personal finance

Written Summary of 3 Financial Tips Every Young Doctor Needs to Know

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The video podcast for the original post was a beast (> 500 MB) and unwieldy for those deployed with suboptimal internet speeds, so I added a written summary, which can now be seen here:

3 Financial Tips Every Young Doctor Needs to Know

3 Financial Tips Every Young Doctor Needs to Know

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1. You can’t control the investment markets, so focus on the two things you can control – investment costs and your asset allocation.

No one, and I mean no one, knows what is going to happen in the investment markets. Study after study have shown that the overwhelming majority of people who try to beat the markets fail. Because of this, you should forget about trying to predict the markets, and focus on things you can control – investment costs and your asset allocation.

All investments have costs, and the impact of these costs on your investment return compounds over time, taking a larger and larger bite out of your investment returns. If you invest $100K for 25 years and earn 6% per year, without costs you’d have $430K. With just a 2% annual cost you wind up with only $260K. That 2% annual cost consumed $170K, almost 40% of your potential investment! (Source: Vanguard.com)

In addition, because they have to overcome higher costs, investments with higher costs lag the performance of similar investments with lower costs. If you look at stock and bond mutual funds in the highest and lowest cost quartiles, you’ll see what I mean:

Type of Fund Highest Quartile of Cost Lowest Quartile of Cost
Stock 6.9% 7.8%
Bond 4.0% 4.4%

Average yearly return from 2004-2014. (Source: Vanguard.com)

If you want to take one step that will guarantee that your costs are among the lowest in the industry no matter what you invest it, you should invest with Vanguard or the Thrift Savings Plan (TSP). Vanguard is actually owned by its own investors (you), and they leverage this corporate structure to provide the lowest investment costs across the board with the exception of the TSP, which has even lower expenses.

If you can’t invest with Vanguard outside of your TSP, perhaps because your have access to a retirement plan that doesn’t offer Vanguard investments, then you need to get into the weeds on your investment costs. While there are many different potential investment costs, the easiest one to look at is the expense ratio of your potential investments.

According to Morningstar.com, the expense ratio is “the annual fee that all funds or ETFs charge their shareholders. It expresses the percentage of assets deducted each fiscal year for fund expenses, including 12b-1 fees, management fees, administrative fees, operating costs, and all other asset-based costs incurred by the fund.”

Wow. That was a mouthful. Bottom line…high expense ratio bad, low expense ratio good.

You should be able to find your investments’ expense ratios on your investment website or Morningstar.com.

In addition to investment costs, the other things that you can control is your asset allocation. While there are many asset classes you can invest in, the two most basic are stocks and bonds. Here are some of the returns for stocks and bonds from 1926-2013 in commonly utilized portfolios:

Annual Return 50% Stocks & 50% Bonds 60% Stocks & 40% Bonds 80% Stocks & 20% Bonds 100% Stocks & 0% Bonds
Highest 32.3% 36.7% 45.4% 54.2%
Average 8.3% 8.8% 9.6% 10.2%
Lowest -22.5% -26.6% -34.9% -43.1%

(Source: Vanguard.com)

As you can see, the higher your allocation to stocks over bonds, the more risk you are taking and the bumpier the ride. Along the way, though, you have historically been rewarded for this bumpy ride with a higher average annual return. Just like the extra 2% cost that was previously discussed compounds to make a huge difference, so will a small difference in your returns. In other words, the more risk you can take, the more money you will probably end up with.

The application of these principles is that you should take as much risk as you can. In other words, you should invest as much of your portfolio in stocks as you can while still sleeping at night and not lying awake worrying about the stock market’s ups and downs. There will be another market downturn, and when that occurs you need to keep buying stocks because they are on sale, not sell out because you can’t handle seeing your net worth and portfolio value decrease.

Invest is as high a percentage of stocks as you can without making the critical mistake of selling stocks during the next market downturn. For me, that has been 100% stocks for the majority of my career, but for some people they’ll panic even at a much lower percentage of stocks. If a 50% stock and 50% bond portfolio is the only one that will keep you from selling during the next market downturn, then that is the right portfolio for you.

If you have been investing for long enough, look at your actual behavior during the 2007-2008 market downturn and what your asset allocation was at the time. Mine was 100% stocks and I kept on buying. Your allocation and actions will tell you a lot about your own risk tolerance.

