Emails are notoriously difficult to deliver when you are sending hundreds or thousands at a time. So if you weren't able to get all of the Financial Boot Camp emails, you can find them here. Or if you're just impatient. Either way, I'm glad you're here and wish you a warm welcome to our community. Let me know if there is anything else I can do to help you. This is a 14 email series (12 steps plus an intro and a final email)
Welcome to The White Coat Investor Community!
My name is Jim Dahle. I'm a practicing emergency physician and the founder of The White Coat Investor blog, podcast, and, well, everything. I want to empower you with the financial knowledge you need to build the financial life of your dreams.
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James M. Dahle, MD, FACEP
Founder, The White Coat Investor
Second Email (Step 1)
WCI Financial Boot Camp Step # 1 Disability Insurance
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Step 1: Sponsor
Step 1: Disability Insurance
Can I Skip This Chapter?
Ask yourself a question: Do you have to work at some point in the rest of your life for financial reasons? If the answer to that question is yes, then you need disability insurance. If the answer is no, you can skip the rest of this chapter.
Why You Need Disability Insurance
Disability insurance gives you an income to live on if you become so disabled that you can no longer work. Essentially every high-income professional in their first decade or two out of school should own a policy. If you don’t own one, you need to go get one, now. Well, I don’t mean RIGHT NOW. You can finish this chapter first. But then you should put this down and go get one. Here’s how you do it.
Items to Gather
First, you need to gather up a few things. You need to know your income (check your last W-2 or 1099 form provided by your employer), you need to know about how much you spend (if you’re like most, it’s a very similar number to what is on that W-2,) you need to know if your employer offers any disability policies (check with Human Resources,) and you need to get a copy of the group policy offered through your specialty society or the American Medical Association.
Take these items with you and call an independent insurance agent who specializes in disability insurance for physicians and other high-income professionals.
Choose an Independent Agent
By independent, I mean this agent can sell you a policy from dozens of different companies, not just one. If it were just one, she would be a “captive” agent, not an “independent” agent.
Northwestern Mutual, for instance, is a company that uses captive agents. You can’t get a Northwestern Mutual disability policy from an independent agent, and you often won't be offered a policy from any other company from a Northwestern Mutual agent. That’s okay, their policies aren’t so hot anyway, so you can afford to just ignore them if you like. It beats having to deal with two different agents, doesn’t it?
It’s not like shopping for disability insurance is fun. If you can’t find an independent agent on your own, come by the website (using the links at the end of the chapter.) I keep a list of good ones that hundreds of my readers have used in the past. Yes, they are paid advertisers on my website, but they’ll treat you well. If they don’t, let me know and I’ll take them off the site.
From Application to Policy in Hand
Now, when you go to the independent agent, you’ll need to provide her with a little bit of information, like your age, gender, health status, specialty and state of residence. She can then discuss with you the various policies available from the various companies. She can also help you compare them to your employer’s group policy, your specialty association group policy, and the AMA group policy.
If you buy a policy from her, she’ll be making thousands of dollars off of you in commission, so now is the time to get your money’s worth. Ask every question you can think of and really educate yourself on the pluses and minuses of each policy.
Then you can decide which of the “bells and whistles” you’re willing to pay for. Take the time to do this right, and hopefully, you won’t have to ever do it again for the rest of your life.
Once you select the policy you like you will need to fill out an application, have a paramedic physical (usually just vitals, blood, and urine) and then in a month or so, you’ll have a policy.
Agent’s Conflicts of Interest
There is quite a bit more to learn about disability insurance, which I will discuss below, but a good independent agent can teach you most of this. Just keep in mind she is incentivized to sell you an individual (instead of a group) policy, to sell you as large of a policy as you can qualify for, and to sell you as many of the bells and whistles as possible.
The rest of this chapter will give you an unbiased opinion on those questions. Take my opinion, combine it with your agent’s recommendations, spend some time thinking, and you’ll get to the right place. In the end, any disability insurance is better than no disability insurance, and if you go through this process, you will almost surely end up with a good policy.
Be sure of the following to secure that good policy:
- Read every word in the policy and have your agent explain to you what they mean.
- Take notes, right in the policy, to remind you later what you’ve been told.
- Be sure to ask for a discount. If you buy from an agent who has worked with hundreds of doctors, she should be able to offer you a “preferred producer multi-life” discount because she has already sold several policies to doctors working for your employer.
- Be aware that disability insurance is more expensive for women then men, so men should generally buy a “gender-specific” policy and women should generally buy a “unisex” policy.
Individual Versus Group Policies
There are a number of benefits of an individual policy.
- You control of all the details.
- You choose how much insurance you want to pay for.
- You choose which of the bells and whistles you are going to get.
- The policy is “portable” meaning you still have it if you change employers (or if your employer just decides to change the policy.) As a general rule, the policy is also “stronger,” meaning it is more likely to actually pay you if you get disabled. As I’ll discuss below, disability isn’t always black and white.
There are two main benefits to a group policy:
- The first is that they may be dramatically cheaper than an individual policy. A typical individual disability insurance policy will cost you 2-6% of the amount of income you are protecting. That is to say, if you want a benefit that pays you $10,000 a month if you become disabled, your premiums will likely be $200-600 per month or $2400-7200 per year. That is a significant budget item for most high-income professionals, and looking at ways to decrease the cost is wise. A group policy might be ¼ of the price, and if it is good enough for your needs, then it is good enough.
- The other benefit of a group policy is that it is easier to qualify for. They don’t ask as many pesky questions about your health or risky hobbies. They probably don’t require an examination at all. So a group policy from your employer or association is a great option if you are having trouble qualifying for an individual policy.
Personally, I have one of each type of policy. I bought the individual policy years ago as a resident (so I’m closer to the 2% price) but it excludes any disability caused by rock climbing (one of my many bad habits.) So I also purchased the policy offered by my partnership, which does not exclude rock climbing injuries (which is good, since many of the partners climb!) The group policy is much cheaper but does not have as strong of a definition of disability. It also has the irritating habit of going up in price each year and occasionally changing the terms of the policy.
The Definition of Disability
The most important part of any disability insurance policy, and which you must go over word for word with your agent, is where it defines what a disability is and what it isn’t.
Life insurance is much easier in this regard. Life and death are pretty much black and white. Now, I’m an emergency doc, so I get to see all the shades of gray between life and death, but I can assure you that within an hour or two, it is all going to be sorted out.
Not so with disability. Getting disability payouts is an entire niche within law and it all comes down to how the contract reads. The strongest definition is one that states if you cannot work in your chosen occupation (defined as your specialty) that the policy will pay out its full amount. Specialty-specific, own occupation. Those are the words you’re looking for.
Weaker definitions include “modified own occupation” and “any occupation.” It’s possible, for the right price, that you should purchase a policy with a weaker definition. Just realize that the weaker the definition, the more circumstances there are where you could become disabled, but not receive payments from the insurance company.
Residual Disability Riders
Most good policies also include a provision for a partial disability. That means if you can still work part of the time, or you can still earn some money, that the insurance company will help make up the difference. This is also an important aspect if your disability is only temporary. As you gradually recover from the disability, the residual disability rider will ensure you get some financial assistance to make up for the lost income.
I see little reason to buy a policy without this type of protection. I consider this rider mandatory. But be aware that the rider with each company is slightly different. Some are better than others and the better ones usually cost more. You will generally get what you pay for in this regard.
Cost of Living Rider
All individual policies, and some group policies, will offer a Cost of Living or Inflation rider of some type. This ensures that your payments will go up with inflation as the years go by. Again, the rider is different with each company. Be aware that this rider does not increase the initial disability payment you receive.
If the policy you buy in 2016 says it will pay you $10,000 a month if you get disabled, it will only pay you $10,000 that first month you get disabled whether that is in 2026 or 2046. But once it starts paying it will gradually adjust upward.
For this reason, I think this rider is mandatory in the first half of your career. However, since most policies only pay until age 65 or 67, I don’t see much reason for someone in their 50s or 60s to be paying for it.
Future Purchase Option Rider
This rider allows you to buy more insurance later when your income goes up without having to prove you are still insurable (i.e. no questions or exam.) It does not lock in the low price you received when you first bought the policy.
I think this is a smart rider to purchase when the company does not allow you to buy as much insurance as you need. For example, most residents and fellows are limited (by insurance company policy and by their inability to afford it) to buying less benefit than they really want to live on for the rest of their life.
So for a resident, it makes sense to buy a future purchase option rider. But if you’re an attending in your peak earnings years? Just buy the amount you need and save money on the rider.
Catastrophic Disability Rider
Many companies now offer a catastrophic disability rider. This basically says if you’re really, really disabled (i.e. can’t do at least 2 activities of daily living such as dressing or bathing), it will pay you extra. Sometimes this rider is just a part of the policy (meaning you don’t have the choice to reject it and save some money.) But as a general rule, I think you are better off using the money the rider would cost to just buy a larger benefit to start with.
Some companies allow you to buy a rider that, if you become disabled, not only pays you a monthly benefit to live on, but also puts some additional money into a separate account for your retirement.
Since the investment options the company is likely to use are generally poor compared to what is available on the open market, I recommend you skip this rider. Of course, you need to make sure the benefit you have purchased is sufficiently large that you can not only live on it, but also save for retirement on it, since the policy will only pay until you are in your mid 60s.
Guaranteed Renewal Versus Non-Cancelable
There are a few more weird terms used in the insurance world you should be aware of. A policy is one of three things – conditionally renewable, guaranteed renewable, or non-cancelable.
