Investing is a huge component of building wealth and financial independence. Unfortunately, it’s also something we as doctors learn next to nothing about in our medical education. Without clarification of each investment vehicle and its pros and cons, it can be hard for physicians to pick investments that fit their personal financial plan. Below, we look at some of the most common types of investments that physicians will likely hear about and should understand.
Disclosures: This page contains information about our sponsors, as well as affiliate links, which support the group at no cost to you. These should be viewed as introductions rather than formal recommendations. We do not provide individualized advice and are not formal financial, legal, or otherwise licensed professionals. You should consult these parties as appropriate and do your own due diligence before making decisions based on this page.
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Stocks
Stocks are shares of publicly traded companies that are available for purchase on stock exchanges like the New York Stock Exchange (NYSE) and the Nasdaq (National Association of Securities Dealers Automated Quotations). When you own a stock, you own a stake - however tiny - in that company. Depending on how many shares you own, you might be eligible to attend shareholder annual meetings.
There are over 10,000 different stocks available in North America. Analysis shows that buying and holding diversified securities such as index funds almost always outperforms the single-stock investment approach, and one that we find is often the safest option for beginning investors. That said, many doctors also hold individual stocks in companies that they really believe in or have reason to think are going to go up in value based on research and knowledge of the company, and will therefore buy up larger amounts of that individual stock.
Picking and selling single stocks (day trading) is a side gig many people claim can reap large returns, but also large losses. If you choose to do this, you should understand that it comes with a high degree of risk, and the research is time consuming. It’s far from passive income!
How You Make Money
Stocks, similar to other investment types below, generate income in two different ways: by appreciating in price per share and by paying dividends. A company that is doing well financially should overtime increase in price per share, and you can make money by buying that stock at a lower price than what you sell it at.
Alternatively, if a stock is doing well and paying lots of dividends, you can make money this way. A dividend is profit that a company distributes to its shareholders. Some companies will choose to do this rather than reinvest that portion of the profit. A dividend aristocrat is a stock traded on the S&P 500 that has increased its dividend every year for at least 25 years. There are pros and cons to dividends, and you should be aware that corporations can adjust how much of a dividend they distribute. Also note that a distribution of dividends has tax implications, so these are not the most tax efficient vehicles.
It’s also important to note that while we’d all like to think that stock performance always reflects how a company is doing, stock prices can also be based on emotional components related to news (good or bad) or hype or other factors that affect the stocks’ market value. Therefore, they can be volatile or lose money even if a company is doing well overall. Typically, higher appreciating stocks have lower dividends and vice versa, but not always. That's why it's important to do your research when selecting which stock(s) to invest in.
Some stocks also come with shareholder benefits. For example, if you enjoy traveling and cruises, some cruise lines offer shareholder benefits. It's worth investigating the stock's history itself to make sure it's a worthy investment with a likely net overall benefit once you take into account the stock buy-in and historical values and dividends.
Taxed As
Stock dividends are taxed as ordinary income at your regular marginal tax bracket.
Good Fit For
Single stocks can be a way to invest in companies you believe in and can diversify your investments. Just be careful about tying up too much of your net worth in single stock purchases, as this exposes you to a lot of risk if the company or stock encounters difficulties for reasons beyond your control.
Bonds
Bonds are debt securities or fixed-income instruments that represent loans made between an investor and a borrower. A bond is essentially an IOU with interest, typically made by a government entity or corporation. The municipal bonds and corporate bonds we cover in short-term investments are examples. Bonds require the borrower to pay back the principal plus interest (typically a fixed interest amount) by a set end date.
Bonds are one of the main asset classes covered in a three-fund portfolio. They are more stable than stocks, though this means historically they have lower returns. It's important to note, though, that different types of bonds have different track records. Government bonds are traditionally more stable than municipal bonds, while corporate bonds are usually the riskiest of the types, so it’s important to choose wisely based on both your desired returns and your risk tolerance.
