During residency: contribute to 403b or pay down loans?

[Interpolfanclub]

The residency program I am about to begin mandates residents contribute 7.5% of their paychecks to a university retirement program. We can then invest this money in about 17 different mutual funds or the default fund which guarantees 4.15% interest. I'll probably add another post later for advice with mutual funds...

We pay no social security taxes because of the retirement plan and this state has no income tax.

I am trying to decide whether or not to pay down my loan debt or contribute to the university's 403b program. I am pretty sure they do not match our contributions (a max of 14,000/yr.)

Right now I am leaning toward contributing to the 403b as much as I can since I think return from that will outpace my student loan rates over time (10 yrs or so). I consolidated a large portion of student loan debt at around 2.8% and my residency relocation loan of 15K is at around 7.5%.

Thanks

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[The White Coat Investor]

The residency program I am about to begin mandates residents contribute 7.5% of their paychecks to a university retirement program. We can then invest this money in about 17 different mutual funds or the default fund which guarantees 4.15% interest. I'll probably add another post later for advice with mutual funds...

We pay no social security taxes because of the retirement plan and this state has no income tax.

I am trying to decide whether or not to pay down my loan debt or contribute to the university's 403b program. I am pretty sure they do not match our contributions (a max of 14,000/yr.)

Right now I am leaning toward contributing to the 403b as much as I can since I think return from that will outpace my student loan rates over time (10 yrs or so). I consolidated a large portion of student loan debt at around 2.8% and my residency relocation loan of 15K is at around 7.5%.

Thanks

It doesn't sound like you have a choice. 7.5% of your money is going into your 403b. If it were matched, you would need to be sure you contributed enough to get the full match.

After that, you need to contribute to a Roth IRA, plus to a Roth IRA for your spouse. (8K total this year.) Since you're a resident, you probably won't have any more extra money after that. But if you did, I'd put it toward that 7.5% loan.

As far as your individual fund allocation questions, you'll get better advice at diehards.org.

 

[Jocomama]

I am not aware of a mandate in the US in any state that mandates you must contribute to retirement. You should discuss with an accountant in that state.

It is not a bad idea. Depending upon your age, younger more aggressive - but I usally suggest a mix of 2-4 funds maximum.
1. Aggressive: Typical tech or emerging markets
2. Mid aggressive/growth: large cap balanced fund
3. Semi-conservative: dividend paying fund
4. Conservative - PIMCO or similar bond fund.

I only look at 10yr history before choosing, and how long the manager has been with fund, and of course I only go with no-load funds. This is just my personal opinion; there are many others.

It doesn't sound like you have a choice. 7.5% of your money is going into your 403b. If it were matched, you would need to be sure you contributed enough to get the full match.

After that, you need to contribute to a Roth IRA, plus to a Roth IRA for your spouse. (8K total this year.) Since you're a resident, you probably won't have any more extra money after that. But if you did, I'd put it toward that 7.5% loan.

As far as your individual fund allocation questions, you'll get better advice at diehards.org.

 

[Interpolfanclub]

The 7.5% deducted from my salary doesn't go into a 403b, the 403b program is separate from the university retirement plan that the 7.5% goes into. We can contribute to a 403b plan if we choose. But that's sort of splitting hairs.

The retirement plan is a mix of about 17 different mutual funds of which we can choose a mix. I was thinking about putting around 50% into the default program which guarantees around 4.15% returns. Which barely beats inflation...and then there's the fund expenses...

So I was thinking about putting the other 50% (or maybe more) into funds which have a 10yr history of greater returns. One fund invests in the stock markets of Japan, UK, etc. etc and has had 20% returns over 10 years. Which seems almost too good to be true. I was going to put some towards that and then maybe some more in an index fund and diversify the rest among large cap value, mid cap value.

Thanks a lot for the advice, I've been reading extensively while I have the time. I just tore my ACL and have lots of time to read now...argh. Gonna check out diehards.org too.