This is when the insurance company can cancel the policy whenever it likes and is very rare.
The insurance company can raise your rates, so long as it raises the rates of everyone else that is like you with regards to age, state, or specialty, but cannot cancel the policy if you pay the premiums.
The insurance company cannot raise rates at all and must renew the policy so long as you pay the premiums.
Obviously, the non-cancelable policy is the best option, but it is pretty rare for a company to raise rates, so if you are offered a substantial discount for a policy that is only guaranteed renewable, consider taking it and put the money toward another good cause.
Choosing a Waiting Period
Policies will often give you a choice of a waiting period, that period of time between the date of disability and the date when payments begin. You should have an emergency fund consisting of at least 3 months of expenses sitting around in a very safe place. In the event of disability, use that money to live on for the first three months. This will allow you to choose a 90 day waiting period for your disability insurance policy rather than a more expensive 30 day period. There is not much of an additional discount for a 180 day period.
How Much Disability Insurance Do You Need?
As a general rule, insurance companies will allow you to buy enough insurance to replace 60% of your gross income. Since most high-income professionals are paying 15-35% of their income toward taxes, that is usually MORE than enough income to live on. Remember that disability insurance benefits, unless the premiums were paid for by your employer, are completely tax-free to you. If you already have a nest egg that by age 65 will be sufficient to provide your desired retirement, then you may need even less.
As a general rule, decide how much to buy based on your actual expenses, not some percentage of your income. If you are spending $8,000 per month, and need to put $3000 per month toward retirement and $1000 per month toward college, then you need a disability benefit of $12,000 per month whether you are earning $20,000 per month or $40,000 per month.
When to Buy A Policy
My general recommendation is to buy your coverage as soon as you get out of school, although it is possible to buy a very small policy even as a medical student. Then upgrade your policy (either by purchasing an additional policy or exercising a future purchase option rider) upon completing your training.
When To Drop Your Policy
There are two times to consider canceling your policy.
- When you no longer need it. If you become financially independent, such that you no longer need to work for money, ever, then cancel your policy.
- When it is no longer a good deal. When you are 30, if you become disabled your policy will pay for the next 35 years. If you are 60, it will only pay for 5 more years. But the premiums are the same. At a certain point, you’re paying a lot of money for not much benefit. If you are in that situation, consider dropping your policy and putting the money toward retirement to hopefully help you become financially independent even faster.
If you anticipate early financial independence, allowing you to cancel your disability policy by your early 50s, ask your agent about a graded premium policy. With graded premiums, you pay less now and more later for the same benefit rather than one flat rate over the years. But if you are able to cancel the policy at a relatively young age, you never have to pay the higher premiums.
In summary, unless you are already financially independent, or can live off of your spouse’s income in the event of your disability, you need to buy disability insurance. Policies vary, both in features and in price. Shop carefully the first time, put your premiums on autopay, and move on to other financial matters.
Your Chore List
- If you do not already have disability insurance, gather up your W-2, your spending, and the group policies available to you and make an appointment to meet with a good independent disability insurance agent. Do it today.
- If you do have disability insurance already, go get your policy out of your filing cabinet. Does the benefit amount still make sense? Do you have enough? Do you have too much? Are there riders you would like to drop to save some money? If it all still looks okay to you, put it away and know that you're done with your homework for the next week. If it doesn’t, schedule an appointment with a good independent disability insurance agent and go meet with her to discuss your concerns.
List of good independent agents
Original series on disability insurance on the WCI blog
A personal story of a doctor living off the proceeds of his disability insurance policy
Another personal story from a disabled doctor
Great calculator for estimating your personal chance of being disabled
Details of the American Medical Association group policy
Details of the American Academy of Family Practice group policy
Details of the American College of Physicians group policy
Details of the American Academy of Pediatrics group policy
Details of the American College of Surgeons group policy
Details of the American College of Emergency Physicians group policy
There. That wasn't so bad, was it? 11 more steps to go. See you next week. Also, and this is important, take a moment now and add my email address to your contacts or whitelist it. For some reason, many email providers randomly send bulk emails like these to your spam box if you don't do this.
James M. Dahle, MD, FACEP
Founder, The White Coat Investor
Third Email (Step 2)
WCI Financial Boot Camp Step # 2 Term Life Insurance
Welcome back! I'm glad you're still here. How did your homework last week go? I hope you all now have disability insurance (or no need for it.) If not, flag this email for later review and go back and do last week's homework. The knowledge doesn't do you any good, only the behavior. So make sure you're doing both.
Today we're going to talk about life insurance, which is critical if you have anyone else depending on your incom. See that picture up there? That's me with my daughter Whitney on top of the Grand Teton. Whitney is an occasional columnist on The White Coat Investor and a frequent partner in my outdoor adventures. But I carry life insurance so her life wouldn't change if I fell off a cliff. But before we get into all that, a word from this week's sponsor.
Step 2: Sponsor
This newsletter is sponsored by Bob Bhayani at Dr. Disability Quotes.Com. He is a truly independent provider of disability insurance planning solutions to the medical community nationwide and a long-time WCI sponsor. Bob specializes in working with residents and fellows early in their careers to set up sound financial and insurance strategies. He has been extraordinarily responsive to me any time any reader has had any sort of an issue, so it is no surprise I get great feedback about him from readers like this recent one:
Bob and his team were organized, patient, unerringly professional and honest. I was completely disarmed by his time and care. I am indebted to Bob's advocacy on my behalf, and on behalf of other physicians, and to you for recommending him.
If you need to review your disability insurance coverage to make sure it meets your needs, or if you just haven't gotten around to getting this critical insurance in place, contact Bob Bhayani at Dr. Disability Quotes.Com today by email at [email protected] or by calling 973-771-9100.
Step 2: Term Life Insurance
Can I Skip This Chapter?
Is there anybody who depends on your income besides you? If so, you need life insurance and should read this chapter, even if you already own some life insurance. If nobody else is depending on your income, and you have enough assets to pay for your burial, wonderful! You can skip the rest of this and I'll see you next week.
More Income Insurance
Just like disability insurance doesn’t reverse your disability, life insurance doesn’t bring you back from the dead. Its purpose is to eliminate the financial consequences of your death. It will do nothing for the other consequences. In order to figure out how much insurance you should buy, you will need to determine what the financial plan will be if you died tomorrow. Then, buy enough insurance so that, financially speaking, the consequences are the same whether you live or die.
For example, our financial plan is for my wife not to ever have to go back to working for money. That means my life insurance serves as an “instant retirement nest egg.” When we first started earning money, I needed enough life insurance that if I died, she would have a nest egg that, managed in a reasonable manner, would last the rest of her life. We also needed enough to pay off the mortgage and enough to cover a big chunk of our childrens’ education expenses. Now, over the years our real retirement nest egg has grown, our mortgage has been paid off, and the college funds have grown. Thus, our need for insurance has become less and less over the years. At a certain point we will have no need for life insurance, as we will be financially independent from paid work.
Bear in mind that some couples choose to buy life insurance even on the stay-at-home partner. The services provided to the family by that partner also have a monetary value. It really just comes down to what the financial plan is if that person dies.
Term Versus Permanent Insurance
As you can see, there is only a limited period of our life where we will need life insurance. So the least expensive way for us to pay for that need is to buy what is called “term” insurance, that is, insurance that will only pay out if I die during a specific term. There are other types of insurance, collectively called “permanent” insurance, that will pay out whenever the insured dies, whether that is at age 30 or age 90. Obviously, permanent insurance costs a lot more than term insurance, because it guarantees that if you keep paying the premiums, your heirs will get the death benefit eventually. How much more does it cost? Well, it depends on what type of term insurance and what type of permanent insurance, but it would not be unusual to cost ten times as much to get that permanent death benefit.
To make matters worse, permanent insurance has an almost endless number of variations, and has a veritable army of salesmen working their tail off to sell as much of it to you as you will buy, using dozens of well-honed sales techniques. For the vast majority of doctors and similar high income professionals, buying any permanent insurance policy is optional at best, and probably a financial error. The reasons why are a bit beyond the scope of this book, but suffice to say that at this point in your financial life, what you need is term insurance, and a lot of it. If you wish to add on a permanent life insurance policy at some point down the road, be sure you understand exactly what you are buying and are committed to holding it until death. In general, permanent life insurance doesn’t replace term life insurance, so it’s not an “either/or question.” It’s a term or term plus permanent question. Either way, you need some term insurance.
How Much Life Insurance Do You Need?
Deciding how much life insurance to buy requires you to do some rudimentary math. However, if you are like most doctors, the number you will end up with will be between $1 Million and $5 Million. The calculation works like this:
Determine how much income your loved one(s) would need going forward if you died today. Now multiply that by 25. That will provide a nest egg for them to live off of for the rest of their lives.
Now, look at your latest mortgage statement. Add on the amount you still owe. If you are currently renting, take a look at what the house you would like your loved ones to live in would cost to buy with cash. Use that amount instead.
Next, consider how much you would like to have for your childrens’ education. If you plan to pay for the entire experience, plan on $50-200,000 per child.
Now, consider any other large ticket items there may be, such as your spouse’s student loans, the mortgage on a vacation home, or any other debts. Remember that your student loans are forgiven if you die.
Add it all together. Subtract your current nest egg and college savings from it. Now, round up to the nearest $1 Million. That’s how much term life insurance you should buy.