How You Make Money
Since a bond is a loan, the company or government entity borrowing money pays interest on their loan. As an investor who holds a portion, or all, of a bond, you get paid via their interest payments.
Bonds have maturity dates which govern when the borrower must pay back their loan. (Think of it in terms of a mortgage: a 15-year mortgage would equate to a 15 year maturity date for a bond.) Once you’ve held the bond for the contractual length, you get your principal investment back. Bond maturity dates can vary from a few months to 15 - 30 years. The maturity date can dictate the interest rate you make, with bonds that are held for longer commanding higher interest rates..
Taxed As
Taxes for bonds can depend on the type you are looking at investing in, with some being taxed on both the federal and local level and others being taxed differently. Visit our short-term investments page for more information.
Good Fit For
Bonds and funds that are made up of bonds are a key component to any balanced portfolio, as they help balance risk. As you get closer to retirement, the rule of thumb is that more of your portfolio should be weighted towards these ‘safer’ assets as you should prioritize wealth preservation over aggressive growth at these stages. Some say the percentage of bonds in your portfolio should mirror your decade of life. Of course, depending on where you are in your journey towards financial independence, these rules may become less pertinent. If you need help setting up your asset allocation strategy, visit our financial advisor database.
Mutual Funds
A mutual fund groups together a bunch of different stocks, bonds, or other types of securities into a single security you invest in. This can allow you to better balance your portfolio while holding a single mutual fund, as the fund can consist of thousands of individual assets. Unlike stocks, where you buy the stock directly from an exchange, mutual funds are bought through the company that owns the mutual fund. The major brokerages you invest in may partner with those companies or have their own proprietary funds.
The terminology here can get confusing, as index funds also meet this definition of grouping together different securities into a diversified single security. Index funds are therefore considered a subset of mutual funds; however, index funds (covered in more depth below) are passively managed and just set to mirror the index reflected in the name. In contrast to this, when we refer to mutual funds, it is usually actively managed by a fund manager that hand picks which securities that are included in the mutual fund, with the goal being to try to beat the average market returns. A fund's expense ratio is the combined total of an advisory or management fee and its administrative costs. Because of this personal involvement and the research component, actively managed funds charge higher expense ratios than the average index fund. For example, most index funds have expenses that are almost a tenth of the average mutual fund. They can have a front end load or back end load, which are fees charged when buying or selling the funds. Remember from our tracking net worth article that fees can really erode into your money’s ability to compound annually.
These funds also tend to swap out their holdings to buy what’s doing well or what a fund manager anticipates will do well and remove underperformers. It’s important to note that this can generate tax consequences, although a good fund manager will try to balance out the ‘losses’ with the gains of the fund to make sure they’re as tax efficient as possible. For example, they will likely try and hold the securities for at least a year so that they will not be subject to short term capital gains taxes, which are higher than long term capital gains taxes.
If you choose this approach of trying to beat the market, check the historical track record of the fund. While past returns don’t promise future returns, they are a good indicator of how well the fund manager has done their job in the past. They may also have more rules associated with them in terms of liquidity, so check before purchasing if there’s any penalties for not holding them for a certain period of time.
Types of Mutual Funds
There are several types of mutual funds, including:
Money market funds invested in high-quality, short-term investments
Bond funds invested in a variety of different bonds
Stock funds invested in corporate stocks
Target date funds include bonds, stock, and other investments, the mix of which gradually shifts according to the fund’s targeted retirement date and the fund’s strategy
Stock Mutual Fund
Stock mutual funds can be further classified into different types, such as
Growth funds - focused on capital gains in share price over time versus dividends
Income funds - focused on providing regular dividends
Index funds - see below
Sector funds - focused on a particular industry (such as healthcare or tech)
Socially responsible funds - focused on a particular interest (such as environmental or religious)
How You Make Money
When the value of the stocks, bonds, or other securities within the mutual fund goes up, your investment in them increases (this is your capital gains).
