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By Dr. James M. Dahle, Founder of WCI
Investing is simply putting off spending in hopes of being able to spend or give away even more money later, and it’s an important part of achieving any serious financial goal. You can’t invest what you don’t have, so the first part of investing is simply saving. You save money every time you spend less than you earn, and the truth is that the vast majority of people, including doctors, spend more money than they should. The average US savings rate has fluctuated widely over the past few decades. It was above 10% until the mid-1980s, but thereafter it was around 7%, with a brief dip below 3%.
Although temporarily higher during the COVID pandemic when travel and spending have been particularly difficult, it has returned to historic ranges as the pandemic wanes. Doctors are probably no different. Annual Medscape surveys show that 60% of physicians save less than $3,000 per month. Given the average annual physician income of $275,000, that means well over half of physicians have a savings rate below 13%.
How much should doctors save?
How much should doctors save? If they analyze the numbers with reasonable assumptions, most physicians will arrive at a necessary savings rate of about 20% of gross income, just for retirement. Any money that is used to pay off additional debt, save for education, buy a second home or a sports car is added to that.
The best place to start any business 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 your financial assets. Include the value of your home and anything that can easily be appraised and sold, such as vehicles. Then pour yourself a drink and add up all your debts. Subtract debts from assets, and that will give you your net worth.
Now calculate your savings rate for the last year. Focus only on retirement for now. Determine how much you earned (the easiest way is to look at the total income line of your tax return). Add up how much you have 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’s probably time to get serious about financial planning, including a written spending plan or budget.
Now that you know where you are, think about where you want to be. The biggest mistake investors make is that they don’t have any kind of written goals or plan to achieve them. Investing is achieving your goals. If you don’t know where the finish line is, how will you know when you’ll reach it or how much effort you’ll have to put in to get there?
How to achieve your financial goals
Once you have a goal and a general idea of how much money you need to spend on it each year, think about the accounts available to help you reach that goal. The U.S. government actually wants you to save for your retirement, and it has strongly encouraged you to do so by offering substantial tax breaks to investors. Some of the biggest tax breaks available to doctors include tax-protected retirement accounts such as 401(k)s, 403(b)s, 457(b)s, SEP IRA, Roth IRA, profit sharing plans and cash balance plans.
If you are an employee, become an expert on the plans offered 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 is provided in retirement accounts for that year, you can always save an unlimited amount in a simple taxable account, sometimes called a non-qualified account or brokerage account. There are always tax advantages, such as lower tax rates for qualified dividends or long-term capital gains or the ability to use depreciation to offset investment income.
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 are going to invest. The combination of these types of investments is known as asset allocation. Diversification, not putting all your eggs in one basket, is the guiding principle here. Although you will almost certainly have to take substantial risks to achieve your goals, do not take more than necessary and certainly avoid risks that are not likely 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 amounts if desired. Even within the three broad categories, there are an infinite number of subclasses that can be used.
The key is to maintain broad diversification, take enough (but not too much) risk, and stick to your reasonable long-term plan even when the talking heads on TV — and even your own stomach — make you shy. worry about that money in the next economic downturn. If you’re like most investors, you’ll find that the majority of your portfolio will need to be invested in risky assets, like stocks and real estate, to achieve your financial goals. Investing only in safe asset classes, like bonds, will require you to save well over 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 when the markets go down.
Once you’ve decided on your asset allocation, it’s time to choose investments. Most retirement investors turn to mutual funds, where they can pool their money 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 attempt to match the market rather than beat it generally have higher long-term returns, especially after tax. These mutual funds are known as low-cost index funds, and an investor does not need to invest in anything else to be successful. Index funds are available for stocks, bonds and even real estate.
Unfortunately, often the investor matters more than the investment. By their very nature, people are prone to making all sorts of behavioral errors that lead to low returns on investment. These include trying to time the market, panic selling at market lows, picking individual stocks and chasing performance with the latest trending asset class, whether tech, gold or bitcoin stocks. Staying on track with your reasonable long-term plan is actually much more important – and perhaps much more difficult – than coming up with the plan in the first place.
Investing is an important aspect of your financial plan. The sooner you put a plan in place, the easier it will be for you to achieve your goals.
As an investor in a white coat, are you saving enough money? Have you developed your investment plan? Was it difficult to stay the course? Comments below!
[This article originally appeared in the American Academy of Emergency Medicine’s Common Sense magazine.]