Is the number between $1 Million and $5 Million? Good. Don’t worry about buying a little too much. This stuff is cheap and it’s better to have a little too much (especially when future inflation comes into play) than too little.
How Long Of A Term?
Remember the idea with buying term life insurance is that you need to save and invest enough money every year to eventually become financially independent. In order to decide how long of a term you need, you need to know about when you expect to be financially independent. This will require another financial calculation. If you don’t have the ability or desire to make this calculation, buy a 30 year level term policy. That gives you 30 years to learn how to make this calculation, and hopefully you’ll learn it a lot sooner than that. It might cost you a little extra, but since you can’t really buy a term longer than 30 years, at least you won’t come up short.
If you would like to learn how to do this calculation, it’s not that hard. Open a spreadsheet, such as Microsoft Excel, and input a calculation called “NPER.” You will need to input a few variables. Here’s how to do it:
NPER is the “number of periods,” i.e. number of years, until you reach your financial goal. This is the solution of the equation.
RATE is the first variable, and is the annualized rate of return on your investments. Adjusted for inflation, I think 5% is a reasonably conservative number, and is what I would recommend using in this calculation.
PMT is the second variable, and is the payment, or amount of money you intend to save for retirement each year. When you enter it into this calculation, this is a negative number, so put a minus sign in front of it.
PV is the present value, i.e. the current size of your nest egg. It is also a negative number.
FV is the future value, i.e. the amount of money in today’s dollars you need to retire. In order to get this, estimate how much income you will need per year in retirement, and multiply it by 25. This is a positive number in the equation.
Type is either a 1 or a 0, depending on whether you will be adding the payment at the beginning of the period (a 1) or at the end (a 0.) It doesn’t matter all that much for the purposes of this equation.
So, let’s say you want $100,000 per year to live on in retirement, and are saving $40,000 per year toward retirement. How long will it take you to get there? Here is what you would put into the spreadsheet:
The solution is 29 years. So if that is you, buy a 30 year term policy
However, let’s say you are a bit more frugal and you already have $100,000 saved for retirement. You plan to save $60,000 per year and can live on $80,000 per year in retirement. What would your equation look like?
The solution here is 22 years. A 25 year term policy ought to be adequate.
What if someone is already well into her career but still needs life insurance? Let’s imagine someone who has $1 Million already, is saving $50,000 per year but wants $100,000 in retirement income. How long should her life insurance term be?
The solution here is 11 years, so a 10 or 15 year term is probably adequate.
As you can see, these equations don’t require a precise calculation. If you’re not sure about a variable, just guess, then round up. These are not irrevocable decisions.
How To Buy Life Insurance
Term life insurance is essentially a commodity. For the most part, it is a simple product. You pay a premium once a year, and if you die during that year, you get the face value of the insurance policy from the insurance company. If you don’t die, you don’t get anything. Any reasonably financially secure insurance company is going to be able to pay out if you die such that you should not spend a great deal of time, effort, and especially money trying to get a policy from a “better” company. You want the cheapest policy for the money. It’s a commodity, like gasoline. Sure, there are a few purists who like to argue about the merits of Chevron gas over Texaco, just like some agents want to argue about the strength of Minnesota Life over Metlife. But in the end, it’s just gas and it’s just insurance. It all works fine.
So your goal when you go to buy term life insurance is to buy the cheapest policy you can get. If you are very healthy, this is a simple process. You simply go to an online site using software such as “Compulife” (see resources below) which will provide you quotes from dozens of insurance companies without requiring any personal information. You then print out the list of quotes, go to an independent agent (i.e. one who can sell you a policy from any company), and ask them to sell you the least expensive policy for the face amount and term you have already decided on. It is that simple.
If you are not healthy, or engage in dangerous hobbies such as flying, skydiving, SCUBA diving, or climbing, it gets a little more complicated. Here is where the independent insurance agent really earns his commission. He will have to informally “shop you around” to the various companies, to see which one will give you the best price.
Avoiding the Upsell
Most, if not all, insurance agents who you go to see for term life insurance will attempt, at least briefly, to sell you a permanent life insurance policy. It is best to be politely persistent, using a phrase such as, “I am here today to buy term life insurance only. If you treat me well today, I may be back at a later date to purchase permanent life insurance from you. But that date is not today.” Better yet, just use an agent off my recommended list such as this email's sponsor and you won't have that pressure.
Annually Renewable and Laddered Policies
Although term life insurance is very inexpensive compared to disability insurance, there are a couple of ways in which you can save even more money on your premiums.
When you purchase a 20 year level term policy, your premium remains exactly the same for 20 years. In year 21, should you decide to hold on to the policy, the premium will dramatically increase and will continue to increase each year. But for the length of the term, the premium is level. If you expect to become financially independent relatively early in life, you may wish to consider an annually renewable policy. In the first few years, an annually renewable policy is less expensive than a level term policy. This can be very helpful both because your early career years tend to be more lean than later years and because it will give you more of your income that you can invest for the future, speeding your financial independence. But if you find you’re not accumulating wealth as quickly as you expected, you can still just keep paying the premiums and keep that life insurance in force as long as it is needed.
Another option to consider is to ladder your policies. Instead of buying one 30 year level term policy, you can buy a 20 year level term policy and a 30 year level term policy, each for half the amount of insurance needed. The 20 year policy will cost much less, and after 20 years, you should have less need for insurance and can make do with just the 30 year policy.
Life insurance is much less complicated to purchase than disability insurance, but it is just as important.
Don't want to wait for Step 3? Consider just buying The White Coat Investor's Financial Boot Camp book now available on Amazon.
Your Chore List
- If you do not already have life insurance, but need it, get started today. First, calculate how much you need. Then calculate how long you need it for. Then go to a site such ashttp://term4sale.com or http://insuringincome.com and get a list of quotes. Now make an appointment, in person or by phone, with an independent life insurance agent to purchase a policy.
- If you already have life insurance, run the two calculations in this chapter to ensure you have enough and that it will last long enough. You may find you need to buy some more, but you might also find out you no longer need your policy and can cancel it.
Step by step guide to buying life insurance
Access to Compulife database- free instant quotes
List of techniques used by insurance agents to sell whole life insurance inappropriately
Still think whole life might be for you? Read through these questions first
Regretting buying a whole life policy? This post is for you.
Two steps down. Ten to go. Get your homework done and I'll see you next week.
James M. Dahle, MD, FACEP
Founder, The White Coat Investor
Fourth Email (Step 3)
WCI Financial Bootcamp Step # 3 A Spending Plan
Welcome back! I'm glad you're still here. How did your homework last week go? I hope you now have both disability insurance and life insurance (if needed.) If not, flag this email for later review and go back and do last week's homework. The knowledge doesn't do you any good if you don't do anything with it. Today we're going to talk about spending, which is critical to any financial plan. If you spend all your money, you can't save anything. If you can't save anything you can't invest anything. If you can't invest anything, you'll never be financially free and at some point, that lack of freedom is going to make you very unhappy. Before we get into it, a word from this week's sponsor.
Step 3: Sponsor
This newsletter is sponsored by Bob Bhayani at drdisabilityquotes.com. They are a truly independent provider of disability insurance planning solutions to the medical community nationwide and a long-time WCI sponsor. Bob specializes in working with residents and fellows early in their careers to set up sound financial and insurance strategies. He has been extraordinarily responsive to me any time any reader has had any sort of an issue, so it was no surprise to get this feedback about him recently from a reader:
Having had some pretty terrible financial salesmen come speak to my residency program….I'm trying to do better now that I curate our conference as a chief…[Bob] was generous enough to come speak with us last week. Bob was knowledgeable, straightforward, and answered all of our questions. I wouldn't hesitate to recommend him to anyone and his place on your “recommended” page is well-deserved.
If you need to review your disability insurance coverage to make sure it meets your needs, or if you just haven't gotten around to getting this critical insurance in place, contact Bob Bhayani at Dr. Disability Quotes.com today by email at [email protected] or by calling 973-771-9100
Step 3: Spending Plan
Can I Skip This Step?
Do you have any consumer debt? (credit card, auto loans etc.) Do you have a written spending plan (i.e. a budget) in place that you compare your spending to at least once a month? If you have no debt and have already aligned your spending with your values- Congratulations and well done! You may move on to the next chapter.
Credit Cards Aren’t For Credit
As Americans, we have a serious problem. We spend money we don’t have on stuff we don’t want to impress people we don’t like. The problem has become so bad that “getting ahead” for many simply means getting back to being broke. The average US household owes $15,000 in credit card debt, $27,000 in automobile debt, $48,000 in student loans, and $166,000 in mortgage debt. Unfortunately, physicians and other high income earners aren’t exempt from this phenomenon and in many cases, despite their high income, their debt totals are even higher. In short, being in debt has become “normal.” Surveys show that 1 out of 4 physicians admits to living beyond her means and carrying credit card balances from month to month.
Part of the issue for physicians is that many of them have to borrow astronomical sums to pay for their medical school tuition and living expenses. This experience habituates them to being in debt. So when they get out of school, they continue the habit right through residency and into the rest of their lives. Nearly every physician I’ve interacted with is entirely too comfortable with debt. While there may be some times in life when it cannot be avoided, debt and particularly the spending habits that tend to go along with it, has a serious drag on the accumulation of wealth and financial independence. Do yourself a favor and become uncomfortable with it.
