return. Still, you may be thinking, "I don't know anything about stocks. I could run a code with half my brain tied behind my back, but I don't know the first thing about P/E ratios or cash-flow statements." Investment professionals have worked for years to convince most Americans that they can't be successful in the market if they go it alone, and they'll need to rely on high-priced investment advisors if they want a piece of the action. However, with the arrival of several new investment vehicles over the last decade, as well as the ease-of-use of most online brokerages, any reasonably intelligent resident can achieve a long-term rate of return similar to that of the S&P 500 with minimal work, no advanced knowledge, and no need for expensive help from investment advisors and traditional brokers. You don't need to pay someone to manage your money; I'll show you how.

Exchange traded funds (ETFs) offer an excellent opportunity for both novice and experienced investors to earn a rate of return similar to the overall stock market with minimal effort and know-how. ETFs are aggregates of the major stock market indexes, but can be bought and sold like any stock. The three most popular ETFs are SPYDERS (ticker: SPY), which mirror the S&P 500 (the 500 largest U.S. companies), DIAMONDS (ticker: DIA), which mirror the Dow Jones Industrial Average (30 large U.S. companies), and CUBES (ticker: QQQ), which mirror the Nasdaq 100 (the 100 largest companies on the Nasdaq exchange, mainly technology companies). Generally, the S&P 500 (SPY) is the least volatile of the three and is the standard that most stocks and mutual funds are compared to. The 11% historical rate of return of the stock market refers to the S&P 500. DIA and QQQ are generally more volatile than SPY, and typically offer better returns than SPY in a good year and worse returns in a bad year. DIA and QQQ are more volatile because they are an aggregate of fewer stocks (30 and 100 versus 500) and because the companies within each index are not as diversified as SPY. There are dozens of other less well-known ETFs available, but many of them are sector/industry-specific and will subsequently be much more volatile since they are not as well diversified.

So, even if you know nothing at all about the stock market, you should be able to earn a solid rate of return by simply buying shares of an ETF and holding for years or decades. You do not need to keep track of any developments or know anything about investment analysis, just buy the shares, and put your portfolio on autopilot. By buying an ETF like SPY, you already have the advantages of a diversified portfolio (low volatility) by buying only one stock (which mirrors the performance of 500). Don't bother trying to predict whether the market is going up or down and whether it's a good time to buy or sell. Very, very few Wall Street professionals have shown they can time the market with any consistency, and you shouldn't try. Several studies have shown that investors that buy and hold over the long-term outperform those that trade frequently, mainly because they have less transaction costs and are fully invested in the market more often. The timing of your investments should be based on the timing of your income and expenses. Simply put, anytime you have money that you won't need to tap into for several years, you should fully invest it in the stock market. Also, realize there will be short-term peaks and valleys; the successful, disciplined investor will not panic and sell their holdings when prices dip and miss out on the inevitable recovery and new highs.

Mutual funds and hedge funds are popular choices for many investors. In both, a team of finance pros trades dozens of stocks each year for the benefit of its investors. Mutual funds allow you to buy and sell your shares in the fund at any time and have relatively low expenses, but they are subject to several regulations that make it more difficult for them to take advantage of market opportunities. Hedge funds often require you to have your money locked in for several years at a time, often take ~ 20% of the profits as their management fee, and are relatively free to operate as they wish. The great majority of mutual funds, after fees and expenses, offer a rate of return lower than that of the S&P 500, even though they are typically more volatile. Very few mutual funds have consistently performed better than the S&P 500 over a long-term period. Generally, funds with the lowest expense ratios (fees) have outperformed funds with higher fees. Hedge funds are often much more volatile than the S&P 500 and mutual funds. Few hedge funds consistently beat the S&P 500, and those that do are often only available to a select group of wealthy investors. There are also several mutual funds and hedge funds that offer unique opportunities to earn a good rate of return without being correlated to the market's fortunes as a whole. For example, the Merger Fund (ticker: MERFX) earns its profits by taking advantage of the arbitrage spread when two companies merge; it has earned an average of over 10% a year since it was formed and has virtually no correlation on the stock market as a whole. Overall, mutual funds and hedge funds offer lower returns and higher volatility than ETFs such as SPY. In addition, there's more work for the novice investor to identify high-performing funds with a risk profile you are comfortable with. Still, for motivated investors who don't mind doing a little research, there are certainly good opportunities out there.

Individual stocks should only be traded after you've acquired substantial investment knowledge and discipline. Individual stocks, especially of smaller companies, are much, much more volatile than most ETFs and funds. Although many investors can achieve a better rate of return trading individual stocks than the S&P 500 for a year or two, very few can beat the indexes over the long-term. A stock's price is a reflection of all known information about the company and its prospects at that precise moment, adjusted for supply and demand, and investor psychology (greed versus fear). When buying individual stocks, you are, unfortunately, not on a level playing field. The price of a stock is largely influenced by large investors and investment banks that have access to much more information than you do about a company. You may diligently read all publicly available information about a company, but that simply does not compare to major investors that are having lunch with the CEO of the company and have a team of analysts consulting with experts in the field. You should never buy or sell a stock on breaking news, as almost always the "big money" will have learned the information and acted on it well before you.

