There's much that needs to be done when putting together a comprehensive financial plan, but first, you need a strong foundation.
Many physicians put in approximately 35,000 hours into their training prior to going out into practice. Yet, I have found they receive only about one to two hours of training or sound counseling on how to handle their personal finances when they make the jump to their higher salaries following their residencies or fellowships. And then they often spend more time planning their next vacation than the next 30-plus years of their own financial security.
So, a framework to build knowledge will be explained in this first column. Keep in mind that page after page can be written on each one of the issues in this overview, but it is important to have a sense of the 30,000-foot view before diving into the specifics.
A sound financial strategy is not something that is quickly thrown together and then dusted off again once you approach retirement. It is something that you need to put significant thought into and monitor throughout your career and into retirement.
When working on assembling a financial strategy, one must spread their time and resources over many areas at once, all while prioritizing and attacking the areas of the highest need. The following graphic shows a starting point to visualize the main areas of need. Of course, the products and strategies will evolve, but each of these areas can be applied at all stages of a physician’s career.
Click to enlarge
This article deals with the base of the pyramid.
The security and confidence stage
These three areas should be made the priority of a financial strategy before moving to any advanced and more complex wealth accumulation strategies. This is the area that we would parallel to being the “preventative care” of a physician’s financial strategy to avoid or guard against any financial issues in the future. Each of these three areas is no more or less important than the other two, and all should be given equal attention.
Emergency reserves should be in an account that emphasizes liquidity, safety and preservation of capital — the goal here is NOT rate of return. Unfortunately, in today’s interest rate environment, the best option is typically a money market account.
The important item within reserves is to set a threshold of where you want this account to be and then not let your reserves continue to build up just because it ‘feels good’ to see a big number due to the negative real rate of return (the national average for a bank’s money market account with a balance of over $25,000 is at .68% as of March 2012 and with inflation at an annual average of roughly 3.43% per year, dollars in checking, savings and money market accounts are losing purchasing power every day that they remain there).
A quantitative rule of thumb is to have three to six months of fixed expenses, and the qualitative rule is whatever amount that allows you to sleep well at night. The point is to have a rainy day fund for all of life’s unexpected setbacks that are bound to come up at some point in time or another. With the emergency reserve you won’t have to take on debt in the event some quick cash needs to be available.
The second area of a financial strategy that should be addressed is debt management. The key to this is the word “management,” which does not mean “immediate debt elimination.” Although it would be nice (and often very tempting) to never owe anybody anything, it is often not a shrewd long-term decision to eliminate long-term low interest debts sooner than necessary.
A general rule of thumb is to eliminate debts aggressively at 7.5% or higher and to consider opportunity costs of the use of the money when the interest rate is lower. The idea is that if you put the same money into an investment vehicle that can potentially outgain the interest rate or cost of borrowing, you will increase your overall net worth throughout time.
If you run the math on a difference of just out investing your borrowing rate of 1% -plus over a long-term time horizon, the numbers eventually get very overwhelming and should help outweigh any urges that arise to pay off the mortgage or student loans earlier than scheduled. It would be advisable to discuss this with a financial professional who can help quantify these decisions.
The third area that should serve as a base to any financial strategy is risk management. This includes both consulting with an attorney on the legal documents that should be in place (e.g wills, trusts, etc.) and obtaining the proper types of insurance.
As a med student simply having a health, renters and auto insurance is typically what is needed. In residency and fellowship years this expands to adding in specialty specific disability insurance, umbrella liability insurance and potentially life insurance. When in practice all of these types of coverage should be increased, and there should be an increased level of awareness on asset protection concepts and what aspects of your net worth are protected from potential creditors. When progressing towards the end of a career, it would be prudent to analyze the need for long term care insurance and life insurance for estate planning purposes to protect the nest egg you have worked diligently to build.
Protecting hard work
Overall, a good base of reserves, well managed low-interest debt and risk management are necessary cornerstones to any physician’s financial strategy no matter what stage they are at in their career before aggressive wealth accumulation or investing should be made a large priority. It is easy to overlook or put off some of these fundamental financial concepts, but it would be foolish not to protect the thousands and thousands of hours of time you put into your career and simply think that your life will go perfectly according to plan.
A “Real Life Financial Plan” continues to work well even if reimbursements go down, a disability or death takes place, a job loss occurs, or any of the other countless unexpected detours that occur throughout our lives.
For more information or to request a copy of Jon's book, Real Life Financial Planning for Physicians, go to www.askjonylinen.com.
Jon C. Ylinen is a Financial Advisor with North Star Resource Group and offers securities and investment advisory services through CRI Securities, LLC. and Securian Financial Services, Inc., members FINRA/SIPC. CRI Securities, LLC. is affiliated with Securian Financial Services, Inc. and North Star Resource Group. North Star Resource group is not affiliated with Securian Financial Services, Inc. The answers provided are general in nature and are not intended to be specific recommendations. Please consult a financial professional for specific advice in relation to your individual circumstances. This should not be considered as tax or legal advice. Please consult a tax or legal professional for information regarding your specific situation. 469432/ DOFU 3-2012