The securities can also pay out dividends or interest depending on the type of security, which are passed along to the mutual fund investors. You can set these up to automatically reinvest to capitalize on compounding growth or take them to help cover the corresponding tax bill.
Taxed As
When a mutual fund sells securities within the fund, it distributes the profit (capital gains) among the investors. You will owe taxes on these capital gains (if held outside a tax-advantaged account). The more turnover a mutual fund has, the more likely you are to owe taxes on this type of capital gains, so consider low-turnover funds.
When you sell your mutual fund shares, you will be taxed at capital gains as well.
Short-term capital gains (held under a year) are taxed at your marginal tax rate. Long-term capital gains are subject to 0%, 15%, or 20% tax rate depending on your taxable income level.
You are also taxed on dividends and interest payments.
Dividends can be qualified or non-qualified. Qualified dividends are taxed at capital gain rates. Non-qualified dividends are taxed at your ordinary income rate. Interest is taxed at your marginal tax rate.
Good Fit For
Different types of mutual funds are better suited for different situations. For example, money market funds are great for short-term investments to keep up with inflation but aren’t great as a large portion of your retirement savings for financial independence. Target date funds can be a great investment for ‘lazy’ DIY investors who haven’t done much research into investing but want to make sure they don’t miss out on the power of compounding growth.
You can learn the basics of portfolio balancing with the three-fund portfolio. If you need help setting up your asset allocation strategy, visit our financial advisor database.
Index Funds
Index funds are funds that are passively managed and balanced to track as closely as possible the performance of a specific market benchmark, so an index fund mirroring a specific benchmark will have the same securities and keep the same weightings of holdings. They can be mutual funds (see above) or ETFs (see below). One of the most common benchmarks is the S&P 500 Index, which tracks the stock performance of 500 of the largest companies listed on the US stock exchanges. There are many different index funds created with the goal of providing exposure to specific asset classes; for example there are index funds targeting small cap stocks, large cap stocks, international stocks, etc.
So if, for example, a certain health tech company saw a massive jump in their stock value and became one of the top 500 stocks in the US, the index fund may sell off the stock of the company that fell off the bottom of list and purchase stock of the health tech company in order to track the S&P 500 Index.
How You Make Money
Index funds follow the same profit generation outlined in the mutual fund section.
Taxed As
When sold, they are taxed as either short-term or long-term capital gains. Dividends can be qualified (capital gains) or non-qualified (at ordinary income rate). See above for more details.
Index funds tend to be relatively tax efficient, as they are created to mirror the holdings of a particular index and therefore don’t bring in and trade out of different securities as often as actively managed funds do.
Good Fit For
Index funds are a good fit for busy DIY investors, and a favorite in our community, especially amongst ‘lazy’ investors. In this case, laziness is not a bad thing. They allow you to track the overall performance of the stock market without having to research and keep tabs on numerous individual stocks. While they won’t “beat the market,” index funds have great success records versus active investors who try to beat the market but not infrequently fail in this goal, or when considering fees, don’t actually beat the market. Consider them when building your three-fund portfolio strategy.
ETFs (Exchange-Traded Funds)
ETFs are like mutual funds with two significant differences.
You buy and sell ETFs on stock markets, whereas you purchase mutual funds through a fund company such as Fidelity or Vanguard. Since they are bought and sold on the market, their prices fluctuate throughout trading days. Mutual funds, on the other hand, only update their value once a day when the investment markets close. If you are a long term investor, when you buy during any given day shouldn’t matter, so many people dabble in both mutual funds and ETFs interchangeably.
While a lot of mutual funds can require significant minimum initial investment amounts to buy into the fund originally, ETFs can offer lower investment minimums, as low as $1 depending on the ETF.
How You Make Money
Similar to mutual funds, ETFs make investors money by selling your shares at capital gains. You may also receive dividends or interest, depending on the ETF.