Credit cards aren’t for credit, they’re for convenience. Studies are quite clear that you spend more when you use them for your purchases. If you are saving plenty of money, that’s probably no big deal. If you are not, a great way to decrease your spending is to use a debit card, a check book, or even better, cash. But whether you use cards or cash, if you are carrying a balance on a credit card you have proven you cannot handle it. Cut up your cards, treat paying off the balance as an emergency, and never use them again.
Using an auto loan to purchase a car is also silly as an attending physician. A reasonably reliable car that will last years can be purchased for $5-10,000. A typical physician making $200,000 per year gets paid that much every two weeks. Surely that amount of money can be saved up without difficulty within 2-3 months. If you wish to drive something nicer, that’s fine, but purchasing it on credit by definition means you cannot afford it. Wait until you have the money and then buy the car. If you are currently making car payments, it is reasonable to keep the car if you can have it paid off within one year. Then keep making the payments to your bank account so you can pay cash for your next one. If you cannot pay your car off in a year, sell it and purchase a $5,000 car. You can upgrade it in a year or two when you have the money. The same perspective can be taken with most items in your life. Vacations should be paid for in advance. Boats, ATVS, snowmobiles and other toys are a lot of fun, but they’re even more fun when you know they’re paid for.
Establishing an Emergency Fund
An emergency fund is a pool of money invested very safely that can be accessed quickly in the event of an emergency. The purpose is to prevent you from having to go into debt or sell long-term investments in the event of a major financial event such as illness, job loss, car wreck, appliance malfunction. A typically recommended amount is 3-6 months worth of your typical monthly expenses. Some of this can be kept in cash at the house, some in your checking account, and the rest should be invested in a high-yield savings account, money market fund, CDs, I Bonds, or a short-term bond fund. An emergency fund allows you to avoid debt, worry less about your investments, and raise the deductibles on your insurance.
Getting What You Want Out Of Your Money
“Budgeting” has a bad reputation for making people miserable. I prefer to think of a budget as a spending plan. It allows you to decide a priori how to spend your money. If you’re smart, you will choose to spend your money in a way that maximizes your happiness- that is, you’ll spend more on experiences and stuff that make you happy, and less on things that make you unhappy. The key to budgeting is to “give every dollar a name” before the month begins. All of your money is allocated to various categories at the beginning of the month- so much for food, so much for utilities, so much for entertainment and so forth. When you run out of money in a given category, you quit spending until the next month. Sure, it requires some discipline to be successful, but if you have the discipline to successfully pass USMLE Step 1, you have the discipline to live on a reasonable budget. The good news for most high income professionals is that they don’t even have to be frugal to live on a reasonable budget, they only have to be relatively frugal- that is, frugal relative to their income. They can probably still spend two or three times what an average American household makes and still be just fine.
Some Budgeting Tips
There are dozens of different ways to budget and plenty of technology to help you, ranging from pencil and paper to a spreadsheet to software like Mint, You Need A Budget, or Every Dollar. Use whatever works well for you and, if applicable, your partner. Successful couples realize that unless they are both working together they are unlikely to be successful.
Some successful physicians have discovered that they don’t even need to really budget by category if they just take their savings off the top as soon as they’re paid. Even better, you can set up automatic transfers to your savings and investing accounts so this all happens without requiring any work or willpower. They can then spend the rest guilt-free and still be very successful. In some ways, a budget is simply “training wheels” until you can train yourself to get your spending down to a level where you’re saving enough to reach your goals.
Try to minimize your fixed expenses so the majority of your budget consists of variable expenses that can be decreased as needed or preferably truly discretionary expenses that can be eliminated completely if necessary. That way when an unexpected expense comes up, or income drops for some reason, you don’t even have to touch your emergency fund but can simply shift spending from other categories to cover it. Some couples find that having a small “allowance” that they can spend without having to account to their partner for it helps them to stick with the plan. If you’re not sure where to start with your budget, start by going back to the last 1-3 months and just write down whatever you spent your money on. Most people who do this realize they’re spending a lot of money on stuff they don’t care about that isn’t making them any happier. Cut back on that stuff so you can spend money on what really matters to you. In the end, a spending plan just helps you align your spending with what you actually value. Whatever it takes for your plan to work, put it in place, write it out, and follow it. You won’t have anything to invest if you spend your entire income.
Your Chore List
- Establish an emergency fund (i.e. open an account, put some money in it, label it your emergency fund)
- Pay off credit cards like your life depends on it
- Pay off auto loans within one year or sell the car(s)
- Develop a written spending plan (Yes, physically write it down this week)
- Going forward, commit to pay cash for everything in your life except your home
Three steps down. Nine to go. Get your homework done and I'll see you next week
James M. Dahle, MD, FACEP
Founder, The White Coat Investor
Fifth Email (Step 4)
WCI Financial Bootcamp Step # 4 Student Loan Plan
Welcome back! I'm glad you're still here. How did your homework last week go? I hope you now have both disability insurance and life insurance (if needed) and a written spending plan. If not, flag this email for later review and go back and do last week's homework. The knowledge doesn't do you any good if you don't do anything with it.
Today we're going to talk about student loan management, a major issue for younger doctors and other high income professionals. Before we get into it, a word from this week's sponsor.
Step 4: Sponsor
Splash Financial is proud to partner with WCI to help you save thousands when refinancing your medical school loans. Splash partners with credit unions, banks, and other top lenders to bring you market-leading rates. The fast and easy online application allows you to check your rate in under 3 minutes and apply with no application, origination or prepayment fees. Refinancing through Splash will simplify your loans and could lower your monthly payments, helping you achieve your financial goals. Residents and fellows can refinance and pay as little as $100 per month while in training. And if you have questions, the US-based customer service team is available every step of the way. WCI readers also receive a $500 bonus when they successfully refinance over $100K in loans.
Step 4: Student Loan Plan
Can I Skip This Step?
Do you have student loans? Do you have a written plan to be rid of them within 5 years of completing your training? If you have no loans, or already have a written plan for your loans, you may skip this step.
If this step is overwhelming or if you have questions about the right path for you and your personal situation, please visit www.StudentLoanAdvice.com (a White Coat Investor company.) An experienced student loan consultant will sit down with you and help you determine the best plan to follow to take care of your student loans. For a small one time fee, you will meet with the consultant, receive a written plan and even get 6 months of free followup. Contact www.StudentLoanAdvice.com today!
Public Service Loan Forgiveness
Although there are several forgiveness programs available for government loans, the only one that is usually attractive to physicians is the Public Service Loan Forgiveness (PSLF) program. Under this program, if a borrower makes 120 payments while directly employed by a non-profit 501(c)3, the remainder of the student loans are completely forgiven, tax-free. Most residents and fellows are 501(c)3 employees, and so if they have been making payments throughout their training, they likely only have 4-7 more years of payments to be made. Academic physicians and others working for 501(c)3s should take advantage. There is a risk that this program may change in the future, but most experts feel those currently in the program will be grandfathered in. If you are particularly concerned about the risk, I suggest you save up an amount equal to the loans in a side account, which can be applied to the loans if forgiveness doesn’t materialize.
If you are not going to work for the government or a 501(c)3 after residency, you will generally want to refinance your loans at residency completion. Many doctors have lowered their interest rates by 2-5%. That could mean tens of thousands of dollars that would have gone toward interest can now go toward principal, allowing you to pay off your loans in significantly less time. It is important to be 100% sure you do not want to go for PSLF before refinancing, since there is no going back. It is also important to be sure you will not need the safety net of the government income driven repayment programs. Although this would be quite rare for a physician, it would not be uncommon for many other high-income professionals with high debt burdens such as dentists, veterinarians, or attorneys.
Even if you are going for PSLF, remember that you can only get federal loans forgiven. So any private loans should be refinanced as soon as possible.
We have negotiated special deals (commonly up to $1,500 cash back) for loan refinancing to WCI readers (and they help support the site.)
Dealing With Loans in Residency
Figuring out what to do with your loans during residency can be complicated, but it is much less complicated since the institution of the Revised Pay As You Earn (RePAYE) program in December 2015. This is the fourth iteration of the income driven repayment programs for federal loans. The first program Income Contingent Repayment (ICR), is rarely used anymore, but there are plenty of doctors still in the second (Income Based Repayment-IBR) and third (Pay As You Earn-PAYE) iterations. Each of these programs has its advantages, but the general rule is a gradual movement from less beneficial programs to more beneficial programs. For example, the ICR program required payments of 20% of your “Discretionary Income” (Your income minus 150% of the poverty line), but that was decreased to 15% for IBR and 10% for the two newest programs.
One issue with all of these programs is that the payments are less than the interest on the loan, so for the typical resident, the loan burden increases significantly from medical school graduation to residency or fellowship completion. For example, the interest on a $200,000 6% loan is $1000 per month, but your monthly payment might be only $100-400 per month, depending on location, the number of people in your family, and your income. The payments have nothing to do with the size of your loan burden or the interest rate.
The largest advantage of the RePAYE program is that the government effectively subsidizes the interest rate during your training period. It will pay ½ of the difference between your payments and the accruing monthly interest. So if your payment is $200 a month, and the interest is $1000 per month, only $400 a month will be added to the total loan burden, and the government will waive the other $400. Because of this subsidy, this is the preferred program for most residents to enroll in upon exiting residency.
