Personal Financial Management and the Young Emergency Physician: The Basics
Jesse M. Pines, MD MBA FAAEM
Vice President, Young Physicians Section, AAEM
Many physicians, especially young physicians, don’t know how to manage money. I don’t usually use stereotypes, but this one is true: doctors are not good financial managers. How do you learn about managing money? Personal finance is certainly not taught in medical school or residency. There’s so much else to learn in emergency medicine. Now you’re done with residency, and you’re out in the real world with your first job. What do you do now? You’re in a financial situation that is unique to physicians: you’re probably in your 30s or older, you may or may not have a lot of medical school debt, and now you’re making a big salary (maybe 200k or more). Some of you may have a spouse, kids, car payments, a house payment and maybe even pet insurance. How do you keep from going broke and still have a little fun with your money?The bad news is, if you don’t know how to manage money, it’s easy to make mistakes. And the more money you earn the bigger mistakes you can potentially make. The good news is that money management isn’t rocket science. If you can finish medical school, you can certainly learn to manage your money. But like any field, you have to know what you’re doing first. This article is intended to lay out a few easy strategies for young physicians (and maybe even some of the older ones) to ensure long-term financial health. This list of strategies is not meant to be exhaustive; it merely serves as a guide to start you on the right track. I don’t claim to be the Yoda of finance. If you’re really interested in learning about personal wealth management in depth, I would recommend either taking a course, going to your local bookstore and buying one of the many books on financial management or meeting with a professional financial counselor.
Step 1: Figure Out What You Have, What You Owe, and What You Spend
Begin by asking yourself, “What are my assets and what are my liabilities?” Simply put, your assets are what you already have, such as cash, investments and maybe your car. Your liabilities are what you owe, like the mortgage on your house or your college and medical school debt. Once the big bucks starting rolling in, it’s very easy to spend freely, especially if you’re single. This is actually the best time to start budgeting and to figure out exactly what you plan to spend. It’s OK to buy that new plasma TV or the diamond earrings. Just don’t buy them all at once or before you have some tangible savings. Expenses can add up quickly. By writing down your assets, liabilities and a basic budget, you can figure out a starting point.
Step 2: Get Rid of Credit Card Debt
The second step is getting rid of your credit card debt. If you get nothing else out of this article, know that ridding yourself of credit card debt is the best thing you can do to improve your financial health. It’s like quitting smoking. Why is credit debt so deadly? Credit cards take advantage of the worst parts of human nature. Credit cards are a racket. Convenient? Yes. And they are actually a wonderful invention if you pay your bills on time. If, however, you carry a balance on your credit card every month, they are the most expensive lender out there (except for maybe Vinny, your bookie). But instead of breaking your kneecaps if you don’t pay up, credit card companies will quietly cause your savings to waste away. And who reads all that little writing on the back of the application? It basically says that after your “introductory period,” they can charge you whatever they want. Credit cards want you to carry a balance because this is how they make their money. How do you get out of credit card debt? You can try to get a low interest bank loan. ‘Nuff said, don’t be a sucker. It’s like flushing money down the drain.
Step 3: Plan to Increase Your Savings
You may ask: why should I save when it’s so much more fun to spend? Gee, I’m out of residency now, shouldn’t I treat myself to that BMW 7-series? That may be OK, as long as you save money every month. Saving early is the key to building wealth. The reason for this is a simple concept: time + money = more money. This wonderful economic concept is also called the time value of money. Let me give you a basic example. Let’s say you start saving $1,000 per year starting at age 60 and it compounds at an annual rate of 7% per year. When you’re ready to cash out at 65, it’s worth $7,153.29. Wow, that’s a $2,153.29 profit. Now, if we crank the clock back to age 50 and start investing the same $1,000 per year, at the end of 15 years you have $27,088.05 - - for an investment of $15,000. If you start at 40, for the same $1,000 per year investment for 25 years, you’ll have $68,676.47, and if you start at 30, you’ll have $148,913.46. Save early, save often and start saving now!