2. Your savings rate is the most important factor determining your eventual net worth, and it should be at least 20-30% of your gross income.

The most common recommendation you’ll find or hear when it comes to saving for retirement is to save 15% of your gross or pre-tax income for retirement. There is nothing wrong with this recommendation, but built into it is the standard mentality of working until age 65 and then retiring. If you want the freedom to retire early, work as much or as little as you want, and achieve financial freedom/independence, then you will need to save much more than 15%. I’ve saved 30% over most of my adult life, and that’s why I’m writing a personal finance blog post.

If you want to take a look at various saving rates and how they impact your financial life, you’ll want to check out the blog post “The Shockingly Simple Math Behind Early Retirement” at MrMoneyMustache.com. There you will find a chart that shows you how many years you will have to work until you can retire based on your savings rate. If you go with the standard 15% savings rate, you’ll have to work 43 years before you can retire. If you go with my 30% rate, you’ll work 28 years. If you manage to save 50%, you can retire in 17 years! The more you save, the earlier you reach financial independence and can work as much or as little as you want.

The other standard advice you’ll hear and read is that you’ll spend approximately 80% of your pre-retirement income during retirement. For a physician with a typical high income, that can be a lot of money!

You have to realize that 80% is probably high for a physician because after you retire you’ll have greatly reduced expenses. This is because:

  • You’ll be in a lower tax bracket.
  • You’re no longer saving for retirement.
  • You no longer need life or disability insurance.
  • You’ve hopefully paid off your mortgage.
  • Your kids are out of the house (if you had any).
  • You have no more job-related expenses.
  • You can give less to charity if you need to.

In the end, you can probably live off of 25-50% of your pre-retirement income, not the standard 80%. This fact can multiply the effect of a higher than normal savings rate.

3. You are your own financial worst enemy.

Unfortunately for us, we engage in self-defeating behaviors all the time, including:

  • Assuming too much debt.
  • Living above our means in order to keep up with the doctor lifestyle.
  • Purchasing too large and expensive a house.
  • Purchasing too expensive a car.
  • Not maxing out our tax-advantaged retirement account contributions.

Luckily there are some simple rules that, if followed, can keep young physicians and medical students out of trouble.

First, realize that anytime you assume debt you are simply borrowing from your future self for current gain. Sometimes that is a good idea, like when you borrow to pay for medical school, but pausing before you assume debt to purchase something can help you out greatly.

Getting down to brass tacks, no one really cares what medical school you went to, so you should probably go to the cheapest one you can get into.

In addition, no one really cares how large your house is or what kind of car you drive. You think they care, but they really don’t. Don’t try to impress other people.

If you have student debt, you need to get smart about ways to refinance it or get it forgiven with the Public Service Loan Forgiveness Program. Thanks to the HPSP program, I never had student debt, so I’m not going to pretend to be the expert on it. If you have student debt, go to WhiteCoatInvestor.com and learn about options to refinance or get your loans forgiven.

When it comes to houses and cars, if you can’t afford the house you are purchasing on a 15-year fixed mortgage then you are probably buying too expensive of a house. Rent until you can put down a larger down payment or look at less expensive houses.

When it comes to cars, you should realize that you can buy a very reasonable used car that is 5-10 years old, plenty nice, and very reliable for much less than a new car will cost. You should make it your goal to pay cash for cars. If you can’t pay cash, then you should purchase a cheaper car.

Low or no interest loans are tempting because people think they are getting “free money,” but using “free money” to pay for a depreciating asset (one that declines in value) is not a smart financial move. Your goal should be only to borrow money for appreciating assets (ones that increase in value), like businesses or real estate.

Finally, make sure you maximize your tax advantaged retirement contributions every year, like the TSP. It is one of the few legal ways to hide money from the IRS, and the compound growth year after year is an opportunity you don’t want to miss.

In summary, here are the three things every young physician or medical student needs to know:

  1. You can’t control the investment markets, so focus on the two things you can control – investment costs and your asset allocation.
  2. Your savings rate is the most important factor determining your eventual net worth, and it should be at least 20-30% of your gross income.
  3. You are your own financial worst enemy.

Somebody out there is going to take this advice to heart and get rich. Is it going to be you?

