Having supervised residents for more than a decade, I see most start their professional lives with a major mistake: being complacent about personal finances. Consequently, along with teaching the art of ophthalmology, I discuss how saving and spending properly early in a career will support a comfortable future and retirement. Investment advisors and insurance agents are well-aware that many doctors are financially illiterate. To guard against grave fiscal mistakes, I offer these general guidelines. The tips are not to make you rich but to help you lead a secure financial life.
Your Current Life
• Stop fearing money.
Finances, budgets, debt, loans and investments require only basic arithmetic.
• Stop overspending.
Focus on buying what you need, not everything you want. While you may think random strangers are impressed by your fancy car and clothes, truthfully, they don’t care what you drive or wear.
• Pay off credit cards monthly.
Carrying a balance on your credit cards indicates overspending. The interest on credit cards means those shoes you bought at a bargain price will actually cost much more.
• Live like a student.
At least for a few years after you start earning a professional’s income. This will allow you to pay off student loans, amass savings and decide what you want money to do for you in life.
• Start paying student loans.
If rates are low (1 to 3 percent), there is not much hurry to pay them off. If interest is 5 percent and above, concentrate on paying them off as early as you are able. If you take the full 10 years, you will pay far more than what you originally borrowed because of accruing interest. As you start your first job, set aside money to pay some of the interest and capital each month. One of the best days of your life will be the day you make your final payment.
• Know your FICO score.
Comparing your debt to credit ratio, this score summarizes your credit worthiness and determines what interest rate you will get for a mortgage, car loan, etc. Canceling a credit card will reduce the amount of credit you have, lowering your FICO score. Unless you pay an annual fee, keep all your credit cards open even if you never use them. Go to myfico.com to buy your FICO report. Work to push your score into at least the upper 700s. Also, check your personal credit reports from the three credit reporting agencies—Equifax, Experian and TransUnion— for accuracy. You may check all three free annually at annualcreditreport.com.
Looking a bit farther over the horizon, here are a few important considerations regarding needs that may not seem apparent at present, but require thoughtful planning.
• Save an emergency fund.
Determine how much money you and your family need to live every month—rent, food, diapers, restaurants, movies, etc. Keep six to eight month’s worth in an accessible savings account. If someone in your family gets sick, this fund will allow you to decrease your workload to help.
• Buy disability insurance.
You have spent so much time and money training for this career that, if you become disabled, you should still be able to live securely. Find what is referred to as “own occupation” disability insurance, which give you payments if you cannot perform your own occupation but may be able to do another.
• Buy life insurance only if someone else depends on your income.
Buy insurance to cover five to seven times your annual income. Avoid the combination life insurance and investment policy known as whole, variable or permanent life insurance. Insurance agents aggressively push these because of large commissions. Keep life insurance and investments separate. Buy term life for a fixed term of 20 or 30 years. This is much cheaper and pays out if you die while your kids are still young. By the time they are 20 or 30, they will no longer be dependent on your salary.
• Save for 25 to 30 retirement years.
With lifespans rising, expect to live 90 years or more. Assuming you retire near 65, you will need money to live an additional 25 to 30 years but without income from work.
The following rules are supported by solid financial research:
Save 15 to 20 percent of your income yearly in a combination of retirement investment vehicles, personal investment accounts and saving accounts.
Take no more than 4 percent of your savings out per year when you retire. For example, save $1 million for every $40,000 you need yearly—achievable if you save as recommended.
Most will need 70 to 80 percent of their current income to maintain living standards after retirement.
Pay off your house, car and any other large expenses before retirement.
When investing, most will buy mutual funds and hold for decades until retirement. Over the long term, assume an 8 percent return yearly on average. The compounding of this interest over many years causes your money to double and triple. The earlier you start investing, the larger that final number will be, by a significant amount. For example, starting at age 30 instead of 20 could cost you over $1 million in the long run.
Retirement Investment Vehicles
Over decades, if invested wisely, your money compounds so you will have enough at retirement. Once you put money in, do not touch it until retirement. Legally, you are allowed to borrow money, but doing so will incur fines, fees and taxes. There are four main stock investment vehicles.
