Developing a Plan and Sticking to It
Ronald A. Charles, MD
Assistant Professor, Emergency Medicine; University of Texas Southwestern Medical Center; Dallas EMRA RRC/EM Representative, 1993-94
You get that dream job and you're ecstatic. If you have not already established a financial plan you risk getting yourself into debt and wondering what happened to all the money. Setting short and long term financial goals will help ensure your financial security.
The best time to set your budget is during your residency training before you start moonlighting. Budgets will adapt with time, family, and income. If you don't have a budget, your first purchase may set off a cycle of shop, spend, charge, shop, and spend.
This article addresses important financial issues outside the workplace. Remember a perspective on what is important. The car, house, and vacations all enhance your life, but your peace of mind, friends, and family comprise fulfillment. Planning can help provide a comfortable lifestyle and financial security.
Realize the information discussed in this article is my educated opinion. I live fairly well on the limited income of an academician with a large student loan responsibility. Your situation may be different, but the general rule is the same: Develop a plan and stick to it.
Choosing a Financial Advisor
Investing can be tricky and time consuming. Just as you spent many years training as a physician, financial advisors spend many years learning their profession. Just as you continue to refine your knowledge base through reading and continuing medical education, so do good advisors.
Whether you decide to manage your own investments or work with an advisor, you need to be aware of the variety of investment options. My advice is to get educated help. Physicians have the reputation of inept money managing and poor investing. Mistakes can be very costly. Choose an advisor carefully. Get recommendations from friends and colleagues. Interview at least three candidates. Ask about their business and clients. Do they have set buy and sell disciplines? Do they have a long range plan or do they select "hot" stocks. Are they willing to work with your accountant and attorney to make sure your financial plan is comprehensive? Find someone you trust who will address your short and long term interests. A good advisor listens to your needs, is flexible, takes the time to educate you and provides a variety of options. Make sure your advisor has experience and feels comfortable with your objectives and tolerance for risk.
Financial advisors work to increase your income and deserve payment. Investing is their job. Not only do they manage for return, but for risk as well. Remember, the potential for financial loss from managing your own portfolio could be devastating. A good financial advisor should be worth the expense over time.
The most important factors for retirement saving are to start early and maximize the amount you set aside. Choosing the best format for your retirement account is challenging, and the specific details are beyond the scope of this article. However, you should follow a few general rules The younger you are, the more aggressive you can be. Generally, investing in individual stocks is the riskiest and most aggressive investment. Because of this risk, many retirement plans do not allow for individual stock purchases.
Mutual funds are the most common investment vehicle for retirement plans. The perception is that mutual funds reduce risk and are managed by professionals who follow the market closely. However, mutual funds can be risky. Mutual funds do provide greater diversification than individual stocks, but their objectives vary from conservative and stable to aggressive with high risk.
When considering a fund family, evaluate the overall objectives, disciplines and performance history. Compare fund managers. Usually, the more experienced the better. Team managed funds usually offer a set discipline, greater stability, and less volatility with managerial changes. Find a group of funds from an established company that encompasses the marketplace (growth, international, small stock, etc.). Many advisors recommend what I call "conservative aggressiveness" for young investors. That is, they invest a certain percentage in aggressive mutual funds or blue chip stocks and spread the rest in more conservative funds. A balanced portfolio is the goal.
Take into account loading charges, the fund's five- and 10-year performance records, and the type of fund. Remember, retirement plans are long term investments; the last six months' performance may be misleading. The long term performance illustrates the fund's stability and provides a better comparison of how the fund performs. Looking at the daily fluctuations can drive you insane. Many experts recommend reviewing your account annually.
Most experts recommend using "dollar cost averaging" which dictates you invest the same amount each month regardless of market changes. Stocks and mutual funds fluctuate with time; however, over the long term the returns have been generally positive. By investing the same amount monthly you average out the fluctuations and provide long term stability for your investment.