However, there are certain exceptions to this rule. The main one is if you are married to another high earner. The RePAYE program looks at both of your incomes, no matter how you file your taxes. But if you are in the PAYE or IBR programs, you can file taxes as “Married Filing Separately” and possibly reduce the size of your required payments in residency. While this will have little effect other than improved cash flow during residency if you pay off your loans eventually, if you are going for PSLF, those lower payments mean more money to forgive after 10 years of payments. You can even switch between the income driven repayment programs during residency if you like, but be aware you will have to make one “full payment” between them, which could be $2000 or more depending on your loan size. It will probably still be worth it if your RePAYE subsidy is large and you have the cash on hand. However, if you are in a situation such as this, it can make sense to pay a few hundred dollars to get high quality advice about your student loan situation.
You can even refinance your loans in residency, although rates are generally higher than what an attending can get. Bear in mind your effective interest rate under RePAYE can be as low as 3-4%, so be sure to compare apples to apples when deciding whether to refinance or not. Still, it often makes sense to refinance high interest rate private loans which are not eligible for the RePAYE program.
Live Like a Resident
Finally, it is important to remember that enrolling in a program or refinancing your loans doesn’t actually get rid of your loans. The only way to eliminate your loans is to throw massive sums of money at them each month. The big issue isn’t the $1000-2000 in interest each month, it’s the $200-400,000 loan principle. The best way to get rid of your student loans is to use your great asset—your high earned income, right at the beginning of your career before you get used to it—to pay off your debt. You can do this by simply continuing to live like you did as a resident.
If you are earning $250,000 as an attending, and living on $50,000 per year, even with the increased tax burden you should be able to clear all of your student loans very quickly. Even if you give yourself a 50% raise (huge in any other profession) you should still be able to throw a six figure amount at the loans every year. But you can’t buy the fancy doctor house, get the fancy doctor car, and take the fancy doctor vacation AND pay off those loans. The point of “living like a resident” isn’t to do it for your entire career, but if you will do it for just a short period of time (2-5 years) at the beginning of your career, it will do wonders for your future financial freedom.
Your Chore List
- If in training, enroll in RePAYE (or if you think you might be an exception to this general rule, see a student loan professional.)
- If in training, refinance any private loans you may have if possible.
- If you are post-training, and going for PSLF, be sure to certify each year.
- If you are post-training and not going for PSLF, refinance your loans and make a written plan to have them paid off within 2-5 years of graduation.
- Live like a resident until student loans are gone.
List of companies that will refinance your student loans and details of special WCI deals
Information about refinancing during residency
Public Service Loan Forgiveness
Income Based Repayment
Switching to REPAYE
Live Like A Resident
Public Service Loan Forgiveness annual certification form
Four steps down. Eight to go. Get your homework done and I'll see you next week.
James M. Dahle, MD, FACEP
Founder, The White Coat Investor
Sixth Email (Step 5)
WCI Financial Bootcamp Step # 5 Boosting Income
Welcome back! I'm glad you're still here. How did your homework last week go? At this point you should have insurance, a written budget and a plan to manage your students loans (including refinancing). Be sure to do the homework as you go along. It doesn't do any good to just read about it.
Today we're going to talk about boosting your income and getting paid what you're worth. Before we get into it, a word from our sponsor.
Step 5: Sponsor
Contract Diagnostics is a long-term partner with us here at WCI. I love this company as they’ve helped over 10,000 physicians get a ‘fair shake’ when it comes to reviewing and understanding their employment contracts – it's 100% what they do there. This is a company that specializes in physician contract reviews and compensation analysis – specialization is something we can all appreciate here. All contracts are reviewed by an in-house attorney and presented in a simplified educational way back to you. Their system uses custom documentation, proprietary compensation data, and review times from 6am to 8pm (even select weekend slots). They make it simple and easy for you to sign up (it takes a minute) for any package. All packages are flat priced so you know what you will pay upfront – residents and fellows can even make interest-free payments over time. They have a new ‘Compensation Rx’ division (under $300) offering for those of you happy in your positions as well, but just looking for details on how fair your pay is, and how you can potentially ask for more. So look them up today –contractdiagnostics.com or 888-574-5526. They have helped over two thousand of your WCI colleagues and would love to work with you.
Step 5: Boosting Income
Can I Skip This Step?
- Make a lot of money
- Save a big chunk of it
- Invest it wisely
- Protect it from loss
But the contribution that each of those factors makes to becoming wealthy varies quite a bit. My estimate is that about 45% of getting rich comes from your income. Doctors and other high income professionals generally command a fairly high earned income, which is sufficient to build wealth. But sometimes, even for a high income professional, it is easier to make more money than to save more of what you are currently earning. This step will discuss ways to increase your income.
Have Contracts Reviewed
Employment and partnership contracts should be reviewed by a qualified person. You need to understand every clause in the contract and what it means. You may not even know what questions to ask about your contract, so be sure to hire a contract review service or a health care contract attorney in the same state as the job to review it before signing on the bottom line. A huge percentage of doctors change jobs within 1-3 years of leaving training and there are far too many horror stories out there about physicians who signed a contract without knowing what it really said. The contract is just the verbal agreements set down on paper. You need to know how everything works- the compensation structure, benefits, call, non-competes, what happens if you leave, what happens if you are fired etc. A really good service will also have salary data (such as MGMA) for your specialty and area so you will know if the offer is competitive. You can hire somebody to negotiate for you, which isn’t a bad idea if you are uncomfortable doing so. But the principles of negotiation are not complicated. Understand what is in the negotiator’s power to grant and what isn’t, and always try to negotiate from a position of strength—ideally using another job offer you view as acceptable.
Do You Hate Your Job?
You may already have a job as an attending physician, but dislike some aspects of it. Life is too short to stay in a job you hate for long. See what changes you can make to your current job. That might mean a better mix of shifts or less call. Maybe it is more support staff or a different mix of patients or procedures. But if you are an employee, it is also time to be looking around. Sometimes the grass really is greener on the other side of the fence, especially if you can get a job you like better that pays more in a lower cost of living area that you will like just as much as your current location.
While continually trying to run faster on the treadmill is a certain recipe for burnout, if done in moderation or for limited periods of time, working more is a great way to boost your income. That might mean more call or more shifts, or it might just mean creating efficiencies in your practice that allow you to see more patients and do more procedures. In some cases, it means a second job. This might be a locum tenens job in another city or even state, or perhaps even a second career or other side gig. You can often create a synergy between your job in medicine and a job outside of medicine. One great benefit of being self-employed, at least for part of your income, is it allows for many additional tax write-offs, including perhaps the ultimate one—an individual 401(k) plan in addition to your employer’s.
Multiple Streams of Income
Most physicians are not the entrepreneurial type, at least at the start of their long careers. However, once they see the benefits they often develop an entrepreneurial mindset. An entrepreneur sees businesses everywhere. Every unmet need is a business in embryo. Decades ago, a typical American worker worked for one company for his whole career. Now, not only do many people switch jobs every few years, but many people live on income from dozens of different sources. Some of these sources are more active than others, but they may include interest, dividends, real estate rents, franchises and other small businesses, websites, speaking fees, book royalties, affiliate marketing/advertising on a blog or podcast, etc. Keeping your eyes open to these possibilities is likely to increase your income eventually and will likely increase your enjoyment and appreciation of your medical career and income.
Your Chore List
- If you are looking at a new job, have the contract reviewed by a review service or qualified health care contract attorney in that state.
- Consider ways to increase your active income through a raise, a better job, making your practice more efficient, taking on a second job, or exploring non-medical “side hustles.”
- Consider exercising your entrepreneurial spirit and developing more passive income streams from franchises, websites, books, real estate, and other small businesses.
Contract review services
The importance of contract negotiation
Half of doctors make a below average income
Earning tips from real life physicians
Developing passive income streams
A WCI Network blog devoted to developing passive income
Five steps down. Seven to go. Get your homework done and I'll see you next week.
James M. Dahle, MD, FACEP
Founder, The White Coat Investor
Seventh Email (Step 6)
WCI Financial Bootcamp Week Six
Welcome to week six of The White Coat Investor Financial Bootcamp. I hope you're finding these emails helpful. How did your homework last week go? At this point you should have insurance, a written budget, a plan to manage your student loans, and a plan to boost your income. Be sure to do the homework as you go along. It doesn't do any good to just read about it.
Today we're going to talk about your home, and what you can do to make it work out well financially. But first, a word from our sponsor.
Step Six Sponsor
Looking to take advantage of current low interest rates, but worried your student loan debt will get in the way of refinancing or purchasing a home? Consider exploring Laurel Road’s Physician Mortgage, a home loan tailored specifically for physicians and dentists.
Laurel Road will analyze your overall financial health with the understanding that as a physician, you may have a lot of debt, but also have a high earning potential.
Visit laurelroad.com/partnerships/wci/#mortgage and get one step closer to enjoying the benefits of homeownership.
With Laurel Road’s Physician Mortgage, eligible physicians have access to:
- Low to $0 down payment options1
- Competitive interest rates
- Up to $650 off closing costs2
- No private mortgage insurance required3
NOTICE: This is not a commitment to lend or extend credit. Conditions and restrictions may apply. All mortgage products are subject to credit and collateral approval. Mortgage products are available in all 50 U.S. states and Washington, D.C. Hazard insurance and, if applicable, flood insurance are required on collateral property. Actual rates, fees, and terms are based on those offered as of the date of application and are subject to change without notice.
- Laurel Road offers up to $650 in lender's credit towards your mortgage closing costs. Credits cannot exceed borrowers’ actual costs to close. For more information refer to the Rewards Program at https://www.laurelroad.com/partnerships/wci/?wci#disclaimer
- Doctor of Dental Surgery (DDS), or Doctor of Dental Medicine (DMD). Retired doctors are not eligible. Additional conditions and restrictions apply.