Step 4: Improve Your Investment Portfolio
The next step is to improve your investment portfolio, or if you don’t have one, start investing in the right things. In Step 3, the assumptions were that you were making 7% a year, compounded. What if you can get a higher return by being invested in the right stocks? But in what do you invest? How you can maximize that rate of return? A general principle is that the more risk you take, the higher your expected return. At the same time, the more risk you take, the more money you can potentially lose. If you have a brokerage account, the mutual funds will probably give you an idea of a risk profile. Determining your individual risk depends on your own personality and your specific financial goals. The good news for physicians is that our jobs are what economists call inelastic. That means that our business doesn’t fluctuate with the economy, like season tickets to your hometown NFL team. Yes, next year people will continue to get into car accidents, develop chest pain and run out of their Percocet for their chronic pain syndromes. What this means is that, barring disaster, you can pretty much plan on a stable income. But when determining your risk profile, you also need to determine what the money is going to be used for. If you need a down payment on a house in six months or need to pay your kids’ tuition, you probably shouldn’t be invested in a high-risk investment. In general, if you want to invest in individual stocks, you have to 1) have luck on your side and 2) be willing to watch your portfolio carefully. Picking the right stocks and beating the market is very difficult. Some trust Jim Cramer , and others may speak to an investment advisor. If you’re more conservative, you might want to choose some balanced mutual funds or just keep your money invested in index funds. If you’re still relatively young and don’t need your invested money right away for something like a down payment on a house or kids’ college, you can probably afford to take more risks and invest in riskier stocks or funds. If you’re really risk-averse you can invest in bonds, but they will give you a much lower rate of return.
Step 5: Set Long-term Financial Goals
In general, you should start planning for retirement as soon as you exit the womb. In order to maintain your standard of living during retirement and not spend your kids’ inheritance, you will need roughly 65% of your annual income per year. For emergency physicians, this amounts to about $100,000 per year. But what about Social Security? I can only hope that Social Security will still be around when we are able to collect. If you are born after 1960, you can start collecting social security at age 67. In 2004 dollars, your social security benefit will be $1,660 per month. This only adds up to about $20,000 per year. So where does the other $80,000 come from? The answer is retirement income. When you’re planning your savings, you need to anticipate how much you will need in retirement in order to maintain your standard of living. If you need $80,000 per year in retirement savings and you’re just using income from your investment account, you will need about $2 million in savings at the time you retire. Again, see Step 3, start saving now!
Step 6: Own Your House
If you can afford it, own your house. If you can’t afford it, figure out a way to afford it or set a plan to buy your house. The government wants you to own your home as much as I do, but the difference is that the government will give you tax breaks. The good thing that comes from owning a house is leverage. Leverage means that you’re investing other people’s money (OPM) – that is, a bank’s money. Let me give you an example. Let’s say you have $100,000 to invest. Scenario 1 is that you take that $100,000 and it sits in a great mutual fund for 10 years earning a whopping 12% per year – you chose right, Indiana Jones . At the end of year 10, you have $310,585.80, or a profit of $210,585.80. Ready to retire? Now, let’s take that same $100,000 and invest it in a house. When you buy a house, you can invest some of the bank’s money (OPM); in fact, most loans make you put down 20%. You buy a house for $500,000. Since houses always go up in the long term (since the late 1800s, reliably), let’s say it’s a lean 10 years and you get 8% per year compounded on your home. At year 10, the house is worth $1,079,462.00, and for that $100,000, you just made a $979,462.00 profit minus expenses to buy and sell. That’s leverage - - and you didn’t pay rent and you got to deduct a lot from your taxes. So stop hemming and hawing: just do it. Despite the recent downturn, unless sinks into the ocean as Al Gore predicts, real estate will always go up.
Bottom line: if you are the head of household and primarily managing the family’s money, you need to know the basics. By following these six simple steps, you will be well on your way to financial security.