Taxed As
Capital gains are taxed at capital gain rates (short- or long-term). Dividends and interest are taxed at your marginal tax bracket. With some brokerages, ETFs are more tax efficient than their mutual fund counterparts as well.
Good Fit For
ETFs can be a great fit for new investors who don’t have thousands of dollars to invest in each fund they want to include to diversify their portfolio. They can be a great fit for DIY investors who handle their own investments outside a fund company.
Real Estate
Real estate is a favorite within our community as real estate investing offers many benefits for physicians. There are both active and passive forms of real estate investing, each with several options. We cover REITs below as it is a passive real estate option most similar to the other options discussed here, and can also be traded publicly. Check out our real estate page for more information on others such as: short-term rentals, long term rentals, and syndications.
REIT (Real Estate Investment Trust)
REITs are a passive real estate investing opportunity that allow you to invest in real estate without having to own or manage any individual properties. They are a popular investing option for those looking to diversify their investing portfolios past a standard three-fund portfolio to also capture the real estate market. Similar to syndications, REITs include income-producing real estate. They can be very broad or very focused, and include several types of assets such as
Apartment buildings
Offices
Hotels
Self-storage facilities
Farmland
Retail centers
There are three main types of REITs:
Equity - holds income-producing real estate they own and operate
Mortgage - holds mortgages on real estate properties
Hybrid - holds a mixture of mortgages and owned properties
There are also three ways REITs are bought and sold:
Public traded REITs
Public non-traded REITs
Private REITs
Regardless of the type of REIT, the IRS has set requirements they must meet. By meeting these rules, REITs are given certain tax breaks, which generally allows for higher dividend returns.
How You Make Money
Investors make money on REITs through income on the investment properties included in the REIT. This interest can be generated through mortgages and/or rental income. As part of the requirements the IRS has imposed on REITs, they must pay out 90% of their taxable income to their investors.
It’s important to note that private REITs can have limited redemption options, so your investment can be tied up for significant lengths of time, depending on which type of REIT you invest in. On the other hand, publicly traded REITs can be bought and sold like stocks and thus are highly liquid.
Taxed As
REITs dividends are typically taxed as ordinary income (though some deductions may be available). REITs do qualify for a tax advantage through a 20% deduction on dividends via section 199A qualified business income (QBI). Depending on how the REIT is structured, they may also be tax advantaged in other ways.
Good Fit For
REITs are a great option for physicians interested in passive real estate investing. Since they produce a steady stream of income that is taxed like ordinary income, REITs are a great fit in tax-advantaged accounts such as IRAs and 401(k)s so you aren’t paying taxes on the income generated during your higher earning years.
Options
An option gives the option holder (buyer of the option) the right to buy or sell a security–typically a stock–at a chosen price at some established point in the future. This chosen price is the exercise price or strike price. While the option gives the holder the opportunity to buy or sell at the chosen price, they aren’t required to. There are a few main types of options, including
Call option - the buyer (option holder) purchases an option contract for the right to buy the security at the exercise price
Put option - the buyer purchases an option contract for the right to sell the security in question at the exercise price
Covered call - this is a strategy that is often used to protect a large holding you already own (think of it like an insurance policy). The call is exercised only if the security price increases. While this forces you to sell your optioned shares and take the capital gains, you get paid whether the security increases in value (via the option) or decreases in value (by selling the covered call option to the buyer).
Should the security fail to reach the chosen price in an unfavorable market, the option holder can let the option expire without having to capitalize on any losses. In a favorable market, the option holder can exercise their option to capitalize on the market situation.
How You Make Money
If you sell an option on a security, you make money from the buyer who purchases the option from you for an agreed amount, which typically depends on
the current valuation of the security you are optioning
the exercise price you set for the option
If the option is exercised, you can also make money on the capital gains.