The only way to consistently make a high return buying individual stocks is to have a better understanding of a company's prospects than the Wall Street big-shots. As a physician, you may be in a position where can out-analyze the Wall Street analysts for a select group of medically related companies. You may have a better understanding of how well certain medical devices, pharmaceuticals, practice management software, etc. may be received by physicians and patients than even the most informed MBA, who nonetheless lacks an MD and is not in the trenches with you. However, realize that for most of the larger (multibillion) healthcare companies (includes most pharmaceutical companies), the Wall Street folks will hire several MDs, scientists, etc. as consultants for investment analysis. Therefore, your best opportunities will be with less-known, smaller healthcare companies. Of course, you'll still need to have a thorough understanding about the company's management, finances, product, competition, etc. Since most physicians will not be able to devote enough time to learning the art of stock trading and to researching a stock in depth, you should rely on ETFs and mutual funds rather than trading more volatile, individual stocks.

Investment professionals love to say the word "diversification" until they are blue in the face. They hope to convince you of the dire need to be completely diversified, and that you will need their services to accomplish it. Diversification refers to having your eggs in many different baskets. By investing in an ETF or broad-based mutual fund, you will be very well-diversified within the U.S. stock market. Sure, if the U.S stock market tanks, such as in 2001, you will lose money in the short-term. However, you do not need to be in a rush to further diversify by investing in international stock markets, bonds, real estate, and other investment vehicles. Diversification does help to lower the volatility of your profits and losses. However, if you play it smart, and are investing for the long-term, your very good years will offset your very bad years; time is the only risk-reducing strategy that you need. However, when you are old and fat, and approaching the end of your illustrious life, further diversification does make sense, as anything can always happen in the short term. I have heard several talks by different investment professionals who try to explain that diversification will allow you to earn overall higher returns. This is complete nonsense, and goes against everything I learned in high school math.

There have been thousands of books and articles written that offer strategies on how to beat the market. By definition, virtually all are useless. Rarely is there any merit to any published strategy, as it would be much more profitable for the author to keep it a secret rather than offer it to the masses. Furthermore, the "efficient market theory" notes that any published strategy that works will be quickly adopted by the masses; by the time you could ever take advantage of it, the opportunity will be gone. Investing books can be useful to teach novices the fundamentals of evaluating a company. However, don't expect to make a windfall by finding a hidden gem with a low P/E, high PEG, and technical analysis that shows its poised to break through its 180-day moving average (don't worry if you don't understand these terms)…rest assured, if you found this hidden gem, countless other, more informed investors have as well, and the price adequately reflects their superior knowledge. Daytrading is also a sucker's bet, as you try to react faster to changing market information than major investors with multimillion dollar information systems and trading platforms, all while racking up huge trading fees.

When investing in the stock market, you should be aware of the huge impact of taxes on your long-term profits. Note the tax rates for your investment gains in the following chart.

In addition, state and metro taxes can add further to this tax burden. Take a look at the chart a few pages back that illustrates the enormous impact taxes can have in your long-term gains. As you can see, lots of short-term trading results in high tax bills that lower your effective rate of return; this is especially damaging as your profits compound in the long-term. Mutual funds, large individual stocks, and some bonds, typically pay a dividend each year, guaranteeing a taxable event that cannot be delayed. On the other hand, if you hold a non-dividend paying investment for a very long time, say 10 or 20 years, you will not owe taxes on your capital gain until you sell the investment, which allows your profits to grow faster since the long-term compounding is not diminished by frequent tax bills. Since ETFs are a diversified aggregate of the market and do not have a yearly dividend, they are ideal investment vehicles to buy and hold for decades, as you need not be concerned about needing to sell based on the prospects of an individual company or the (mis)management of a mutual fund or hedge fund. In a Roth IRA, you pay no taxes ever, and greatly increase your effective rate of return, especially after compounding.

Investment Brokers

It's easy to get started investing online. In the time you spent reading this guide, you could have opened up an investment account with an online broker. I'd recommend only using a well-known online broker, as some tiny firms may not be legitimate (you don't want to be funding some scam artist's coke habit). When choosing a broker, you'll want good customer service, reasonable trading commissions (typically less than $20/trade), and a website that you find easy-to-use. Good choices include TD Waterhouse, Scottrade, and E-trade.

A recent trend among online brokers is the "inactivity fee" or "maintenance fee" where you may be charged $25-$100 a year to maintain your account. Read the fine print, and generally choose a broker with minimal or no account fees. If you have a significant account (>$10,000) feel free to call up the customer service rep and ask them to waive all maintenance fees for your account…many firms will do this if you ask. Also, before you sign up for an account, do a Google search for promotions with the broker you're interested in; most likely they will offer either a cash reward or free trades if you sign up through the promotion site.

Before online brokers, all investors used traditional brokerage houses where they invested in person or on the phone. I strongly advise against this practice. Traditional brokers are much more expensive, generally charging 3-10 times as much commission per trade, and often have high annual fees, often as a percentage of your invested assets. You get no benefit whatsoever from using a traditional broker. Making a trade online is easy, should not ever take more than a few minutes, and if you have rocks for brains, you can always use the online help or call up the customer service rep. In addition, you do not need a stockbrokers help to make investment decisions, as each broker's investment knowledge and moral fiber varies considerably. Often, a stockbroker's "hot tip" is a recommendation to invest in the company in which they will receive a larger trade commission. Remember, if a stockbroker really does know something special about a company and you profit based on his/her "inside information," then you have violated federal insider trading laws and could face stiff fines and/or prison time (insert inappropriate rectal exam joke here).

Conclusion

I hope this guide has shown you that effective financial strategies can allow you to take control of your future and require minimal time, effort, and prior knowledge. Best of luck!

Feel free to send feedback to mreiter@unch.unc.edu. Individual questions will generally not be answered.

DISCLAIMER: This guide should not be construed as investment advice. You are fully responsible for your own investment decisions.

Revised 12/1/04.