Laurel Road is a brand of KeyBank National Association. All products offered by KeyBank N.A. Member FDIC. NMLS # 399797. Equal Housing Lender.
Step 6: A Housing Plan
Can I Skip This Chapter?
Do you already own your dream home? If you have a mortgage, is it at market rate or better? If the answer to both of those questions is yes, you can skip this chapter.
Temper the Fire
The most expensive life purchase for most physicians is a home, although with rapidly rising tuition your education may soon supersede it. Spending too much money on housing is a recipe for financial catastrophe. Large, fancy homes are expensive to rent, buy, maintain, furnish, and sell. Your biggest enemies when it comes to controlling this critical expense is the industry, society at large, and those people in your family picture.
Two of the largest industries in the country are the realtor industry and the lending industry. They want you to buy houses early and often. In fact, those industries are so powerful that over the last few decades the American Dream in our national consciousness has somehow been morphed from upward social mobility to homeownership. In addition, society views physicians as wealthy, despite the negative net worth possessed by most young physicians, and expects them to live in expensive houses. That society includes your in-laws, partner, children, and even yourself. As strange as it may sound, there is an intense burning desire among medical students, residents, and especially their partners to buy a house to show that they’ve made it and to “stop throwing away money on rent.” You will have to combat all of that in order to make a sensible housing decision.
Mortgages Should Be Less Than Rent
There is a huge misconception out there that if your mortgage payment is less than a rent payment, then you should buy a home. What most people don’t realize, at least if they haven’t bought and sold a home or two, is that your mortgage payment should be much less than the equivalent rent payment. Put yourself in the shoes of a landlord. He is running a business and wants to make a profit. The sum total of all his business expenses must be significantly less than the sum total of his business revenue. What is his business revenue? The rent you are paying. That’s it. So the rent must cover the mortgage, insurance, property taxes, maintenance, upgrades, vacancies, acquisition costs and, eventually, selling costs. Plus that landlord wants a profit above and beyond those costs. So of course the mortgage payment has to be much less than rent! Many landlords use “The 45% Rule” where 45% of the rent should cover everything besides the mortgage and profit. So if an investor is looking at buying a house with a mortgage of $1100 per month, he wants to see that it will rent for something like $2000 per month.
Don’t mistake paying rent as “throwing money away.” Paying rent gives you the right to live in a place for that month. You’re exchanging it for something you value, not throwing it away. Besides, let me assure you, mortgage interest, insurance, property taxes, maintenance, and realtor fees all feel just as much like throwing money away as paying rent. The bottom line is it is okay to rent. There are times in life when it makes sense to buy and other times when it makes sense to rent. While the real estate market is obviously hard to predict, your course through life is much easier to predict and should be the main guide you use when making “buy vs rent” decisions.
Residents Should Rent
The main issue with buying is that the transaction costs are so steep. A reasonable estimate is about 5% to buy and 10% to sell, or about 15% round trip. Because of that cost, it will generally require your home to appreciate in value 15% between buying and selling just to break even. Real estate appreciation is hardly linear, but if you’re expecting to see 15% appreciation in less than 5 years you are really taking a gamble. It might pay off, but probably not. Since most residencies are 5 years or less, it follows that most residents should rent a home. Other reasons residents should rent is that they won’t see much benefit from the tax advantages of owning. Mortgage interest and property taxes are deductible, but only to those who itemize, and even for those few residents who do itemize, only the portion above and beyond the standard deduction is really deductible. In addition, residents have limited time and money, both of which are required to maintain a home much more than most first-time homebuyers appreciate.
New Attendings Should Rent
In addition to residents, new attendings should also rent for 6 months to a year after graduation. A large percentage of doctors change jobs in their first 2-3 years of practice, and that job change often means an expensive relocation. Don’t buy a house until both your job and your social situation are stable. While you might lose some potential appreciation, you are far more likely to know what you really want (and what you really want to spend) after a few months on an attending income. You will be in a better negotiating position and likely qualify for better terms on a mortgage. Spending a day or two moving is a small price to pay for all those benefits.
Physicians and similar high income professionals should never pay Private Mortgage Insurance (PMI), which is insurance YOU pay in order to protect the lender from YOU defaulting on the loan. PMI can be avoided in two ways. The first is to make a 20%+ down payment. A down payment is a wonderful thing. It helps you avoid PMI, provides you more options for lenders, and gives you better interest rates and terms. Saving up the down payment also teaches you discipline and that 20% cushion protects you in the event of a market downturn or need to sell shortly after buying. The second way to avoid PMI is to use a “doctor mortgage loan.” There are several lenders in every state who will loan doctors money without requiring PMI. Rates and fees are generally slightly higher than you would see with a conventional 20% down mortgage, but usually only a down payment of 0-10% will be required. This allows the physician to put her limited cash to better uses than a down payment. That might be paying off student loans, maxing out retirement accounts, or even buying into a practice. Whichever route you go, don’t pay PMI when you get a mortgage.
Interest rates change from time to time, and when they go down significantly, you should refinance your mortgage. Simple procrastination causes millions of people to pay too much interest on their mortgage every year. Be careful refinancing, of course. There are fees involved and they are often hidden (usually by throwing them into the new mortgage.) In addition, refinancing resets the term on your mortgage. So even if you’ve paid on a 30 year mortgage for 10 years already, refinancing gives you a new 30 year mortgage, and you won’t be out of debt for 40 total years if you don’t increase your payments appropriately.
How Much Home?
My general rule for how much housing you can afford as a high-income professional is to keep your mortgage to less than 2X your gross income. So if you make $200,000 a year, and want to live in a $500,000 home, you had better have $100,000 to put down. You will notice that this is much less than what a lender is willing to loan you. But they don’t care if you ever build wealth. They only care that you can make the payments. However, if your payments are too large, you will never build real wealth. Even if you eventually pay the house off, you will still be “house-poor.”
Like any rule of thumb, there are always exceptions. If you are located in a high-cost of living area you might have to stretch that rule a bit. But when I say stretch, I’m talking about 3-4X, not 8-20X. A family doctor can’t afford a $1.5 Million home even if all the homes within 20 miles of his office cost that much. Even limited stretching has consequences. It will mean working more, driving crummier cars, taking less expensive vacations, retiring later, and sending kids to less expensive schools. You can have anything you want, but not everything. If you are like most physicians, the amount of joy you get from having a slightly more expensive house will only last a few months, and you will have exchanged years of ongoing happiness for it. When I meet a physician in his 60s with a relatively small net worth, the overconsumption of housing is a universal practice.
A Written Plan
If you are currently renting, or if you own a home that is not the one you imagine yourself in for a large part of your life, write down a plan for how and when you plan to acquire that home. The plan should include how much you will put down, how you will save up a down payment, how much you will spend, what you are looking for, and what kind of a mortgage you will get. It need not be long or complicated. Here are a couple of examples:
We will buy a $600,000 home two years out of residency in Oak Hills School District with a conventional 15 year fixed mortgage. We will put 20% ($120,000) down and will save up that in an Ally Bank High Yield Savings Account.
We will buy a $400,000 home six months out of residency on the East side of Indianapolis with a 30 year doctor mortgage. We will use the home equity from our current home to make a 5% down payment, keeping it in our money market account in the mean time.
Your Chore List
1.If you already own your dream home but have an above market rate mortgage, refinance.
2.If you do not own your dream home, write down a plan for how and when you intend to acquire and pay for it.
Six steps down. You're halfway done with The White Coat Investor Financial Bootcamp. Get your homework done and I'll see you next week!
James M. Dahle, MD, FACEP
Founder, The White Coat Investor
Eighth Email (Step 7)
WCI Financial Bootcamp Week Seven
Welcome to week seven of The White Coat Investor Financial Bootcamp. I hope you didn't forget to do your homework last week. At this point you should have a plan for insurance, spending, student loans, boosting income, and housing. Today we're going to talk about your greatest tax break. But first, a word from our sponsor.
Step 7: Sponsor
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Step 7: Retirement Accounts
Can I Skip This Step?
Have you read the plan summary document for your employer provided retirement accounts? If you have self-employment income have you opened an individual 401(k)? Do you do a personal and spousal Backdoor Roth IRA each year? If you are eligible, do you max out a Health Savings Account each year? Do you know the difference between a marginal tax rate and an effective tax rate? Do you know what your marginal and effective tax rates were last year? If the answer to all of these questions is yes, you can skip this chapter.
Marginal vs Effective Tax Rates
It is important to understand that your marginal tax rate is not the same as your effective tax rate. Your marginal tax rate is probably best thought of as your tax bracket, but given the myriad of phaseouts in our tax code, even that isn’t entirely accurate. Your marginal tax rate is the rate at which you would pay taxes on the next dollar you earn. The easiest way to calculate this is to use the same tax software you (or your accountant) use to prepare your taxes. Simply add another $100 of earned income and observe the amount by which the taxes due go up. If it goes up by $45, you have a 45% marginal tax rate.
Your effective tax rate is even easier to calculate. You simply take the amount of taxes you paid last year and divide it by your gross income. It would not be unusual for someone with a marginal tax rate of 45% to have an effective tax rate of only 25%. While the marginal rate is useful in making decisions about what to do with your money, your effective tax rate gives you a better idea of your actual tax burden.