Provided by your employer, 401(k) is in for-profit companies and 403(b), in non-profits. In 2014, you can contribute up to $17,500 per year pre-tax. You pay taxes only when you withdraw the money at retirement.
Same as the regular 401(k)/403(b) but you pay with after-tax money. The money grows over many years. When you withdraw, you owe no extra taxes.
You open your own IRA at a financial institution. In 2014, you can contribute up to $5,500 pre-tax per year. Those with incomes below $129,000, if single, or $191,000, if married, qualify for a tax deduction. Pay taxes only upon withdrawal of funds.
Same as traditional IRA except contributions are post-tax so you are not taxed when you withdraw at retirement. No one receives a tax-deduction on contributions.
• In a savings account, create an emergency fund to last six to eight months.
• Save 15 to 20 percent of your income each month in the following order: If offered a regular 401(k)/403(b), only contribute to the employer match, or, if offered a Roth 401(k)/403(b), contribute full $17,500. Then, contribute the maximum to a Roth IRA. Then, deposit in a personal investment account at a discount brokerage.
• In 401(k)/403(b), Roth IRA and personal investment accounts, invest in each up to three no-load index mutual funds, all with Expense Ratios of less than 1 percent. Keep 30 percent of your portfolio for bonds and bond funds to protect you in case of stock value drop. Dollar cost average your contributions so market highs cancel market lows.
• Always pay off credit cards in full.
• Never borrow from 401(k)/403(b) or IRA.
• Create a will, powers of attorney for health-care and finance, and a living revocable trust.
• Buy life insurance only if you have dependents, and buy disability insurance.
• Only spend 4 percent of your savings each year in retirement.
• Pay off all large life expenses like house and car prior to retirement.
• Live long and prosper.
If your employer offers a regular 401(k)/403(b) and matches your contributions (usually 1 to 5 percent), contribute only up to the match.
If your employer offers a Roth 401(k)/403(b), contribute the full $17,500/year.
If your income is within the limit, contribute the full $5,500/year to a Roth IRA.
If your income is above the limit, contribute the full $5,500/year to a traditional IRA, but do it with post-tax money. Decline the tax deduction. “Roll over” the money to a Roth IRA. This process is termed a “Backdoor Roth IRA” and can be executed at any income level.
Invest the rest in a personal investment account.
Contribute money to all of these consistently throughout the year until you reach the contribution limits and have reached your target of 15 to 20 percent of annual income. Called “dollar cost averaging,” this method of regularly buying funds, whether the market is up or down, will cause returns to even out in the long run.
Investing Your Contributions
Contributions to your 401(k)/403(b), IRA and personal investment account must be invested in the stock market if you hope to benefit from strong gains. Never invest in individual stocks. Instead, invest in mutual funds, most of which contain a large, diverse grouping of stocks. Particularly good are Index Mutual Funds, which contain the same stocks as a particular stock market index. Stock-market indices are used to judge market performance on a daily basis. Examples of such Index Mutual Funds are any S&P 500 fund, Wilshire 5000 Fund, Russell 3000 Fund, Total Market Fund, Small Cap Fund, Large Cap Fund and Total International Stock Market Fund. (The various investment firms have different names for their index mutual funds, so look closely at their descriptions.) S&P 500 Mutual Fund, for example, has historically bested “actively managed” funds 80 percent of the time. Actively managed funds are those with a management team that buys and sells stocks often, changing the fund over time.
Choose mutual funds listed as “no-load” (costing nothing to buy or sell) and have an expense ratio of less than 1 percent. The expense ratio signifies the cost to run that fund. Taking out more than 1 percent per year for administration will reduce what you receive at the end dramatically. Actively managed funds, for example, tend to have higher costs. To keep your finances simple, choose no more than three index mutual funds per account.
Employers usually limit investment choices for their 401(k)/403(b)s. To open your personal IRA account, go online to a discount brokerage like Fidelity, Schwab or Vanguard. These offer a vast array of choices.
