Today we’re covering 7 financial planning tips for resident physicians transitioning into practice. By utilizing these tips early in your career, you’ll be setting yourself up for long term success.
1) Plan Your Financial Journey
Financial planning is a journey: it begins with identifying your destination and charting your path, and then you must follow it. It’s easy to get lost when you don’t have a map, especially if this is a new path for you. Let your financial plan be your guide. Creating your plan is the most important step in your journey.
Creating your financial plan begins with clarifying your ideal future. Take a minute and put on your long-term thinking hat. Fast forward 1, 5 & 20+ years from now. Think about the following questions:
- What will your life look like?
- What has to have happened for you to be excited about your progress?
- Are you financially independent or is work still required?
- What does financial independence look like for you?
- How willing are you to pass on current lifestyle increases in exchange for future financial independence and security?
- What about money is most important to you and why?
Next, map out what’s required to get there and decide if you’re willing to do what it takes today. If not, adjust your destination and tweak your map until you feel good about your future. This will require balancing spending today versus tomorrow. Weigh these options now while you still have the choice.
The Simple Dollar defines financial independence as the point when you have enough money to survive without further income.
To give you an example of how this might look, let’s say your goal is to reach financial independence by age 50 – figure out what you must save today to reach this goal. Are you willing to make the lifestyle sacrifice to make this happen?
Or maybe funding your children’s college education is important. Run the numbers on what this might look like and determine what it will take in terms of lifestyle sacrifice today. You have two options; either make the sacrifice or change your goal. The sooner you do one or the other, the better.
Maybe really big vacations every few years are important to you. Or maybe you have a big home remodel that’s a priority. It’s all about today’s lifestyle versus tomorrow’s goals. Take the initiative to make your decision on how you balance the two.
When you’re sailing across the ocean, you either have a map to keep you on course, or you don’t and you’re lost at sea. Having a financial plan is a great start, but it doesn’t ensure success. Execution is required and that begins with managing cash flow.
2) Control Your Cash Flow
You’re about to sail across the ocean to an island called “your ideal financial life.” If your financial plan is the map, cash flow is the sail for your boat.
Some of you come fully prepared, raise the sail and immediately catch the wind. As you cruise toward your destination, only minor tweaks are necessary to stay the course. And then some of you haven’t prepared as well and just assume you’ll get there okay. You’ve been on boats before – surely you can figure it out. But as soon as you hit the water, you quickly realize that sailing isn’t as easy as you once thought. You bumble around the port zig-zagging and eventually get to sailing half steam. You’re moving along, but it’s not pretty, and you’re behind on your journey. And finally, some of you don’t prepare at all. When everyone else leaves the port, you float around aimlessly in the harbor with your sail flapping in the wind.
As you approach your transition into practice, it’s the perfect time to plan all this out. It will be tempting to start knocking out lifestyle decisions before you map out cash flow. Resist the temptation! Major decisions like the home you purchase and the car you drive can eat up all your cash flow in no time.
Great cash flow plans require a basic understanding of things like taxes, student loans, and expenses. If you don’t already have a basic understanding, some reading will be necessary to get caught up to speed. Or if you don’t feel extremely confident completing these tasks yourself, talk with a cash flow focused financial planner. If you planned on hiring a financial planner eventually anyway, now is a great time to do this.
Your specific cash flow should be based upon your financial plan. Let your future destination direct today’s decisions. This will be the most impactful action you take when executing on your financial plan.
Keep in mind, though, that managing cash flow is different than a budgeting. Budgeting involves setting spending targets and tracking actual results. Although important, it’s secondary to cash flow. Cash flow includes all sources of income and outflows and takes into consideration short and long term planning. Cash flow helps you see the bigger picture. Every dollar of income should be dedicated to either taxes, giving, lifestyle (including debt) or savings. And this categorization should be based upon your financial plan.
Your cash flow plan will consist of the following components:
- Spending (and debt)
Income is simple. It’s the total money you expect to earn from all sources (before taxes and benefits come out).
Taxes come next. Federal taxes will vary based on income. Depending on where you live, it’s likely you’ll also pay state and local income taxes so add these to your total. Don’t forget Social Security and Medicare taxes “FICA”. And if you’re planning to be an independent contractor, don’t forget you’ll pay 2x FICA tax because you pay the employer share and the employee share. Add federal, state, local and FICA to figure your total tax. When in doubt, error on conservative estimates. For example, a conservative estimate for the typical employee physician might be 30-40% for everything.
Giving should come next if that’s important to you.
Then savings. Total up your ideal savings for short term and long term. For short term, consider things like building cash reserves or major purchases. For long term, think investing for retirement, college funding and charitable desires.
And finally, spending comes last. Start by determining your major existing obligations. Everyone should include their minimum lifestyle This might be your current residency lifestyle. Add to this other necessary obligations like student loan payments.