 

[Jocomama]

Why in Gods name would you put anything into a 4.15% return?

That's insanity. There are CDs that give you better return.
You can give me the money, I'll personally guarantee you 5.5% for the next year
Yes - read and ask questions.

The 7.5% deducted from my salary doesn't go into a 403b, the 403b program is separate from the university retirement plan that the 7.5% goes into. We can contribute to a 403b plan if we choose. But that's sort of splitting hairs.

The retirement plan is a mix of about 17 different mutual funds of which we can choose a mix. I was thinking about putting around 50% into the default program which guarantees around 4.15% returns. Which barely beats inflation...and then there's the fund expenses...

So I was thinking about putting the other 50% (or maybe more) into funds which have a 10yr history of greater returns. One fund invests in the stock markets of Japan, UK, etc. etc and has had 20% returns over 10 years. Which seems almost too good to be true. I was going to put some towards that and then maybe some more in an index fund and diversify the rest among large cap value, mid cap value.

Thanks a lot for the advice, I've been reading extensively while I have the time. I just tore my ACL and have lots of time to read now...argh. Gonna check out diehards.org too.

 

[Sol Rosenberg]

The retirement plan is a mix of about 17 different mutual funds of which we can choose a mix. I was thinking about putting around 50% into the default program which guarantees around 4.15% returns. Which barely beats inflation...and then there's the fund expenses...

Why in Gods name would you put anything into a 4.15% return?

That's insanity. There are CDs that give you better return.
You can give me the money, I'll personally guarantee you 5.5% for the next year
Yes - read and ask questions.

Agree 100% with Jocomama. My savings account pays more. My CHECKING account pays almost as much. If you are really that risk averse, go with some bond fund or something like that. For all practical purposes, if you are looking at the long-term, you really can't go wrong with index funds (like S&P 500 index funds,) though they are technically "riskier" than some other better performing options previously mentioned (bond funds, CDs, etc.) Most financially knowledgeable people will tell you that S&P 500 index funds are relatively conservative, low-risk investments, however.

 

[Interpolfanclub]

Yeah, I couldn't believe that 4.15% was the default account return. I'll probably wind up putting about 20% in bond funds and the rest in stock funds. Diversifiying amongst index funds, international funds, and some mid cap value and large cap value funds.

I'm just having a hard time believing that the guaranteed rate of return on the default fund is so low while some of the other funds have 10-year rates of return from 10-20%. But you'd need to have some financial knowledge to realize how terrible the default fund is, and that you can get a greater return if you take the leap and check off all those little boxes under default...

Gonna call the residency tomorrow and see if they match my 403b contribution. If not then I'm going to consider setting up a Roth IRA when I get over there.

Thanks again for all the advice.

 

[The White Coat Investor]

Most financially knowledgeable people will tell you that S&P 500 index funds are relatively conservative, low-risk investments, however.

Gotta call BS on this one. Any equity (stock) investment is by definition a high-risk investment when compared to bonds, CDs, balanced funds, and money markets. Just because an index fund doesn't run manager (underperformance) risk doesn't make it a low risk investment. However, you are correct in telling the OP that at his age he belongs in riskier investments than his 4.15% money market/stable value fund.

And Jocomama, you're not really still recommending people invest in narrow segments of the market like tech are you?

Nasdaq:

http://bigcharts.marketwatch.com/qu...=nasdaq&sid=3291&o_symb=nasdaq&freq=2&time=13

If you want to be more aggressive, hold more equity (stocks) and less fixed income (bonds/money markets/stable value/CDs.) There aren't any guarantees that tech or emerging markets or real estate stocks or small value stocks will outperform the broader equity markets over the long term. At least with small/value there is evidence it has outperformed in the past, unlike those other slices of the market.

 

[Jocomama]

I don't have any tech investments, so you may have mistaken me for another poster - I do NOT recommend investments.