Taxed As
Taxes for options are complicated due to the different positions (whether you buy or sell the option), the different types (equity versus non-equity securities), and whether the option is exercised or not. We recommend you speak with an accountant to make sure you understand the tax implications when working with options.
Good Fit For
Sounds complicated? That’s because it is. Options trading, while having the potential to be quite lucrative, are also very risky. In order to play this game well (and in some ways, it is a game), you will need to do a lot of research and tracking, coupled with speculation. Ultimately, you don’t have a crystal ball and you can’t predict with certainty how the market will behave. If you could, everyone would be doing this.
For retired physicians who are living off the income generated by their investments, covered calls may be an option to explore as they can help ensure some income generation even in down markets, especially on low dividend producing securities you own, though note you will lose any future growth in the shares you option unless you repurchase them at the higher exercise price.
Commodities
Commodities are physical products that you can invest in, such as
Metals - gold and silver
Agricultural products - wheat and corn
Livestock - cattle and pork
Energy - oil, petroleum, and natural gas
Commodities are popular in futures markets, where investors seek to hedge stakes in them, especially in periods of inflation. They can also be purchased indirectly through stocks, mutual funds, and ETFs.
How You Make Money
Commodities make money depending on how you buy them. As stocks, mutual funds, or ETFs, they follow the same guidelines outlined above for those investment types. As futures, they work similar to options.
Taxed As
If purchased as stocks, mutual funds, or ETFs, they are taxed as such. If purchased as a future, they are taxed on a 60/40 basis (60% of profits are treated as long-term capital gains, 40% are treated as short-term capital gains at your ordinary income tax level).
Good Fit For
Futures in commodities can be a favorable investment strategy for seasoned investors who study the markets and who wish to hedge against inflation with a portion of their portfolio. If you are a busy physician that can’t carefully track the market, this probably isn’t the investment for you. If you do this passively, the historical returns are less than average returns in a typical index fund that tracks one of the major indexes.
Cryptocurrencies
Cryptocurrencies are digital currencies that are maintained by decentralized systems in public ledgers versus a central authority such as a government. While not technically a commodity since they aren’t a tangible product, cryptocurrencies are often lumped in with commodities.
Cryptocurrencies are high risk with potential high reward, so we’ve seen several questions about them in our physician Facebook communities. Since they are a relatively new investment vehicle, they don’t have a long historical track record to assess. Most cryptocurrencies, so far, have been highly volatile in value, allowing for high gains but also miserable losses.
You make money on cryptocurrencies by purchasing crypto through a traditional broker or on a cryptocurrency exchange, then later selling them as the value of your holdings change.
The IRS, somewhat ironically, currently treats these intangible digital currencies like property. Income generated from selling your crypto holdings is taxed as capital gains.
Due to high volatility, we would caution you against going all in on cryptocurrency investing. While there are certainly success stories, investing in traditional index funds is a tried and true pathway towards financial independence. Make sure you set aside money that will reliably lead towards that FI goal. For the risk takers and those willing to take the time to really understand crypto, investing in crypto with a very small portion of your net worth is a way to potentially capitalize big on a new commodity as new currencies continue to develop. Just be careful about investing more than you’re willing to lose, as regulations and value here could always change.
Insurance Products
We generally recommend separating investments from life insurance, but there are a few insurance products that are popular investments, so we cover those briefly below.
Annuities
An annuity is a contract between you and a life insurance company where you make premium payments or a one-time single premium payment. In exchange, the insurance company provides regular payments back to you in one of two ways.
An immediate annuity begins paying you income right away
A deferred annuity (more common) does not distribute payments until a later time, usually several years or decades later once you’ve reached retirement age
Annuities are either
Fixed - provide premiums of a fixed amount guaranteed by the annuity contract based on interest rates set by the insurance company in the contract
Indexed - a type of fixed annuity where the returns are determined by the performance of a market index, such as the S&P 500, though only a predetermined portion of the performance adds interest to your annuity
Variable - you decide how the insurance company invests your premiums (less fees and charges they take out); the amount of your income payment can be either fixed (set at the beginning of distribution) or variable (changes with the value of your investments)
Annuities can also offer a lump sum payment versus scheduled distribution payments.