Take total income and subtract tax, giving, savings, and necessary spending. If there is nothing leftover, you should prepare to continue living like a resident after you transition into practice (at least until your loans are paid off).
If you’re fortunate enough to have excess remaining, use it for additional debt payments, savings, or lifestyle increases. For lifestyle adjustments, it’s good to keep a priority list and use the excess to begin checking those off. This is how you decide on how much home to buy. If you’re left with $20,000, that’s the maximum you can spend on home costs. Remember, to consider all-in costs of home ownership and not just principal and interest on a mortgage.
Your cash flow plan might look like this:
Total Gross Income: $200,000
Minus Taxes: $60,000
Minus Giving: $20,000
Minus Savings: $50,000
Minus Spending: $40,000
This leaves $30,000 for increased home costs and maybe private school for the kids.
The key with cash flow is prioritizing lifestyle increases AFTER taxes, giving, saving, and obligations are addressed! Without a plan, lifestyle defaults to first priority. And nothing is leftover.
Student loans will inevitably be part of most young physicians’ cash flow plans. They have also become quite complex. Check out this student loan flowchart we put together to help you start putting together your student loan plan:
Cash flow is not a one and done deal either. You must monitor over time to keep yourself in check otherwise lifestyle creep occurs! Get in the habit of using a regular system to track your progress. At the conclusion of every month, document total cash balances at the start of the month, total income, total expenses and total cash balances at the end of the month. If you consistently see total expenses are greater than target expenses, it’s time to dig deeper. Add this financial review session as a monthly recurring appointment on your schedule. Don’t skip it!
Click here for (free) access to our cash flow tracking system we use with our clients to help them take control over their money. It’s complete with all the tools and systems you need to monitor where your money goes without spending hours every month counting pennies.
Cash flow planning gives your finances propulsion and will keep you on track toward living your great life. In summary here are the steps to creating your rock solid cash flow plan:
- Review your financial planning goals
- Calculate your target cash flow to hit goals
- Identify specific changes and give every dollar a purpose
- Setup systems for monitoring
- Track progress and make tweaks
3) Build Cash Reserves
Cash serves many purposes for the young physician. It’s there when things don’t go as planned. Or when a unique opportunity presents itself. Cash keeps you afloat. It provides security and flexibility to make solid financial decisions.
If anything has a direct correlation to reduced financial stress, it’s cash reserves.
People with extremely low cash reserves constantly worry about being able to pay bills. They regularly make transfers between accounts to get by, never really building anything. They worry about managing life’s uncertainties and feel paralyzed when they consider life’s opportunities. Saving and investing for the long term is a battle. At best, they have automatic investment plans they occasionally tap into when emergencies occur. Although they know they aren’t saving enough, increasing their investment contributions seems absurd. Sometimes they do it anyway and go into credit card debt.
People with plenty of cash reserves don’t worry about paying bills. They always pay on time and take advantage of early payment discounts. Uncertainty never disappears totally, but it’s certainly less of a concern. This person enjoys work because they aren’t a slave to it. If they stop enjoying work, they have flexibility to pivot into something different. Automatic investment plans are a given, and occasionally this person will dump in more into investments or opportunities that make good sense for them.
Life is always predictable right? Not quite! Most people intuitively know this yet fail to build cash reserves.
Cash reserves are directly related to cash flow. If you’re not setting aside cash regularly, you’ll never build reserves. Having low cash reserves is one of the first symptoms of poor cash flow planning. Make sure you dedicate a certain portion of cash flow to building cash reserves.
If this seems difficult at first, that’s normal. We find many people struggle with this more than they do investing and saving for long term. Cash is so accessible and can cause temptation. So you must be on your game!
To begin making your customized plan for cash flow, start out with “why.” Think about why you should hold cash and prioritize your reasons. Most people end up with three main purposes for cash (organized by priority).
1) Normal Lifestyle Spending
2) Unexpected Emergency Spending
3) Expected Major Purchases
Think of these like buckets to hold cash. Once the first bucket is full, it overflows into the next.
Once you have separated and prioritized purposes for holding cash, determine exactly how much cash each account should hold. And come up with an operations plan for each. Establish ground rules and consider worst and best case scenarios. Remember to keep it simple – it’s easy to end up with 3 checking accounts and 3 savings accounts for unproductive reasons. And it’s a bear to keep up with.
Start with the #1 priority, normal lifestyle spending. Your plan might be to establish one joint checking account where all income and normal household expenses flow through. And you set a target balance of $5,000, at its low point. This will allow wiggle room and eliminate the need to make random transfers from other accounts.
Next priority is #2 emergency spending. This account is off limits unless it’s an emergency expense. Vacations are not emergency expenses! Let’s say you decide a balance equivalent to 4 months of baseline expenses would be ideal for emergency cash. This plus your checking account would allow you to operate for up to 5 months with no income. And based upon your profession and life circumstances, you feel good about this target.