However, for fun, I will share my investments:
1. Condo
2. Home
3. checking/Money Market liquid
4. personal note (12%)
5. Secured note (15%)
5. Private equity
6. Private equity
7. Mutual fund (Old Mutual/PKA PBHG x 9yrs)
8. Stocks:
PCU - Southern Copper
SHPGY-Shire Pharmacuetical
ABR-Arbor Realty Trust
LIFC - lifecell corp
COST - costco

9. and of course 401K and IRA

PS - S&P 500 Index fund as one should invest in a mutual fund (long term) is not a high risk investment based upon investments since the depression era.

Gotta call BS on this one. Any equity (stock) investment is by definition a high-risk investment when compared to bonds, CDs, balanced funds, and money markets. Just because an index fund doesn't run manager (underperformance) risk doesn't make it a low risk investment. However, you are correct in telling the OP that at his age he belongs in riskier investments than his 4.15% money market/stable value fund.

And Jocomama, you're not really still recommending people invest in narrow segments of the market like tech are you?

 

[The White Coat Investor]

PS - S&P 500 Index fund as one should invest in a mutual fund (long term) is not a high risk investment based upon investments since the depression era.

Not sure what you consider "high risk" but perhaps this article will emphasize what I'm talking about.

http://www.usatoday.com/money/perfi/funds/2003-02-24-cover-main_x.htm

Ahhh yes, you say, but it always comes back. Here is an example of a similar index which hasn't yet come back:
http://www.stockmarkettiming.com/nikkei-comparison.html

It has been 17 years, and the Nikkei 225 is STILL down 80% from its highs. Equity is risky...sometimes the risk shows up, sometimes it doesn't. Just because it hasn't really shown up for the S&P 500 doesn't mean it can't.

Some people look at risk as how much an investment can lose in a bad market. The S&P 500 lost 79% in 1929-1932 and 45-50% in 1937-1938, 1973-1974, and 2000-2002. I'm not sure what planet you invest on, but if there is a possibility of 50% loss, I consider it a risky investment.

 

[Sol Rosenberg]

Some people look at risk as how much an investment can lose in a bad market. The S&P 500 lost 79% in 1929-1932 and 45-50% in 1937-1938, 1973-1974, and 2000-2002. I'm not sure what planet you invest on, but if there is a possibility of 50% loss, I consider it a risky investment.

Sorry, I forgot to clarify and state an assumption: That we are talking about investing in the LONG-TERM (as one would do if they were contributing to a 403b plan.)

Your argument falls to pieces if you look at 1929-Present. Or, pick any other 50-year period in that time-frame, for example.

EDIT: I re-read my original post, and I DID EXPLICITLY state that I was talking about the long-term, so your short-term examples are totally out of context.

 

[etf]

Not sure what you consider "high risk" but perhaps this article will emphasize what I'm talking about.

http://www.usatoday.com/money/perfi/funds/2003-02-24-cover-main_x.htm

Ahhh yes, you say, but it always comes back. Here is an example of a similar index which hasn't yet come back:
http://www.stockmarkettiming.com/nikkei-comparison.html

It has been 17 years, and the Nikkei 225 is STILL down 80% from its highs. Equity is risky...sometimes the risk shows up, sometimes it doesn't. Just because it hasn't really shown up for the S&P 500 doesn't mean it can't.

Some people look at risk as how much an investment can lose in a bad market. The S&P 500 lost 79% in 1929-1932 and 45-50% in 1937-1938, 1973-1974, and 2000-2002. I'm not sure what planet you invest on, but if there is a possibility of 50% loss, I consider it a risky investment.

i'd take the investment with a possibility of 50% loss in its worst year and 100% gain in its best year any day. but then again, i'm young, so i can afford to take a lot of risk. it's why i have a 0% bond allocation. it's always different depending on your situation. act accordingly.

 

[The White Coat Investor]

EDIT: I re-read my original post, and I DID EXPLICITLY state that I was talking about the long-term, so your short-term examples are totally out of context.

