Preparing for Life after Residency: A Financial Planning Primer
By Erik W. Thurnher, MD, CFP..Erik W. Thurnher, MD, CFP is a practicing EP in Newport Beach, CA, and Certified Financial Planner.
Physicians are afforded an unique opportunity in life. With intelligent planning, physicians can enjoy both a very comfortable lifestyle and true financial security. Unfortunately, this opportunity is sometimes lost through a lack of attention to sound personal financial practices.
What follows is a set of starting points for financial planning. While space doesn't allow for an in-depth discussion of each topic, this article includes suggestions related to four of the core areas of financial planning: retirement planning, insurance, debt and cash flow management, and investment management. For those who want to seek professional help, there are also suggestions for finding a competent financial advisor who'll put each physician's interests first.
Financing retirement requires a surprisingly large amount of capital. To retire comfortably, most physicians will need to accumulate an inflation-adjusted retirement savings account of between two and four million dollars and possibly more. The good news is that with regular savings and wise investing, accumulating the necessary capital is not nearly as difficult as it might seem.
Start Saving as Early as Possible
Compound growth is a powerful ally in building retirement savings, but it requires time to work its magic. Consider two young physicians, both of whom wish to retire at age 58. Doctor "A" starts saving for retirement straight out of residency at age 28, and contributes $20,000 per year to her retirement plan. Assuming she invests most of her assets in the stock market, which has returned about 11% per year on average over the long-term, she will have 3.9 million dollars to fund her retirement at age 58.
Doctor "B" decides to put off saving for five years, and doesn't make his first retirement plan contribution until age 33. He also contributes $20,000 per year and is able to earn 11% per year. Despite starting only five years later than his colleague, Doctor "B" ends up with 2.3 million, a difference of 1.6 million dollars, or 40%. The point here is that to experience the full benefit of compound growth, start saving and investing as early as possible. The first dollar saved will grow to be the largest dollar in a retirement plan.
Maximize Your Use of Tax Advantaged Retirement Plans
Retirement savings gain a significant boost by making full use of tax deductible retirement plans. These plans come in variety of forms, but all share a key feature: they greatly increase the rate at which savings can grow by minimizing the effect of taxes. The tax deductibility of annual plan contributions will grant an immediate benefit, and there will be an ongoing benefit from the deferral of taxes on any investment gains. Money placed within such plans can be invested in stocks, bonds or mutual funds.
While still in residency and assuming that cash flow allows, consider making use of the retirement plan offered through residency programs. Another option would be to begin contributing to a Roth IRA.
For those who moonlight during residency or who become self-employed after finishing training, and receive 1099 income as an independent contactor, then consider setting up an individual retirement plan. As an example, a SEP-IRA is very easy to set up and will "shelter" up to $24,000 income per year. A Keogh plan will allow even higher contributions, up a maximum of $35,000 dollars per year. Both types of plans can be set up through discount brokerage firms like Schwab or Fidelity.
Create a Retirement Projection
While retirement may seem long way off, starting to think about retirement goals now will help ensure retirement at the time of each physician's choosing. There are a number of online resources available to help with this.
All physicians recognize the need for malpractice insurance. However this understanding doesn't always extend to the need to control financial risk in other areas of their lives. Remember that the purpose of maintaining proper insurance coverage is to provide protection against financial disaster. Purchasing insurance trades a known, but relatively modest cost (the premiums) to provide protection against a financial storm of unknown but potentially catastrophic proportions.
For physicians with dependents such as a non-working spouse, or children, life insurance is a must. Consider buying a 10, 15 or 20-year level term policy. While there are a number of ways to calculate the amount of coverage to purchase, a reasonable rule of thumb is to multiply your pre-tax salary by 7 to 10.
A word of caution: Many insurance salespeople will peddle "permanent" insurance. It comes under many names, including "whole life" and "universal life," but in almost every case it is an expensive product that isn't necessary. Stick with term insurance.
Physicians' potential earning power is their greatest financial asset, and protecting that asset with disability insurance is a critical component of any risk management plan. Remember that disability is far more likely than death. While quality policies are harder to find than once were, it is well worth the effort to seek them out. A good insurance agent can help sort out some of the complexities of purchasing disability coverage, but here are three key features to look for in a policy:
"Own Occupation" - This refers to how the policy defines disability, and simply means that the physician is considered disabled for the purpose of receiving benefits if he is unable to perform his usual function as an emergency physician. This is an important feature. Without it, physicians can't collect benefits even though they are unable to do their usual work.
"Non-Cancelable, Guaranteed Renewable" - This provision ensures that coverage won't be cancelled for illness.