Last priority is #3 major purchases. You decide it will provide better clarity and accountability if you separate out emergency savings and major purchase savings by having two separate savings accounts. This account will be for any big spending that’s not an emergency. You won’t fill this bucket until #1 and #2 are full. As this bucket fills up, you’ll create a priority list of major purchases and knock them out as you have the money.
Let’s review. Create your cash flow plan using the following steps:
- Identify your purposes for holding cash
- Establish and prioritize accounts for each purpose
- Come up with specific targets balances for each account
- Establish ground rules for each account
4) Address Life’s Risks
Life is unpredictable. Bad things sometimes happen to good people. Good planning involves anticipating potential risks and making a plan for them. The biggest financial risk young physicians face is losing their ability to earn income. This can be caused by permanent disability and death. Either scenario can cause financial catastrophe for you and your family. Fortunately, there are insurance plans that allow you to offset this risk to an insurance company.
There are plenty of other risks in life such as lawsuits, job loss or losing your home to fire. Good planning involves considering all of these kinds of risks and having a plan for each.
For example, your disability plan might look like this… If you become disabled, you would use emergency cash reserves. If the disability lasted for more than 6 months (when emergency cash would run out), your long term disability insurance would kick in for 80% income replacement.
When you’re finishing up residency, net worth may be negative but your earning potential is massive. Because you have no wealth, insurance is important. As you become financially independent, you can take on more risks yourself and decrease reliance on insurance. This is why your risk management plan should be revisited every year or two as your circumstances change.
5) Manage Advisors and Salespeople
A quality advisor can act as your expert sailing guide. You hire them to teach you how to sail, help you create the map for your journey, and ride along to help keep you on course. Although they certainly have advice on what kind of boat to buy, they don’t have any financial incentive to sell it. They work for you.
The professional salesperson is like the boat sales rep. They make the buying process extremely efficient and enjoyable. They drink their boat manufacturer’s Kool-Aid and freely share it with others. It’s obvious they know more about the boats they sell than anyone around. They are an extension of the product distribution process and ultimately work for the product manufacturer, not you.
Keep this rule in mind as you navigate working with salespeople and advisors. Use advisors for advice and salespeople to buy products. Don’t take advice from sales people. And don’t buy products from advisors. It may sound like common sense, but people screw this one up all the time. It doesn’t help that sales people tend to try giving advice and advisors sometimes choose to sell products. Do your best to figure out where someone stands before you deal with them. Are they an advisor, salesperson or combo of both?
It gets especially tricky when salespeople start acting like and calling themselves advisors. Financial services firms are especially notorious for graying the lines between salesperson and advisor. There’s an army of “financial advisors” out there that are hungry for your business. Proceed with caution. Peel back the layers and you’ll find most are generally salespeople posing as “trusted advisors.” These sales advisors work for their firms – not you. Mixing product sales AND advice creates massive conflicts of interest you should at minimum be aware of.
How can you figure out who you’re dealing with? Find out how they make money. If they earn commissions and fees (sometimes called fee-based), they sell products AND give advice. If they only earn fees (fee-only), they are strictly advisors. And if they only earn commissions (commission-only), they are strictly product salespeople.
It’s totally ok to demand awareness and transparency when working with advisors and salespeople. If they’re one of the good guys, they’ll appreciate it as much as you. Greater transparency naturally breeds trust and confidence, which are the building blocks of productive relationships.
If I was looking for the best surgeon to perform a major surgery on me, expertise and experience would be very high on my list of qualifications. If it’s their first time cutting, I’m out. My goal would be to find someone in their prime who had done my specific surgery more than anyone else. I would want the best of the best.
When you’re considering hiring others to help you navigate life and money, take consideration of their specialization, experience and expertise. Although your life isn’t at stake (most of the time), the experienced expert certainly increases your chances of positive results.
Most advisors and salespeople don’t turn away business, even when it’s not in their sweet spot. In some cases, it works out just fine for both parties. But the risk of bad advice increases exponentially the further you get from their wheelhouse. Student loans are a good example. In recent years, planning around them has become extremely complex. Very few advisors take the time to keep up with it. Bad advice is tossed around all over the place. And it’s delivered wrapped in confidence and ignorance.
Finding An Advisor
If you’re looking for advice-only financial advisors (aka fee-only) that always operate as fiduciaries, you can find many of them in NAPFA’s find an advisor search. Or if you’re looking for the same type of advisor, but specifically those who serve Gen X & Y clients, try XYPN’s find an advisor search. XYPN’s search also helps you narrow down advisors by specialization. Or if you want an hourly fee-only planner, check out the Garrett Planning Network. The White Coat Investor has a great list of physician-focused advisors and salespeople listed on his website as well. His blog is also a great resource for young physicians looking to learn more about personal finance and investing.
As you work with salespeople and advisors, keep these points in mind:
- Use advisors strictly for advice (not to buy products)
- Use salespeople strictly to buy products (not for advice)
- Find advisors and salespeople that specialize in working with people like you