Taxed As
Annuities are taxed when you withdraw money or receive income from the annuity as a payment. If the annuity was paid for in pre-tax funds, all of the income generated is taxed as ordinary income. If the annuity was paid for in after-tax money, you are taxed only on the annuity’s earnings at your marginal tax rate.
Good Fit For
Fixed annuities are good at providing stable, reliable income when it’s needed in retirement. Generally, however, you will be better off taking what you would pay in premiums and investing it yourself, since annuities can be heavily loaded with fees. This is especially true for variable annuities. Instead of investing with a life insurance company, we recommend reaching out to a financial advisor.
If you are self-employed, a defined benefit plan can be a better alternative than an annuity and provide better tax breaks for physicians.
Permanent Life Insurance
Permanent life insurance, especially whole life, is often pitched with its cash value as a selling point. With this type of life insurance, you pay in premiums and a cash value builds alongside your death benefit (though the cash value goes back to the insurance company upon your death). Fees on these types of insurance policies tend to be high, so it can take quite a few years for your cash value to start building. In general, your annualized returns on these policies is very low and should only be considered a smart strategy if done for estate planning reasons that very few physicians will find necessary.
For the vast majority of physicians, however, you will be better off taking the difference in premiums between a term life insurance policy and a permanent life insurance policy and investing it yourself.
Learn more on our page Should Physicians Buy Whole Life Insurance? and on our life insurance page.
Taxed As
The death benefit from a whole life insurance policy generally isn’t subject to income taxes, unless you receive the payment in installments.
You can withdraw from the cash value tax-free, up to the amount you’ve paid in premiums. If you withdraw gains on top of your premium payments, they are taxed at your ordinary income rate.
Short-Term Investments
If you have money ear-marked for a particular use that you won't need for a few (generally one to five) years, short-term investment options are a great place to park them. Visit our short-term investments page for coverage of investment products such as:
high-yield savings accounts
cash management accounts
CDs
corporate bonds
money market accounts
treasury bills
municipal bonds.
Remember though, these investment types are geared towards short-term strategies, not a way to avoid risk inherent to the long-term investment types outlined above. While everyone has their own risk tolerance and ability to manage greater ranges of risks depending on their portfolios, short-term investments for long-term investing yield lower returns, which can keep you from financial independence longer. Also remember that some of these investment vehicles are not FDIC insured.
How to Buy Different Types of Investments
DIY With a Brokerage Account
You can select and manage your own stocks, mutual funds, index funds, EFTs, REITs, and more by opening a brokerage account. While this requires you to make the financial decisions yourself, we have resources to help. Check out our three-fund portfolio and personal finance pages on investing strategies to get started using the investment types below.
You could also utilize a robo-advisor such as Wealthfront as another ‘lazy’ investment option. Learn more about using a robo-advisor to invest.
Hire a Financial Advisor
Our financial advisors for physicians database is a great resource for those who want to get started but want professional guidance and insight. The page includes information on how to choose a financial advisor, warning signs you should run from an advisor, and a listing of fee-based advisors to explore. Financial advisors can be a great companion along your journey to financial independence by helping you formulate an overall financial strategy and helping make sure you’re on target for your dream retirement.
Private REIT Opportunities
While a brokerage account will allow you to invest in publicly traded REITs, we have also partnered with companies to provide you options for private REITs not traded on the stock exchanges. You can find out more about these options on our real estate investing page under passive real estate investing options.
Conclusion
Many different investment options exist within and outside of the stock market in today's economy. If you'd like to learn more about the different investing strategies implementing the products above, make sure to check out our investing page, along with the Personal Finance tab on our recommended books page.