Retirement Accounts Are Your Best Tax Break
If you are like most physicians and other high income professionals, the best tax break available to you is to save and invest money inside of retirement accounts. If your marginal tax rate is 40%, and you contribute $50,000 to a tax-deferred retirement account, you just decreased your tax bill for this year by $20,000. It would take a very expensive house/mortgage or massive charitable donations to provide you an equivalent deduction. The best part of contributing to retirement accounts is that not only did you get the deduction, but you still have the money, unlike when you spend it on interest or give it away. In addition, in most states retirement accounts receive significant asset protection from your potential creditors.
There are two main types of retirement accounts. Tax-deferred accounts, such as a 401(k) or traditional Individual Retirement Arrangement (IRA), give you an up-front tax deduction and allow your money to grow in a tax-protected manner. When you pull the money out decades later, you then pay the taxes on it, usually at a much lower rate than when you contributed the money. The reason for this is that you can use the withdrawals to “fill the brackets.” For example, if you are married taking the standard deduction in 2017 and have no other taxable income other than withdrawals from a tax-deferred account, your first $20,800 (standard deduction plus personal exemptions) withdrawn comes out completely tax-free. The next $18,650 comes out at a cost of only 10% in taxes. The next $57,250 comes out at a cost of only 15% in taxes. So you can withdraw nearly $100,000 a year from tax-deferred accounts at an effective rate of only 10.8%. Getting a 40% deduction at contribution and only paying 11% at withdrawal is a winning combination!
The other type of retirement account is a tax-free, or Roth account. With these accounts, you do not get a deduction up-front for the contribution, but it grows in a tax-protected manner and when you pull the money out of the account in a few decades, it comes out completely tax-free. Both types of accounts have their advantages and are far superior to investing in a regular taxable, non-qualified, brokerage account where you have to pay taxes each year on distributions and pay capital gains taxes when you sell.
Your largest retirement account is likely to be provided by your employer or partnership. Each plan is slightly different with different contribution amounts and investments available. Your employer is required by law to provide you a summary plan document if you ask for it. You should obtain this document, read it, and log in to your online account to determine what you are actually investing your money in.
If you are self-employed (i.e. an independent contractor or paid on a 1099) you are responsible for setting up your own retirement account. The best type of retirement plan for self-employed high income professionals without employees is usually an individual 401(k). In 2017, you could contribute as much as $54,000 to this plan. If you have employees, you will need professional advice to determine the best plan for your business.
Backdoor Roth IRAs
Prior to 2010, high income professionals with a retirement plan at work could not deduct traditional IRA contributions, could not convert a traditional IRA to a Roth IRA, and could not contribute directly to a Roth IRA. In 2010, Congress removed the income limits on Roth IRA conversions. This opened the “Back Door,” which despite its informal name is a completely legal way for high-income professionals to still receive the benefits of a Roth IRA.
If under 50, you can contribute $5,500 to a personal traditional IRA, and $5,500 to a spousal traditional IRA each year. If over 50, that increases to $6,500 each. Then, you can move that money, for which you received no tax deduction, into a Roth IRA at no tax cost. The end result is equivalent to contributing directly to a Roth IRA. The only real caveat is that it can make tax preparation a little more complicated. Form 8606 is where this transaction is reported to the IRS and because of the way that form calculates the tax cost on Roth conversions, you will need to ensure you have no money in a SEP-IRA, SIMPLE IRA, Rollover IRA, or traditional IRA on December 31st of the year you do the conversion. This is one reason why an individual 401(k) is usually a better retirement account for a doctor to use than a SEP-IRA. The usual methods of dealing with an outstanding tax-deferred IRA are to either pay the taxes and convert the whole thing (best if a small account) or to do a rollover of the money into a 401(k), 403(b), or individual 401(k) (best if a large account.)
The Stealth IRA
Another retirement account that many people overlook is your Health Savings Account (HSA) which can function as a Stealth IRA due to the unique rules associated with it. An HSA is perhaps the best retirement account available to you since it is “triple-tax-free.” You get the upfront deduction similar to a tax-deferred account, you get the tax-protected growth inherent in any retirement account, and, so long as you spend the money on health care, you get the tax-free withdrawals similar to a Roth account. If you use a High Deductible Health Insurance Plan, you can contribute $3,450 single ($6,900 family) to an HSA in 2018, and whatever you do not use can be left in the account for the next year. In fact, that money need not sit in cash, it can be invested in mutual funds just like any other retirement account. Some people worry about what will happen if they don’t need that much money for health care needs. However, after age 65, you can withdraw money from the account without penalty, pay the taxes on it, and spend it on whatever you like. That makes it little different from your 401(k). In addition, you do not have to withdraw HSA money in the same year you consume the health care. Under current law, you can save the receipt and pull that amount of money out tax and penalty-free in a year or 30 years as you desire.
Your Chore List
- Obtain and read the plan document for your employer-provided retirement accounts.
- Physically log in to your retirement account and see what it is invested in.
- If self-employed, open an individual 401(k).
- If possible, open and start funding an HSA and a personal and spousal Backdoor Roth IRA.
- Calculate your marginal and effective tax rate for last year.
A discussion of marginal and effective tax rates
A discussion of the relative size of various tax breaks, including retirement accounts
Why an individual 401(k) beats a SEP-IRA 99% of the time
How to do a backdoor Roth IRA, including how to fill out the tax form
Using a Health Savings Account as an extra retirement account
Seven steps down. Five to go. Get your homework done and I'll see you next week!
James M. Dahle, MD, FACEP
Founder, The White Coat Investor
Ninth Email (Step 8)
WCI Financial Bootcamp Step # 8 Investing
Welcome to week eight of The White Coat Investor Financial Bootcamp. I hope you didn't forget to do your homework last week. As a reminder, you were supposed to learn about the retirement accounts available to you. At this point you should also have a plan for insurance, spending, student loans, boosting income, and housing. If you're missing one of those, just search your email box for WCI Financial Bootcamp and go back and do that step again. Today we're going to talk about investing. This is the longest email I'll send you as part of this program, but persevere! It's worth it. First, a word from our sponsor.
Step 8: Sponsor
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This was written by an employee of CrowdStreet, Inc. (“CrowdStreet”) and has been prepared solely for informational purposes. CrowdStreet is not a registered broker-dealer or investment adviser. Nothing herein should be construed as an offer, recommendation, or solicitation to buy or sell any security or investment product issued by CrowdStreet or otherwise. This article is not intended to be relied upon as advice to investors or potential investors and does not take into account the investment objectives, financial situation or needs of any investor. All investing involves risk, including the possible loss of money you invest, and past performance does not guarantee future performance. All investors should consider such factors in consultation with a professional advisor of their choosing when deciding if an investment is appropriate. CrowdStreet's review process of the Issuer and deal should not be construed as a recommendation or a solicitation to buy. All investors should consider their individual factors in consultation with a professional advisor when deciding if an investment is appropriate.
Step 8: Investing
Can I Skip This Step?
Do you have a written investment policy statement? Do you know how and how much you are paying your financial advisor if any? If you can answer yes to all of these questions, you can skip this step.
The Importance of a Written Investing Plan
The most common question an investing novice will ask a financial advisor or experienced investor is “What should I invest in?” While it seems a simple question, it is an attempt at shortcutting an involved process. Following the process leads to a good outcome. Shortcutting it is likely to lead to investing disaster. The process is as follows:
- Set financial goals
- Determine the amount to save toward each of those goals
- Determine what types of accounts will be used for each goal
- Determine an appropriate asset allocation for each goal
- Select investments according to the asset allocation
“That all sounds boring and hard! Can’t you just tell me what to invest in?”
“Okay, put all your money into the Vanguard Life Strategy Moderate Growth Fund.”
Seriously, if you want to shortcut this process, that’s about the best I can do for you. You’ll probably come out okay, and light years ahead of millions of investors. But I wouldn’t recommend you take that shortcut. Following this process, commonly known as Financial Planning, takes some introspection, some time, and some education. It might cost you a few thousand dollars if you decide to hire even a low-cost, competent financial advisor to assist you. But it is worth it. Let’s look at each of these five steps carefully, then we’ll spend a few minutes on the subject of financial advisors.
Your financial goals, like other good goals, should be SMART:
An example of a bad goal is:
An example of a good goal is:
“Have a $3 Million portfolio by July 1, 2025, such that I can withdraw 4% of it a year to support a retirement income of $120,000 per year.”
It doesn’t matter if your goals change as you go along. That’s life. Set them anyway. Without a goal, the rest of the process makes little sense. You might be surprised how little your goals change over the years.
Determining Savings Rate
The most important factor determining whether or not you will reach your financial goals is how much money you put toward them each year. This “savings rate” is critical and should be calculated and monitored. Most financial goals can be boiled down to a “future value” calculation, which has only four inputs:
- How long you have to save
- Your investment return
- How much you save each year
- How much you already have
Going forward, you typically have more control over the savings rate than anything else. It doesn’t take long playing with a spreadsheet or financial calculator before you realize that saving too little requires unachievable future rates of return. For instance, if you have $200,000 now and want to retire in 20 years with $3 Million in today’s dollars, saving $15,000 per year will require you to achieve an exceedingly optimistic 12% average return (after-inflation, fees, and taxes.) Saving $75,000 per year permits a much more realistic 5% return.