Guest Post – Maximizing TSP Contributions During Deployment

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[Editor’s Note – The process of contributing to the TSP above the $18K annual limit while deployed can be confusing. Thanks to Dr. Levi Kitchen for giving us a first hand summary of how it works.]

By LCDR Levi Kitchen (Levikk81 < at > gmail.com)

Deployment offers a number of financial benefits, including tax free pay which can be directly contributed to your Thrift Savings Plan (TSP). However, this can be tricky. The following numbers are based on 2017 limits, which can be seen at this link.

Normally, the elective deferral limit is $18,000 annually. A deferral is defined as the money you elect to remove from your paycheck and contribute to the TSP. This includes either Roth or traditional TSP contributions. When deployed to a combat zone and therefore receiving combat zone tax exempt (CZTE) pay, the deferral limit for the current calendar year increases to $54,000. However, even when receiving CZTE pay, you cannot exceed $18,000 in contributions to your Roth TSP. The remaining $36,000 would have to be contributed to the traditional TSP. Also, in order to take advantage of the higher limit, the money has to come from your CZTE pay, which has to come directly from your paycheck. So, you can only take advantage of the higher deferral limits while receiving CZTE pay, not after.

Although the decision between the Roth and traditional TSP can be complicated (a matrix can be seen here), it’s probably smartest to max contributions to the Roth TSP first as, due to the CZTE, this money will never be taxed by the federal government. Once you reach a total contribution of $18,000 to the Roth TSP, DFAS will automatically stop deducting money from your paycheck. At this point, you need to change your contributions to traditional TSP in MyPay, because you’ve reached the limit of allowable Roth TSP contributions. Automatic deductions to the traditional TSP would again stop once you reach the total limit of $54,000 ($18,000 in Roth TSP and $36,000 in traditional TSP) for the calendar year, or you stop receiving CZTE pay.

As far as I know, once you stop receiving CZTE pay, your annual limit returns to $18,000 regardless of either Roth or traditional contributions. If you’ve already contributed over $18,000 while deployed, then you cannot contribute anymore to your TSP for that calendar year.

For any comments or questions, please email Levi at Levikk81 < at > gmail.com.

I Paid Off My Mortgage – Should You?

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(Here is a pdf of this article, one of my personal finance columns I write for a national Emergency Medicine newsletter.  Find more of them here.)

I cut a check and paid off my mortgage in February, making me debt-free.  It cut my living expenses by about a third and ensured that in four years, at the age of 45, I’ll be financially independent and eligible for military retirement. What a glorious feeling! Should you pay off your mortgage as soon as you can?

Benefits of Paying Off Your Mortgage

You have one less thing to worry about!  You’ve got food.  You’ve got water.  Now you’ve locked in your shelter and may be debt-free on top of that.  You can move from “safety” to “love and belonging” on Maslow’s hierarchy of needs.

It reduces your fixed monthly expenses, which goes a long way toward setting you up for retirement, fewer shifts, or even an alternative career path.  Housing is usually a large percentage of your monthly expenses, and everyone who decides to purchase their primary domicile should make being mortgage-free a major goal by the time of retirement.

It saves you money, since you’ll likely save tens of thousands of dollars in interest you otherwise would have paid.  In addition, if you no longer have a mortgage you should be able to reduce the amount of life and disability insurance you are paying for each month.

Without a mortgage, you can save and invest more money every month.  Before I paid off my mortgage I saved 30% of my gross income.  I’m not sure how much I’ll save now, but it’ll be more than 30%.

When you pay off your mortgage, you are getting a guaranteed rate of return on the investment.  In my case, the rate on my mortgage was 3%.  I’m usually in the 33% tax bracket, which means that every dollar I put toward paying off my mortgage earned me a guaranteed return of 2%.  This is a remarkably similar return when compared to most low-risk bond yields in recent years.  In fact, this is exactly why I paid off my mortgage.  I wanted to have a small portion of my retirement savings in bonds, but it made no sense to own bonds that would pay me 3-4% while paying 3% on my mortgage.  Paying down your mortgage is a reasonable substitute for buying bonds.