Financial advisors usually recommend portfolio diversification (insurance, savings, bond and stock investments). The diversification concept is also important with mutual funds. Diversification of your mutual funds should include at least three categories; large capitalized growth, large capitalized value, mid capitalized growth, mid capitalized value, small capitalized growth, international growth and individual sectors (health, high tech, utilities, etc.). What makes you successful in the long run is time, persistence and diversification.
If you happen to have some income left after investing for retirement, paying your bills and buying what you need and want, what should you do with it? Many experts recommend keeping two to three months' income relatively liquid (i.e., savings account or money market) for emergencies. Others recommend having a smaller amount liquid, investing the rest but keeping a percentage in a stable, accessible investment. In case of illness or accident, this three-month cash supply provides the income you need until your disability coverage begins.
Your investment approach should mirror your retirement approach but may allow for greater risk. The pure investment options include stocks and bonds. All other options are derivatives of stocks and bonds.
Experts recommend a varying portfolio for investments that includes percentages of aggressive versus more stable investments. The percentage varies with your age, number of dependents, income, and possible need for the income. Stocks are more aggressive than pure growth or industry sector mutual funds. Growth or industry sector mutual funds are more aggressive than growth and income mutual funds which are more aggressive than money market accounts.
High quality bonds are not risky if you hold until maturity. The principal and yield remain constant. If you are unable to hold until maturity the yield fluctuates inversely to interest rates and small increases in interest rates will drive your bond value (selling price) down. Bonds and bond mutual funds may be riskier than you think. The inexperienced investor looking for stable short term investments should stay with mutual funds, money markets and certificates of deposit (CD's).
Again, "aggressively conservative" dictates dollar cost averaging as the investment of choice. Diversification of your investments continues to be important. A variety of mutual funds provide the recommended diversity (international, small stock, blue chip and industry specific). Most mutual funds are liquid, but beware of transaction fees and loads (front and back).
Some highly recommended reading includes The Wall Street Journal, Business Week and Money Magazine.
I prefer the benefits of relatively low deductibles and high limits on automobile, disability, and homeowner policies plus an additional umbrella policy. Others disagree and pay lower premiums but have higher deductibles. For instance, I feel that spending $80 a year on premiums to decrease your automobile deductible from $500 to $250 is cost effective. To break even you have to drive more than three years without having any damage to your vehicle not caused by someone else who has insurance. Your comfortable lifestyle and your assets are always at risk. In today's exceedingly litigious society, I feel it is best to protect yourself in every possible manner. However, your should purchase only the insurance you need and deal with a reputable company. A reputable, established company may not provide the lowest price, but should provide a reasonable one. As with other service oriented fields, paying a fair but slightly higher price can yield a return in service and minimize problems when crises arise.
Automobile, renter's or homeowner's insurance, and disability insurance need to be standard components in every budget. Life insurance, term or whole, depends on your income, lifestyle, age and number of dependents. Automobile and home insurance rates can vary greatly. Shop for all insurance.
Disability insurance must be paid for by after-tax dollars. If it is paid for by your company with pre-tax funds, any disability benefits received become taxable. Research the different policies available and find a well-established company that offers a policy with the fewest restrictions. Some policies no longer allow stress related work loss to initiate the disability policy. The automatic occupational, residual and cost of living increases offered in some policies add to their value. Certain policies even allow for large salary increases such as the income change after residency.
Consider getting and keeping your own disability policy even if your new job offers it as a benefit. If you have disability insurance before signing your contract, is probably best to keep that policy. You must continue paying for the policy, but the benefits may be worthwhile. You will have additional income if you become disabled and have the freedom to change jobs without losing your disability insurance. You cannot get additional disability insurance after you sign a contract if that contract provides disability for 70% of your income, but you keep the insurance you already have.
Life insurance can be very confusing. Term life insurance provides a death benefit only. Whole life is a hybrid policy that doubles as a life insurance policy and investment/savings vehicle. The policy becomes fully paid off when its cash value is large enough to cover the mortality charges of the policy. You may borrow against the values accumulated at lower interest rates or cash in your policy entirely. Since the premiums are paid over time, the policy becomes a forced savings vehicle. This investment format is creditor proof (see next section).
