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Tax Efficient Investing for the Medical Professional
Posted in Wealth Management Solutions | Sep 2010 | Comments (0)
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If you are like most medical professionals, you are already up to your ears in brokers, insurance salespeople, financial advisors and tax practitioners. In an attempt to manage all of the variables that affect your finances, you have likely found yourself frustrated, saturated and with no clearer an understanding than before you endeavored to untangle them. With these frustrations in mind, I present a more holistic approach to investment management. In this article, I will address investment portfolios; future articles will tackle tax planning, succession planning and insurance summaries.
Today’s most prevalent wealth management model is, “Keep as much of what you make as is legally possible.” While this is a rather simplistic paradigm, its application is more complicated than one would expect. In order to accomplish this goal, one must understand investments, tax codes, how tax codes apply to investments and how different investments are subject to different tax regulations. Understanding these concepts demands a specificity for which few professionals outside of the finance world have time. It may seem, for example, that tax efficiency means using tax-free bonds. It does not. Or, to use another example, many believe that insurance-based investing is synonymous with annuity investing; in fact, these two approaches are as different as Novocain and general anesthesia.
Before I go into detail, let me emphasize some guiding principles of sound, practical financial management.
- Management matters. Lack of management is perhaps the best reason to get out of an investment.
- Investing in start-up businesses is risky, plain and simple. No one can predict the market. If someone tells you he can, then he doesn’t know what he doesn’t know.
- You will not miss out on the next big thing if you do not invest right this second. You will rarely lose a chance to invest; something that is good today will most likely be good 90 days from now.
- Inflation eats away at returns. Accept it.
- Taxes can reduce your returns by 20 to 50 percent.
- The market should not affect your investment decisions. It is merely the cash register through which you buy and sell.
This last fact begs the question, “On what then does one base investment decisions?” Ideally, one should base decisions on a solid, empirically backed methodology from a Tax Efficient Perspective--especially today, when we are on the cusp of impending tax legislation. At the heart of Tax Efficient Investing (TEI) is the belief that what matters is not how much you make, but how much you keep! How does the tax efficient investor maximize what he/she keeps? They collectively analyze: 1) Location, 2) Timing and 3) Return of those investments. Let’s examine this closer in the case of Dr. A.
Dr. A heard from Financial Advisor Joe that high yield bonds are a sensible investment in terms of both quality and yield. With this advice in mind, Dr. A invested $100,000 in bond fund XYZ—within his personal account—and saw a nine percent yield. After Federal and state taxes, his yield is cut nearly in half. He finished with a 5.6 percent yield on an investment with considerable risk. (See Exhibit 1.)
Exhibit 1: Tax Efficient Investing: Tax Bond Income vs. Tax Deferred Bond Interest
Dr. A could have considered the following alternatives.
- Had he invested $100,000 within his pension plan, there would have been no taxes on his nine percent yield.
- Had he invested $100,000 in an insured municipal portfolio, his 5.6 percent yield would have been at virtually no investment risk.