There can be asset protection benefits to paying off your home loan.  Some states provide unlimited asset protection for home equity, which makes it nearly impossible to lose your home if a lawsuit doesn’t go your way.  Other states, however, protect very little of your home equity.  If you want to see what your state protects, go to this link and look for each state’s “homestead exemption”:

http://www.assetprotectionbook.com/forum/viewtopic.php?f=142&t=1566

If you are paying a financial advisor who charges you a fee based on a percentage of your assets under management, by taking some of those assets and using them to pay off your house you reduce your investment expenses.

Benefits to Keeping Your Mortgage

When you make your mortgage payment, some of it goes toward principle and increases the equity in your home.  For me this was about $2000/month of forced savings.  If you are not financially disciplined, making a mortgage payment will ensure that every month you are squirreling away at least a little bit of money.

Mortgage rates are still near their all-time lows.  If you can borrow money at 3-4% and invest it in something that will give you a higher net return, it makes sense to invest the money instead of paying off the mortgage.  That said, you have to make sure that you actually invest the money.  In addition, there are very few investments that guarantee a return greater than your mortgage.  Actually, there probably aren’t any, because of the word “guarantee.”  Yes – stocks, high-yield or corporate bonds, real estate, etc. will probably make more than 3-4%, and you can protect yourself by diversifying – but that is certainly not guaranteed.

The after-tax mortgage rate you are paying may be below inflation.  For example, my after-tax mortgage rate was 2%. If inflation had been above 2%, I would have been getting paid (in real terms) to borrow money!

The value of real estate tends to rise with inflation but your mortgage payment is fixed, so when inflation increases the value of your house but your mortgage payment remains the same, you are paying the loan back with dollars that are worth less and less as time goes on.  When your mortgage is paid off, you give up this benefit.

What Should You Do?

Like most financial decisions, situations vary and this decision can be complicated.  The best on-line article I could find that goes through all the complexities of the issue, which my brief article does not, can be found here:

https://financialmentor.com/financial-advice/pay-off-mortgage-early-or-invest/7478

You should always maximize contributions to your retirement accounts, pay off all non-mortgage debt that has a higher interest rate, and save for your children’s education before you consider paying your mortgage off early.  But if you find yourself having taken care of all of this, and weighing investing in bonds versus paying off your mortgage, you can’t beat the peace of mind that comes with being mortgage-free!

Blended Retirement System: 6 Major Considerations Before You Choose

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Here is a nice article for those debating between the current retirement system and the new Blended Retirement System or BRS:

Blended Retirement System: What Will You Do? 6 Major Considerations Before You Choose

Guest Post: Important Update Regarding Disability Insurance for Active Duty Military Doctors and Dentists

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[Editor’s Note: This is a guest post/update from the company that was able to get me supplemental disability insurance (DI), which can be a challenge when you are Active Duty.  I have no current financial relationship with them and they did not pay for this post, although in the past I received some restaurant gift cards when referring people to them.  I asked them to provide it so they could explain recent changes in the disability insurance market for Active Duty personnel. If you want to read about DI, you can go to my Personal Finance page or some other posts like this one or this one.]

As you are likely aware, as a physician/dentist, your greatest asset is your ability to practice your specialty. Military physicians and dentists are not completely protected in the event they become disabled. Those who are informed of this risk exposure have been able to insure themselves by establishing individual disability insurance. Currently, there are two companies offering specialty specific coverage to military physicians/dentists; MassMutual and Lloyd’s of London. Of the two, MassMutual is the only one which offers a non-cancelable and guaranteed renewable policy to age 65. This type of policy cannot be canceled by the company, have its premiums and/or contractual provisions modified, exclusions added, etc. This is the type of policy we recommend to all physicians and dentists regardless of military status.  MassMutual has eliminated this policy’s availability in all states except the following:

  • California
  • New York
  • Florida
  • Connecticut
  • Montana

If you reside in one of these states and wish to protect yourself by obtaining the type of policy that will protect your medical career in the event of disability while you are in the military and while you are out, it is highly advisable to act now.  To protect your medical career in the event of disability, please contact us below:

 

www.di4mds.com

Andy G. Borgia, CLU (andyb@di4mds.com)

D.K. Unger (dku@di4mds.com)

10505 Sorrento Valley Rd., # 250

San Diego, California 92121

888-934-4637

858-523-7511 after 5pm

858-622-1883 fax