Annuities, also sold by insurance companies, are an investment option that defers taxation on growth until you pull the money out of the annuity. Annuities allow for another tax deferred accumulation of funds along with your retirement programs.
Protecting your Assets
Your medical license and malpractice insurance are your tickets to practice medicine. They do not completely protect you or your finances, however. If you get involved in an unfortunate nasty lawsuit (malpractice, motor vehicle, personal injury, etc.) you need to protect yourself financially and know which of your possessions are creditor proof. This varies for each state. Check with your accountant or lawyer to find out what is creditor proof in your state.
In many states, assets held in insurance contracts, particularly annuities and life insurance, are protected from creditors. In Texas, the homestead act protects the equity in your home, pension plans, certain personal use property (two vehicles), limited personal assets ($60,000) and any cash value insurance policies and annuities. In addition, variable annuities and variable universal life offer supplemental options to your retirement program. These are important savings vehicles to consider in your portfolio.
Choosing an Accountant
Talk to an accountant soon after you get a new job or move to a new state. A good accountant will more than earn his/her fees in tax savings. Methodical organization is vital to decrease taxable income. Start a 'tax' calendar to record all your expenses that are tax deductible. All your job search and relocation expenses are deductible. All your medical purchases and expenses for CME or medical conferences are deductible. Meals and entertainment with medical colleagues may be deductible. Also your previously owned medical books, supplies, and computer equipment may allow for a one time deduction.
The factors that dictate what you can deduct include the type of contract you sign and the aggressiveness of your accountant. Independent contractor status allows for a great number of deductions including automobile lease payments or mileage from your purchased automobile. Choose an accountant whose tax aggressiveness matches yours. Make sure your accountant will represent you if the IRS comes calling.
Paying Off Student Loans
Student loan repayment can drain your income. If you find frustration dealing with a variety of lenders, each with different rules and payment dates, consolidation offers great benefits. Consolidation may reduce your interest rate and total repayment. Compare plans when choosing a loan consolidator. Interest rates and the length of repayment time vary. Call your lenders to investigate the specifics of the consolidation package they offer. Compare that package with other loan consolidating companies. Other consolidators to consider include the Sallie Mae Loan Consolidation Servicing Center (1-800-524-9100), the Student Loan Servicing Center (1-800-338-5000) and the William D. Ford Federal Direct Loan Program (1-800-848-0982). Remember that you do not have to consolidate all your loans into the same program or limit yourself to a single consolidator. Consider consolidating with two lenders if you have certain low interest loans that should be kept separate or higher interest loans that you are able to pay off sooner.
Pay off the higher interest rate loans as quickly as possible. Student loans are similar to a mortgage. Making payments higher than the minimum requirements can decrease the total interest paid, the number of repayment years, and the total repayment.
Purchasing or Leasing an Automobile
When you decide to buy a car, you have several options. The first option is whether to buy or to lease. This decision may be based on whether leasing provides a tax advantage, how often you plan to buy a new car, and your annual mileage. If you are an independent contractor or own your own business, a lease may save taxes. Also if you want a new car every two or three years and if you drive fewer than 15,000 miles per year, leasing may be financially attractive. The sales price, interest rate, down payment and residual value all are negotiable and vary among leasers.
Leasing can involve complicated intricacies (mileage, security deposit, etc.). Currently 40% of all new vehicles are leased. Leasing allows you to drive a newer, more expensive car than you can afford to purchase. If you lease, you only pay for that portion of the car being used. For example, the payments to own a $30,000 automobile approach $1,000 per month for 36 months and $800 for 48 months. The car's value at the end of 36 months will be, at most, $16,000, leaving a total pay-out of at least $19,000 including interest. In other words you have paid $35,000 to have a car worth, at best, $16,000. Lease payments for the same vehicle approximate $400 per month for a total of $14,400. You return the car at the end of the lease and have nothing, but have saved $5,000 over the three years. If you intend to keep the automobile for longer than four years or if you drive more than 15,000 miles per year, purchasing your car may be a better choice.
