So, you have debt. You also hope to retire someday and you want to start investing your money. Both require a commitment. Both require money. Which do you do first, pay off debt or invest?

The first barrier to success in investing is bad debt. Yes, there’s good debt and bad debt. Good debt is money you borrow at a low rate of interest, with which you make a high rate of return.

An obvious example is the money you borrow to buy an apartment complex. The debt covered by the rental income – or it will be in a few years.

Bad debt, by contrast, is consumer debt – money you borrow at a high interest rate to buy things that don’t produce income or grow in value. Things like cars, refrigerators, clothing and trips to Europe.

All of us have done it, and all of us have paid the price.

Roth IRAs are so good that they’re probably not going to last. I think that one of these days the federal government is going to say, “Wait a second, that’s just too good of a deal,” and they’re going to yank it, so you want to get one now and grandfather that thing in.

A Roth IRA is an individual retirement account similar to a 401k or a traditional IRA. They offer a valuable future tax break. Since they are taxed when you put money into them, the income is tax-free on retirement.

Roth IRAs are fantastic because you put money into it after you have paid taxes on it. That’s what makes the Roth IRA different from a regular IRA or a 401k.

## “A Roth IRA is a great, tax-efficient way to save for retirement.”

In a regular IRA or a 401k the money is going in pre-tax which is the big advantage, because you don’t have to pay taxes on that money when you put it in. When you start to take it out, you pay your taxes on it way down the road.

There are some advantages to an IRA or 401k, but the Roth IRA has advantages as well.

Once you put your money into a Roth IRA, it never gets taxed again. This includes all of the money that grows in the Roth IRA. We like to encourage our students who are just getting going as investors and are just scrambling to make a living much less prepare for retirement to use a Roth IRA.

We’re really excited about introducing them to Roth IRAs. I want you guys to really be thinking about this. If you are young, if you are just getting going on your job and you’re not in a high tax bracket, you should use a Roth IRA.

## “If you are young, if you are just getting going on your job and you’re not in a high tax bracket, you should use a Roth.”

As of 2014, you can put up to 5,500 dollars a year into a Roth IRA.

Let’s say that you can only manage to put in $2,000 a year. You keep your belt tight and every month you put in $250 into your Roth IRA after taxes.

Once it’s in the Roth IRA you can start investing as a Rule #1 Investor. As that grows, there are no taxes that are going to be paid on it.

If you put in $2,000 a year, for 10 years, you have $20,000 invested in your Roth. Let’s say you’re earning 15% to 25% a year, pick a number in that area. Let’s say that you’re a good Rule #1 Investor and you can get 25% a year. What you will see is that on that $20,000 that comes in over 10 years, will turn into well over a million dollars.

Here’s Buffett on how to calculate the intrinsic value of a college education:

*“Book value is the cost of the college education plus foregone earnings one didn’t receive for those 4 years. Intrinsic value is the earnings over a lifetime less what would have been made without college discount to grad day at appropriate risk rate.”*

Let’s see how getting a medical degree looks in terms of its book value versus its intrinsic value.

First, let’s have our subject attend an Ivy League school to maximize the over all odds of getting in to medical school. The cost of a four-year Ivy League education is approximately $250,000 in hard costs. Buffett adds in the value of the earning not received, another $100,000, but I’m not going to include that. I’m going to assume our student goes to a good college. Total book value of the undergrad education is $250,000.

Now our student attends a wonderful medical school, again to maximize future earnings. These four years cost about $80,000 per year for a total hard cost of $320,000. In addition, we now forego a significant income.

Let’s assume we have a smart kid here who, instead of choosing biology, picks finance, graduates near the top of her class and goes on to a career in finance. This Ivy Leaguer begins her finance career at about $60,000 a year in earnings, with that amount rising quickly. At the end of four years, she will have taken home (after tax) about $300,000.

Our student’s book value (invested capital) now has an additional $300,000 invested, a new total of $620,000.

Our student is a doctor but the investing is not yet complete. She now begins a 5-year residency program where she will earn about $50,000 a year while working 80 or more hours a week. This apprenticeship adds to the investment cost of her career choice. The alternate choice of a career in finance would have provided our superstar with an income of $100,000 a year after four years in the field and the next five years will deliver another $500,000 in after-tax income. We have to add to the investment in this career the difference between the $40,000 a year after tax income for five years, i.e., $200,000, she will receive and the $500,000 she would have made in finance. That is another $300,000 invested. She now has invested $920,000.

Five years after medical school our doctor begins her career and starts making serious money as a return on her equity (aka book value, aka invested capital). Now we can calculate the Sticker Price or intrinsic value (aka ‘what its worth’) of this ‘business’.

Doctor’s incomes vary widely depending on their specialty and how hard they are working, not to mention the impact of the quasi-nationalization of their profession but let’s assume this five-year residency produces a great surgeon who makes average money in one of the higher paid specialties like orthopedics or urology. The expected income for that surgeon is about $470,000 a year; after taxes let’s call it $300,000 in current dollars. Assuming her income will increase at the rate of inflation, we’ll keep that $300,000 as a constant. In addition, she can probably sell her practice for 3 years of net income in current dollars when she retires in 30 years so in the last year we’ll add an additional $900,000.

Now we can do a calculation that tells us if we should pay $920,000 for this stream of cash. This is a discount rate calculation and the result is what we call the ‘Sticker Price’ of the business. Once we know the dollars invested ($920,000) and the dollars coming out ($300,000 for 30 years with a $900,000 payoff at the end), we need to determine a critical number, the Minimum Acceptable Rate of Return (MARR) which the rest of the world calls the ‘Discount Rate’.

We discount future cash flow because common sense says that it is better to receive $300,000 today than $300,000 thirty years from today. The key question to ask is ‘how much better?’. Well, the answer to that depends on:

- The risk you have of never receiving the $300,000 in 2044
- Some reasonable return for waiting for the money instead of getting it today.

Essentially the question becomes this: If I gave you a choice between #1: get $300,000 dollars today or #2: get Y dollars in 30 years, which one do you want, #1 or #2? Our job is to figure out Y, a number than makes the result of either choice financially the same.

A first step to an answer is to recognize that this is just the inverse of another question: *What is my rate of return on a risk-free investment where I won’t get my money back for 30 years?*

The answer to that question is the current 30-year Treasury bond interest rate, currently a bit less than 3%. This is assumed to be the minimum return anyone would accept since every other investment has more risk associated with it.

Since this is an alternate investment to the ‘risk free’ Treasury bond, the second step is to figure out how much risk there is and then assign that risk a premium return. In essence what we need to know is what the chances are that the $300,000 a year won’t come in. As risk goes, a doctor’s income is low on the list but still, there is risk; she could decide she doesn’t like medicine, the US government could nationalize all the doctors and reduce her income, she could get hurt and be unable to do surgery, surgeons might be replaced by robots, etc.

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