For better or for worse, there is a wide range in salaries between primary care physicians compared to surgeons and other specialists. Some of this difference is due to the increased length of training for some specialties. Neurosurgery has a residency of 7 years, and OB/GYN sub-specialists also spend 7 years in training. Many specialties, including radiology and orthopedic surgery, require 6 years of training after a semi-mandatory fellowship. This is compared to the three years of training required to be an internal medicine physician or a pediatrician.

Of course, more of the difference in salary is due to the unique aspects of the United States healthcare system. For example, the United States healthcare system greatly favors procedures over office visits. In addition, the United States healthcare system greatly favors the quantity over the quality of work done. While the government is taking steps to tie more of medical reimbursement to the quality of work, physicians are still mostly rewarded by their quantity of work.

So how can primary care physicians make up the difference between their salary and specialists’ salary? Unfortunately, they will not be able to make up all of the difference. By taking a few key steps in their investing approach, however, primary care physicians will be able to make up a lot of ground compared to specialists who do not take these steps.

The Impact Of Short-Term Trading Versus Long-Term Trading

Consider the primary care physician who follows my standard advice to invest in low-cost index funds. She sets it and forgets it, never selling shares. For the purpose of this example, she will liquidate her portfolio at retirement.

Compare this with the hotshot specialist, who thinks he is the best at everything. He thinks that he can beat the market, and will trade in and out of stocks on a weekly or even daily basis. Unfortunately, because he holds stocks for only days or weeks at a time, he has to pay short-term capital gains (at his ordinary income tax rate) on all of his trading profits.

For our example, we make the following assumptions:

  1. Assume that the PCP graduates internal medicine residency at age 30.
  2. The primary care physician would make approximately $225,000 annual after residency and save 20% of gross income, or $45,000 annually.
  3. The specialist would spend 6 years in residency/fellowship and make approximately $360,000 a year. He would also save 20% of gross income, or $72,000.
  4. Both physicians earn pre-tax investment returns of 7%. All investments are in taxable accounts. The primary care physician invests in low-cost index funds and does not sell her shares until retirement. At retirement, she sells all of her shares, paying a long-term capital gains tax of 15%. The specialist trades in his taxable account, paying short-term capital gains of 35% annually.
  5. Both physicians choose to retire at age 65.

Results

After paying her long-term capital gains rate at retirement, the slow-and-steady PCP ends up with $5.89 million in retirement. She invested $1.58 million over 35 years, made $5.08 million in investment gains, and paid $0.76 million in long-term capital gains taxes.

The hotshot specialist, on the other hand, only ends up with $5.22 million in retirement. He contributed $2.30 million over 32 years, made $4.48 million in investment gains, and paid $1.56 million in short-term capital gains taxes over the years.

Despite contributing more money to retirement over his career, the specialist made less money in investment gains and paid more in taxes than the PCP. Because of this, the specialist ended up with less money in retirement. The reason why he made less in investment gains than the PCP, despite making the same 7% return, is that he had to pay his (short-term capital gains) taxes every year, while the PCP could pay the taxes in one lump sum at retirement. The PCP was able to earn more compound interest than the specialist.

Caveats

  1. All money was invested in a taxable account. If the money were invested in a retirement account, the specialist would win because he would not have to pay short-term capital gains each year. Taxes are deferred until withdrawal in 401(k)s. You don’t pay taxes at all on capital gains in Roth IRAs.
  2. Specialists can choose to avoid short-term trading just in their taxable accounts just like the PCP did in this example. In that case, they would reap the tax benefits of investing for the long-term.
  3. Specialists enjoy a better lifestyle during their working years. The specialist would have an annual budget of approximately $180,000, compared to a budget of about $125,000 for the primary care physician.

Conclusion

Short-term trading in a taxable account is a very expensive mistake for physicians and other high-income professionals. As demonstrated in our PCP vs. Specialist example, the savings difference between a specialist and a PCP is completely lost if the specialist chooses to trade in his taxable account. If you must trade (and I don’t recommend it), do it in a tax-deferred account.

What do you think? Have you ever made the mistake of trading in a taxable account?

6 COMMENTS

  1. Interesting take on this.

    While you are using this as a metaphor, as a specialist (Cardiologist) I have seen too many of my colleagues invest in stupid, taxable items. Not only are they gambling with their money (last week a friend lost $80K) but their future.

    I wonder if the specialist think they are that much smarter then the generalist and thus more likely to make foolish money moves.

    • Hard to say if specialists are more prone to making money mistakes compared to generalists. Fortunately for you, you can combine the high salary of cardiology with smart financial decisions and really crush it.

  2. I’m lucky to live where I do. From a tax standpoint, my country makes no distinction between trading and investing (for capital gains).

    I know that in some countries like the States, capital gains is taxed at a lower rate than trading. Thus I don’t have a tax disadvantage for trading.

    • Thank you for sharing, Troy. The IRS discourages short-term trading (or perhaps encourages long-term trading) in the United States through its tax treatment of short-term and long-term gains. Many investors don’t realize this (or ignore this) and their after-tax returns suffer as a result.

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