When building your investment portfolio, choose mutual funds that reflect various areas of the market, so if there is a big loss in one area , it will not affect your entire account. An example portfolio at Vanguard could be 35 percent Total Stock Market Index Fund, 35 percent Total International Stock Index Fund, 30 percent Bond Market Index Fund. Some experts dislike bond funds. Instead they like individual bonds, especially municipal bonds. Buying the best MUNIs, however, usually requires the guidance of a financial advisor.
An alternative to different Index Mutual Funds is a target fund. You choose the fund based on the year you plan to retire (e.g., 2055 Target Fund). Target funds move your money from stocks toward the more stable bonds as you age closer to retirement. Some experts dislike target funds because these funds do not respond to the current market. For example, if interest rates go up just as you retire, those bonds will produce nothing, while stocks will produce great dividends. These target funds, however, remain simple, effective tools for those who want to invest and forget until retirement.
When you leave your job, you may either keep your funds in the old 401(k) or send them to a rollover IRA, a much better vehicle because you will gain a larger choice of funds. Go online to a discount brokerage like Fidelity, Vanguard or Schwab, create a rollover IRA, and take advantage of better investment options.
After saving 15 to 20 percent, the rest of the money is yours to spend as you want or save for large purchases like a house.
Important Financial Rules
• Buying a car.
Financially speaking, leasing a car is a terrible idea. Plan to pay it off in three years. If you need longer, you are paying far more than the car is worth.
• Buying a house.
Save at least 20 percent for a down payment on your house. If too difficult to save 20 percent, you cannot afford the house. Choose a 15 or 30-year fixed-rate mortgage. The mortgage payment should be no more than 30 percent of your income.
• Vital legal documents.
Everyone should have a will, health-care power of attorney, financial power of attorney and living revocable trust. The will is for property transference on death. A health-care power of attorney allows another person to make health-care decisions on your behalf when you cannot. A financial power of attorney allows another person to make financial decisions on your behalf when you cannot. A living revocable trust allows property ownership to transfer from one person to another if the owner becomes incapacitated. Unlike a will, when a person dies, a trust prevents having to endure the expensive, time-consuming probate process during which a judge must first declare the will valid. In that trust, place your house, bank accounts and life insurances. The will and powers of attorney can be drawn up cheaply without legal help using any online kits. Drawing up a reliable living revocable trust, however, requires a trust lawyer. The cost ranges from $2,000 to $4,000.
• Funding college for kids.
State 529 Plans are the best vehicles for college tuition savings. Like a Roth IRA, money is contributed post-tax and withdrawn without any taxes when your child enters college. While you may contribute in any state’s 529, your own may offer tax breaks for contributing. Saving at least $6,000 a year and investing in stock mutual funds will allow most to fund a state-school tuition bill completely.
• Prenuptial agreements.
Before you marry is when you and you partner are most likely to be generous to one another. This is the best time to create a prenuptial agreement. Whatever you bring to the marriage (property or family heirlooms) can remain in your ownership alone as long as they are not paid for from a joint account, and the owner’s name is not changed on the documents. In community property states, everything earned during the marriage is divided 50-50 unless you have a prenuptial agreement that says otherwise. Most marital arguments are about finances, so always be honest about money to each other. Budget, pay bills and do taxes together. Divorce will wreak havoc on both your finances.
• Paying bills with a spouse/live-in partner.
If you both work, bills should be paid based on percentage of total income brought to the partnership. So if you earn $100,000 and your partner $50,000, you pay two-thirds of each bill, and your partner one-third. Keep separate bank accounts for yourselves and one joint account for common bills. Again, be very honest about what you have in your accounts.
The most disconcerting part of personal financial planning is the cacophony of contradictory advice from friends, relatives, salespeople and the media. Many have a financial stake in the products they advise you to buy. Instead, follow these tried-and-true steps, all backed by reliable research and experience, to become confident and calm about your financial future.
Dr. Ghosh is an ophthalmologist who teaches residents in New York City. Contact him at
Chandak.Ghosh@gmail.com. He reports no financial interests in any products or services discussed.