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By Dr. James M. Dahle, WCI Founder
Investing is simply delaying spending in the hopes of being able to spend or give even more money away later, and it's an important part of reaching any serious financial goal. One cannot invest what one does not have, so the first part of investing is simply saving. You save money any time you spend less than you earn, and the truth is that the vast majority of people, including physicians, spend more money than they should. The average American savings rate has varied widely over the last few decades. It was over 10% until the mid-1980s, but subsequently, it's been in the 7% range, with one brief dip under 3%.
While temporarily higher during the COVID pandemic while travel and spending have been particularly difficult, it has been returning to historical ranges as the pandemic wanes. Physicians are likely no different. Annual surveys by Medscape show 60% of doctors are saving less than $3,000 per month. Given the average annual physician income of $275,000, that means well over half of doctors have a savings rate under 13%.
How Much Should Doctors Save?
How much should doctors be saving? If they run the numbers with any sort of reasonable assumptions, most doctors will arrive at a necessary savings rate of around 20% of gross income, and that’s just for retirement. Any money that goes toward extra debt payments, college savings, a second home, or a sports car is in addition to that.
The best place to start any endeavor is at the beginning, and when it comes to building wealth, the beginning is figuring out where you are. Check your financial records. Add up all of your financial assets. Include the value of your house and anything that can readily be priced and sold, such as vehicles. Then, pour a stiff drink and add up all of your debts. Subtract the debts from the assets, and that will give you your net worth.
Now, calculate your savings rate for the last year. Just focus on retirement for now. Determine how much you made (the easy way is to look at the total income line from your tax return). Add up how much you saved for retirement and divide it by your total income. Was it more than 20%? Less than 20%? Much less than 20%? If so, it is likely time to get really serious about financial planning, including a written spending plan or budget.
Now that you know where you are, consider where you want to be. The biggest mistake investors make is that they don’t have any sort of written goals or a plan to reach them. Investing is all about reaching your goals. If you don’t know where the finish line is, how will you know when you reach it or how much effort you need to put toward arriving there?
How to Reach Your Financial Goals
Once you have a goal and a general idea of how much money you need to put toward it each year, consider what accounts there are available to assist you in reaching that goal. The US government actually wants you to save for your retirement, and it has heavily incentivized you to do so by providing substantial tax breaks to investors. Some of the greatest tax breaks available to physicians include tax-protected retirement accounts such as 401(k)s, 403(b)s, 457(b)s, SEP IRAs, Roth IRAs, profit-sharing plans, and cash balance plans.
If you are employed, become an expert in the plans provided by your employer. If you are an independent contractor, you have more control but also more responsibility in this regard. You will need to set up your own retirement account, usually in the form of an individual 401(k). If you need to save more for retirement than will fit into retirement accounts for that year, you can always save an unlimited amount in a simple taxable account, sometimes referred to as a non-qualified or brokerage account. There are still tax benefits available, such as lower qualified dividend or long-term capital gains tax rates or the ability to use depreciation to offset income from the investment.
Once you know how much to save and where you are going to save it, the next step is to choose the types of investments in which you will invest. The mix of these types of investments is known as asset allocation. Diversification, not putting all of your eggs in one basket, is the guiding principle here. While you will almost certainly need to take substantial risk to meet your goals, do not take more than you need to and certainly avoid risks that are unlikely to provide sufficient reward for the risk taken.
Types of Asset Classes
Most portfolios are dominated by three asset classes, or types of investments—stocks, bonds, and real estate. More exotic asset classes, ranging from commodities to precious metals to cryptocurrencies, can be added in small quantities if desired. Even within the big three categories, there are an infinite number of subclasses that can be used.
The key is to maintain broad diversification, take on an adequate amount of risk (but not too much), and to stick to your reasonable, long-term plan even when the talking heads on TV—and even your own stomach—are making you worry about that money during the next economic downturn. If you are like most investors, you will find that the majority of your portfolio will need to be invested in risky assets, like stocks and real estate, to reach your financial goals. Investing only in safe asset classes, such as bonds, will require you to save much more than 20% of your gross income for retirement. However, bonds and other safe asset classes will moderate the volatility of the portfolio and make it much easier to stay the course in a market downturn.
Once you have decided on your asset allocation, it is time to choose investments. Most retirement investors lean toward mutual funds, where they can pool their money together with other investors to benefit from professional management, economies of scale, broad diversification, and easy liquidity. The academic literature is very clear that mutual funds that try to match the market rather than beat it usually have higher long-term returns, especially after tax. These mutual funds are known as low-cost index funds, and an investor doesn't need to invest in anything else to be successful. Index funds are available for stocks, bonds, and even real estate.
Unfortunately, many times the investor matters more than the investment. By their very nature, people are disposed to make all kinds of behavioral errors that lead to poor investment returns. These include trying to time the market, panic-selling at market bottoms, picking individual stocks, and chasing performance with the latest hot asset class, whether it be tech stocks, gold, or Bitcoin. Staying the course with your reasonable long-term plan is actually far more important—and perhaps far more difficult—than coming up with the plan in the first place.
Investing is an important aspect of your financial plan. The sooner you get a plan in place, the easier it will be to reach your goals.
Are you, as a white coat investor, saving enough money? Have you come up with your investing plan? Has it been difficult to stay the course? Comment below!
[This article originally appeared in the American Academy of Emergency Medicine's Common Sense magazine.]