Trading in your vehicle can complicate the purchase or lease. Your trade-in transaction should be kept separate from the purchase negotiation. Again, do your homework to understand the value of your car. Negotiate this action independently, but remind the salesperson that you might not purchase the car if you cannot sell your old car. The benefit to trading in your car is to decrease the new car taxes and eliminate the hassle of selling your car. The total taxes are calculated from the price paid (the new vehicle selling price minus the price of the trade-in). For example, the taxes on a $30,000 car with a $10,000 trade-in would be on $20,000. If you sell your care independently, you lose this benefit, which in this case is $625.
Buying a House
Probably the most important investment you will make is your home. Real estate is no longer a premium investment, but purchasing a home has advantages, not the least of which is a sense of identity in the community. Some advisors recommend delaying a home purchase until at least six months after you move to a new area. By that time you will have a good idea about whether you will remain at your new job and a knowledge of the local real estate market. Also, it gives you time to save toward the down payment.
The first step is to decide on the mortgage payment you can afford. You will probably qualify for a loan larger than your budgeted amount. Stick with your budget. When your monthly mortgage payment is too large, you become "house poor," with no funds left over to buy furniture, travel, enjoy life, etc.
Buying a house may involve three individuals who can help make the process relatively safe and painless—a real estate agent, a mortgage broker and a lawyer. Find a buyer's agent you trust and prepare to spend some time looking. Your agent will help you pre-qualify for your loan as well as show you properties and help you negotiate for the best price. During the negotiation process, the agents representing the buyer and seller are the communications conduits between you and the owner. This process can be frustrating.
I started negotiations for my house by offering 90% of the list price and ended up paying 94% of that price. My agent pressured me by telling me that someone else may purchase the house, but I negotiated at my own pace. Many times the seller needs to sell the house more than the buyer needs to buy it, giving the buyer a slight advantage.
After you have agreed on a price, hoose a reputable inspector to look at the mechanical and structural components of the house and a lawyer who specializes in real estate contracts. Then, shop for the best loan. Compare at least three mortgage brokers' interest rates and closing costs. Be sure to ask if they are offering first-time buyer specials.
Many variables, especially points and closing costs are negotiable. "Buying points" is paying a small percentage of the loan up front then "buying down" the loan's interest rate. One point equals one percent of the cost of the house and lowers the interest rate about 0.25%. This lowers the monthly payment by $17.50 for each $100,000 of the loan. Points paid are tax deductible along with the interest on the loan. It usually takes three to five years to recoup the money spent to lower the interest rate. As long as you live in the house longer than the time to recoup the money and provided you have the funds to buy the points, consider buying down the interest rate. Often, the additional funds to buy points can be negotiated into the purchase contract. This reduces the immediate out-of-pocket expense for the house. You will need 8%-10% of the purchase price at closing.
Some lenders offer 100% financing for a new house, while others want a down payment ranging from 5% to 20%. Usually, the larger the down payment, the lower the interest rate. Also, either 20% down or an 80%-10%-10% (10% down and a second 10% loan at a slightly higher interest rate) loan abolishes the requirement for private mortgage insurance. This insurance protects the bank in case of default and may add $60-$100 to your mortgage payments.
Consider buying an adjustable rate mortgage (ARM). ARMs are loans with an interest rate lower than the 30-year fixed rate for a certain time period. During this time period the interest fluctuates according to the market. The rate may increase to the current higher market rate. For example, a three-year ARM is a loan with a fixed interest rate for three years that then becomes adjustable to the current rate for the remaining 27 years, if that current rate is higher. The shorter the ARM, the lower the interest rate during the "fixed rate" period of the loan. As you compare mortgage brokers, they will explain your options in great detail.
Finding the dream job is a significant accomplishment, but it is not the end of your labors. With this job you will realize a marked increase in income. In the short term, a sound financial plan forces you to set priorities and discipline your spending. In the long term, it provides money to handle emergencies and fund your retirement. Don't fall into the stereotype of the doctor who is a poor business person.
Published in EM Resident, April 1997.