Recently I met with a new physician client and his wife that had just accepted a position at a growing Utah practice. Both are in the mid-thirties and we were doing a preliminary review of their financial plan. Most of their adult life to this point has been spent in school, training, and just getting by financially. With his lucrative specialty, the new job will increase their income exponentially. In spite of this newfound wealth and possible dramatic change in life style, I was impressed with their desire to focus on their budget, build retirement savings, and live modestly. With the increased uncertainty looming about health care reform, this seems to be the new norm!
There are not too many professionals that go overnight from barely scraping by to a healthy six-digit salary as physicians do. Extensive schooling and training, along with mounting student loan debt puts physicians in a rather unique financial planning situation, with a shortened time horizon to save for retirement and a large amount of debt. These factors can create delayed gratification by the physician while in college, medical school, residency, and fellowship, which can unfortunately lead some physicians to live lavishly once they are practicing. Indeed, the doctor may feel that after having worked so hard and sacrificing for so long that now is the time to buy a new house and car, and go on vacation. This can unfortunately cause a physician to delay or reduce savings and substantially harm the ability to have enough money in the future to reduce his or her practice hours or take time off or retire early. A qualified financial planner helps physicians understand that even though they have paid a great sacrifice in receiving their training, the goal is to plan a secure retire. Three issues regarding budgeting that I would like to touch on here are mortgages, car purchases, and the emergency fund.
Mortgages and the Happiness Factor
The emotional benefits of paying off a mortgage are hard to quantify but should not be ignored. Unfortunately, inancial advisors, CPAs, and estate-planning attorneys tend to be over analytical and miss the “happiness factor” of getting out of debt and owning your abode. For the strictly number-oriented person this can be a sticking point. After all, even if you have no other debt, why pay off a 3.8 % mortgage (that after tax is costing you around 3% or less)?
I have never had a physician that paid off their mortgage and later remortgaged their home to invest in mutual funds, stocks or bonds. In fact, it is now accepted by FINRA (Financial Industry Regulatory Authority) and other regulatory bodies that a financial advisor that encourages a client to leverage principle residence equity (take out a 1st or 2nd mortgage) to make a security investment is akin to malpractice.
Car Purchases: New vs. Used
At the top of my personal list of dumb financial moves is the purchasing of new cars. I could have purchased the same model 3 or 4 years older and saved a significant amount of money. Live and learn! I acknowledge that for some, including many physicians, a personal preference may be to exchange more cash for that new car smell and the latest model. I thought I was in that group. Looking back, I wish someone had talked me into rethinking my preferences.
According to most car depreciation calculators (here is one: http://www.free-online-calculator-use.com/car-depreciation-calculator.html), an automobile will lose 65% to 70% of its value after 4 years. Over the next 5 years, the car will lose another 20 – 25% of its original value, so that at year 9 or 10 an automobile has typically lost around 90% of its value. Luxury cars retain value longer than these averages, but still depreciate of course.
Because a car’s depreciation slows down significantly after 4 years, a buyer can get the most “bang for the buck” by purchasing a 4-year-old auto at a price that is about 65% less than the new model.
Having an Emergency Fund (EF) is a needed part of a functioning financial plan and a critical part of budgeting. Like mentioned here, even if your budget is simply spending less than you make, you need an EF, as unexpected financial changes are just that….unexpected. How much is a matter of much debate. I recommend 6 months of annual income for physicians, and know the advice by financial advisors can be 3 months to 5 years of annual income. The problem with this advice is that most docs cringe when they see a six-digit portion of their portfolio earning virtually nothing. After taxes and inflation, the Emergency Fund has a negative real return. Of course, making lots of money on your EF is not the point. Having cash when you need it is the point of an EF.
I am surprised at how many physicians will simply park a large amount of funds in their local checking account at their bank at an almost negligible yield (0.05% or less). I have found physicians can park a good portion of their EF in an FDIC insured money market such as ING Direct, Emigrant Direct, Ally Bank, Discover Bank (with an EFT link to their regular checking account) or other competitive source and still maintain liquidity with some return (currently .80% or more). Also, a portion as much as half can be invested using a shorter three – five year muni bond ladder (highest investment quality) which will create at least a tax equivalent yield (considering the Doc is in the upper bracket) slightly better than the insured money market yields. The muni bond ladder does not have the immediate liquidity or ultimate safety of the FDIC insured money market funds and a physician may justifiably not feel that the added risk/liquidity issues are not worth the extra yield.