It is important to realize there is an equity RISK premium, not just an equity PATIENCE premium. Equities usually pay more because there is a chance they will pay less, EVEN IN THE LONG TERM. Japan's meltdown is a good example of long-term risk. There is no reason that the story of the Nikkei 225 from 1990 to present couldn't be the story of the S&P 500 from 2010 to 2027.

This guy can explain this point better than I can:

http://homepage.mac.com/j.norstad/finance/risk-and-time.html

 

[Sol Rosenberg]

It is important to realize there is an equity RISK premium, not just an equity PATIENCE premium. Equities usually pay more because there is a chance they will pay less, EVEN IN THE LONG TERM. Japan's meltdown is a good example of long-term risk. There is no reason that the story of the Nikkei 225 from 1990 to present couldn't be the story of the S&P 500 from 2010 to 2027.

This guy can explain this point better than I can:

http://homepage.mac.com/j.norstad/finance/risk-and-time.html

Sure there is. The reasons for the sluggish recovery of Japan's economy/stock market are well-understood and are ultimately tied to policy decisions. There have been articles about it in The Economist for years.

Your advice is technically correct (it's always POSSIBLE for us to enter into a 10-15 year stock market slump) but practically useless (it's never happened before.) All investments (even CDs and bonds) carry risk -- I didn't say that there was NO risk investing in S&P 500 index funds -- I said that they were "relatively conservative, low-risk investments." Note the word "relatively" that I used in that phrase.

I have very little time to continue splitting hairs. I was merely giving practical advice, and you told me that I was spouting BS. Invest your money in the way that makes you most comfortable, and I'll do the same.

 

[p9142]

I don't see why you would put any money into a 403b unless there was a match. Isn't the whole point of the 403k/b that you pay in while you would be taxed more, and take the money out at a lower tax rate. It would probably make more sense to just pay taxes on the money now, when you will be in the low tax bracket.

 

[etf]

well i know in my mothers case, while there is no match, she can put in $20k a year into her 403b and another $20k into the 457. I then roll this money over into an IRA, and in 2010 plan to convert all those IRAs to roths. higher contribution limits - more money that ultimately ends up tax free.

 

[The White Coat Investor]

I don't see why you would put any money into a 403b unless there was a match. Isn't the whole point of the 403k/b that you pay in while you would be taxed more, and take the money out at a lower tax rate. It would probably make more sense to just pay taxes on the money now, when you will be in the low tax bracket.

Let me jump back in here for just a minute because this is a really important point. An investor needs to understand the 3 types of accounts one can invest in:

1) 401k/403b/457/Traditional IRA
You pay no taxes when you make the money
You pay no taxes as the money grows
You pay your regular income tax rate on the money as you withdraw it

2) Roth 401k/Roth 403b/ Roth IRA
You pay your regular income tax rate on the money up front
You pay no taxes as the money grows
You pay not taxes when you withdraw the money

3) A regular taxable/brokerage type account
You pay your regular income tax rate on the money up front
You pay capital gains rate taxes on your dividends and capital gains as the money grows
You pay capital gains rate taxes on the capital gains when you withdraw the money

Why would someone contribute to a match-less 403b if he knew he would be in a higher tax bracket at withdrawal than now? To take advantage of the initial tax-break AND the tax-free compounding for decades prior to withdrawal. Obviously a Roth would be a better choice, but if it isn't available (or it is already "full"), one must go with what is left. Even a 403b without a match is probably better than the alternative, a fully taxable account, except in a few unusual circumstances (highly tax-efficient investment, a short investment period, or a hyper-expensive 403b)

Good luck investing

 

[Someguy2007]

That cleared up a query I had, thank you kind sir!

 

[edmadison]

I am not aware of a mandate in the US in any state that mandates you must contribute to retirement. You should discuss with an accountant in that state.

Non-federal government entities can opt out of social security, believe it or not. Employees still must contribute 7.5% of their income. That is what the OP is referring to.

Ed