"Future Insurability" -As physicians' incomes increase over time, it is important to increase coverage. This provision ensures that the ability to purchase such coverage without going through the underwriting process each time. How much coverage should you get? Most financial planners recommend buying as much as you can reasonably afford. But keep in mind that companies generally won't insure you for more than 60% of your income.
Cash Flow & Debt Management
Thoughtful management of cash flow and debt load is a necessary first step to funding other financial planning goals. By monitoring and planning income and expenses, it is possible to squeeze the most from each paycheck and make the most of one's salary.
Pay Yourself First
As a rule of thumb, saving 10% to 15% of income over the long-term will leave anyone in great financial shape. "Paying yourself first" refers to the practice of making savings the first priority with each paycheck and is best accomplished through paycheck deductions that are directly deposited into a retirement plan and/or savings accounts. Using the direct deposit approach makes it easier to stick to the savings goals and to avoid over-spending.
Pay-off High Interest Debt
Financing current consumption through consumer debt such as credit cards or auto loans can have an extremely corrosive effect on financial well being. Make paying down this debt a top priority.
For those homeowners who have built up equity, consider taking out a home equity loan to pay off credit card or educational debts. Not only will this lower the interest rate, but the interest may be tax deductible.
For physicians with high interest student loans, consider trying to lower the interest rate and monthly payments by consolidating or refinancing them. For those unable to get a better interest rate or payment schedule, pay down this debt after paying off any credit cards, starting with the highest interest rate loans first.
Taking Out a Mortgage
Unlike consumer debt, a mortgage can be a net financial positive. A mortgage finances a basic need (shelter), and unlike consumer loans, interest rates are lower and interest payments are tax deductible. An individual's ability to qualify for a mortgage will be dependent on income and total debt. Typically, lenders want to see that total debt payments, including mortgage and all consumer loan payments, plus home insurance and property taxes, don't exceed 38% of gross monthly income. Remember that the decision to buy a home needs to be assessed within the context of one's overall financial situation and must be weighed against other goals.
Computerize your Finances
Consider keeping track of income and expenses using a computer program such as Quicken. Such programs allow an analysis of spending patterns, and help highlight areas of overspending where income can be better deployed.
Investment planning can be a complex topic. However, for most investors, following basic investment principles keeps them on track:
Match Investments with Goals
How money is invested should be an outgrowth of what the money is to be used for. In general, the longer the time horizon, the greater the portion of the portfolio should be stocks or stock mutual funds, which generally provide the highest returns over time. For instance, because of the long time horizon involved, most young physicians investing for retirement should keep 90% to 100% of their savings in the stock market. Conversely, investing money for a short term goal (within three to five years), say for a down payment on a house, should include something predictable, like a money market fund or a CD.
Keep Investments Diversified
Diversification is one of the keys to controlling risk in investing. A great way to diversify a portfolio, and to simplify the task of investing, is to use no-load mutual funds. Mutual funds provide "built-in" diversification because they typically invest in dozens or even hundreds of different securities. And there are over 10,000 mutual funds to choose from, investing in everything from growth oriented companies and technology stocks, to more conservative blue chip stocks or bonds.
To get ideas on which no-load funds are best suited to each physician's individual needs, and on how to configure individual portfolios, start with the Morningstar website at www.morningstar.com.
Avoid Stock Trading and Market Timing
The temptation to make quick profits by timing the stock market, or through frequent stock trading, almost always ends up being counter productive. A long-term, buy and hold approach with regular savings contributions is the most reliable way to build wealth over time.
Getting Professional Help
Depending on each physician's level of experience and comfort in dealing with financial matters and time constraints, consider seeking professional help. When evaluating a financial advisor there are a number of criteria worth considering. First, be sure that the advisor has the necessary training and experience. The Certified Financial Planner (CFP) mark indicates that the advisor has undergone comprehensive education and training in financial planning, and is subject to the CFP Board's practice standards and ethical guidelines. Evaluate the advisor's investment performance if that is a service he will provide. Also, make sure the advisor works on a fee basis, either by the hour or based on a fixed percentage of assets. Working with a fee-based or "fee-only" advisor helps avoid the conflicts of interest that arise when compensation is based on commissions.
One final word in regards to maintaining a sense of financial and personal balance: With the exception perhaps of maintaining adequate insurance, it unrealistic to expect to be able to address all financial goals immediately. Prioritize goals, and work toward each one, as the resources to do so become available. After years of training and sacrifice, don't forget to live for the moment while planning for the future.
The opinions expressed in this article are provided as guidelines. EMRA disclaims any liability or responsibility for the consequences of any actions taken in reliance on these statements or opinions.
Originally published in the April/May 2001 issue of EM Resident