The next step is to decide which accounts to invest in. General guidelines include to always obtain any employer-provided match, favor tax-deferred over tax-free accounts during your peak earnings years, and to favor any tax-protected account over a non-tax-protected account. In the case of somebody who wanted to save $15,000 per year for retirement, he could likely do all of that in just a 401(K). A physician wanting to save $75,000 per year might need to use a 401(k along with a personal and spousal Backdoor Roth IRA, with any remaining savings going into a taxable account. Some accounts are obviously better for some purposes than others. A 529 is ideal for a college saving goal, but not so useful for retirement. Likewise, a Roth IRA can be used to save for a home down payment, but you would usually be better off using it for retirement and using a taxable account to save up for the home.
Advanced readers may wonder about which assets should go into which accounts. Proper tax location can have a small effect on overall returns of the portfolio. The general rule is that tax-inefficient, high-expected return assets go preferentially into tax-protected accounts. If that seems complicated, don’t worry about it. The effect isn’t large.
The vast majority of the return from your portfolio will come from your selected asset allocation, that is, what percentage of the portfolio goes into large stocks, small stocks, value stocks, growth stocks, international stocks, real estate, bonds, precious metals, commodities, or other asset classes. The ratio of stocks to bonds in the portfolio will matter a lot more than which individual stocks or which individual bonds you select. In fact, since the data suggests you are better off investing in low-cost, passively-managed mutual funds than individual securities, you should spend most of your time thinking about asset allocation rather than security selection.
The truth about asset allocation is that the “correct” asset allocation can only be known in retrospect. Your asset allocation needs to take on enough risk that if adequately funded it will allow you to reach your goals, but not so much risk that you won’t be able to stick with it when the inevitable market downturns occur. An appreciation of financial history is critical. For instance, many investors panic and sell stocks when the stock market drops 10-30%. Buying high and selling low like this can be a financial catastrophe, especially if done within a few years of retirement. A cursory knowledge of stock market history would show a beginning investor that a drop of 10% or more (called a “correction”) occurs on average about once a year and a drop of 20% or more (called a “bear market”) occurs about every three and a half years. If your investing career is 60 years long (30 years before retirement and 30 after), you should plan to pass through about 60 corrections and about 17 bear markets. That is to say, it shouldn’t be surprising when your investments in stocks lose 10-30% of their value. That’s what you expect them to do. It is certainly no reason to sell them.
Your goal is to choose a reasonable asset allocation. There are dozens, perhaps even hundreds of “reasonable” asset allocations. None of them are perfect, but your goal is to avoid an unreasonable one. Here are some guidelines that may help:
- Choose a stock to bond ratio between 75% stocks and 25% stocks
- Invest somewhere between 20% and 50% of your stocks in international stocks
- Aim for 3-7 total asset classes with no more than 40% nor less than 5% in any one asset class
Here are some examples of reasonable portfolios, with increasing levels of complexity. All of these have been adjusted to have a stock:bond ratio of about 60/40. You can adjust as needed.
- 30% US Stocks, 30% International Stocks, 40% US Bonds
- 30% US Stocks, 25% International Stocks, 5% Real Estate Investment Trusts (REITs), 40% US Bonds
- 30% US Stocks, 25% International Stocks, 5% Real Estate Investment Trusts (REITs), 30% US Bonds, 10% Inflation-Protected Bonds (TIPS)
- 25% US Stocks, 20% International Stocks, 10% Small Value Stocks, 5% Real Estate Investment Trusts (REITs), 30% US Bonds, 10% Inflation-Protected Bonds (TIPS)
- 25% US Stocks, 15% International Stocks, 10% Small Value Stocks, 5% Real Estate Investment Trusts (REITs), 5% Precious Metal Equities, 30% US Bonds, 10% Inflation-Protected Bonds
There are a few dozen more asset classes that can be used, but these are the ones that generally predominate in most mutual fund portfolios. Certainly a portfolio as simple as these, when combined with adequate discipline and a good savings rate, is perfectly fine. Good investing need not be complicated and is supposed to be boring.
Once you have an asset allocation, selecting mutual funds to fit it can be very easy. In fact, it is possible to have a sophisticated 3-5 asset class portfolio with a single fund thanks to mutual funds like the Vanguard Target Retirement or Life Strategy funds. However, the general strategy is to choose one mutual fund for each asset class in your asset allocation. So if your asset allocation were number two above, you might pick an S&P 500 index fund in your 401(k) for your US stock allocation, a bond index fund in your 401(k), the Vanguard Total International Stock Index fund in your taxable account, and the Vanguard Real Estate Investment Trust Index Fund in your Roth IRA.
There are a few nuances to portfolio construction, but they can be addressed as you learn more about investing. These include such things as which account to place which asset class into (asset location), when and how to rebalance your portfolio back to the original percentages, and how to make do with a crummy 401(k). See the other resources section for more detail on all of these topics. Alternatively, you can hire an experienced advisor charging a fair hourly fee to help you write up and implement your investing plan, even if you don’t wish to have the advisor do the ongoing investment management.
When selecting mutual funds, you should generally favor “index” or “passive” mutual funds instead of “actively managed” mutual funds. While you might expect to be able to find a talented active manager who can assemble a portfolio of individual stocks (or bonds, or REITS) that will outperform the market average, it turns out this is a very difficult task to do over the long run after paying the cost required to do so, especially after-tax. In fact, this “game” of trying to beat the market is so difficult, the winning response to it is simply not to play. Those who don’t play this game, and just buy all the stocks (or bonds) and accept the market return will end up outperforming 80-90% or more of active managers over 20 or 30 years. There are two reasons this strategy works so much better. The first is a cost issue. It is very cheap to get the market return, but quite expensive to try to do all the analysis required to beat the market. It isn’t that active management cannot work, it is that it doesn’t work well enough to overcome the costs of doing so. The second is a talent issue. Decades ago it was easier to outperform the market. 90% of trades were made by individual “mom-and-pop” investors. Now, 90% of trades are made by professional investors with far more talent, knowledge, and computer power than you can hope to possess. It isn’t that there aren’t any talented managers, it is that there are too many talented managers. The end of result of all of that talent analyzing stock prices is that the market itself becomes more and more accurate and efficient at pricing stocks. At a certain point, it becomes wiser to simply keep your costs low and just buy them all. That is what an index fund does. There are index funds for every asset class and low cost, well-managed index funds are available from several providers including Vanguard, the federal Thrift Savings Plan, iShares, Fidelity, and Charles Schwab. You should have a very good reason to use anything other than an index fund in your portfolio.
Many investors, including a sizeable majority of doctors, do not have the interest, knowledge, or discipline to successfully design their own investing plan or manage their own investments. While a person intelligent enough to get into medical school can develop the ability to successfully manage their own investments, they still need to develop enough interest in doing so in order to be successful. Like with medicine, a commitment to at least a low level of life long learning is required. In addition, you will need to do some upfront learning that consists of reading a handful of good investing books at a minimum. In addition to some relatively easily acquired knowledge, you will also need to develop the discipline to stay the course with your plan, particularly in bear markets.
If you are concerned you lack the required knowledge, the interest in obtaining it, and/or the discipline to properly manage a portfolio over decades, you would be wise to hire the services of an advisor who offers good advice at a fair price.
The most important thing is to make sure you’re getting good advice. There is no price too low for bad advice. That means you need to have an advisor with as few conflicts of interest as possible in giving you good advice. Many people who call themselves “financial advisors” are really just commissioned salesmen in disguise. They may specialize in selling insurance products like whole life insurance or annuities, or perhaps investment products such as private REITs or loaded mutual funds. That is not the advisor you are looking for. You want a “fee-only” advisor. Bear in mind that “fee-based” is not “fee-only.” If they are fee-based, they also earn commissions and their investment advice cannot be completely trusted.
You will also want to get an advisor with one of the harder to obtain credentials, such as a Certified Financial Planner (CFP), Certified Public Accountant with the Personal Financial Specialist designation (CPA/PFS), or a Chartered Financial Analyst (CFA.) There is an alphabet soup of credentials out there, but most of them don’t mean a lot in terms of education. In addition to education, you want someone with some experience. Do they advise a lot of clients with financial lives similar to yours? Do they have any gray hair? Have they helped clients through a bear market or two?
Bear in mind, of course, that even a fair price is very expensive and will have a significant drag on your returns over the years when compared to a competent do-it-yourself investor. If your pre-fee long-term portfolio returns are 8%, and you are paying an advisor 1% of your assets under management per year, that is exactly equivalent to earning 7% a year. If you are saving $50,000 a year for 30 years, the difference between 7% returns and 8% returns is almost a million dollars (about 17% of the end portfolio value.) And that fee doesn’t even stop there. If the advisor is managing your portfolio in retirement, he’ll continue to get that 1% every year throughout your retirement. For the $4-6 Million portfolio we’re discussing, that’s $40-60,000 per year in fees.
Financial advisors charge fees using various models. Some are paid via commission, such as life insurance commissions, annuity commissions, or mutual fund loads. If you’re not sure how you’re paying your advisor, or if you think your advisor is advising you for free, this is how you are likely paying him. Unfortunately, this is the worst possible way, since the worst investments have to offer the best commissions to be sold. Thus a commissioned salesman, even the most ethical one in the world, faces an insurmountable financial conflict of interest to provide you the advice you really need.
The other models are considered “fee-only” (remember that the phrase “fee-based” means commissioned and is not the same thing as “fee-only.”) The most common is to charge a percentage of assets under management (AUM) each year. So if the advisor is managing $1 Million and charges 1% of AUM each year, that is the equivalent of $10,000 per year. While 1% is often considered the industry standard, there are plenty of advisors out there willing to manage assets for less, particularly as your portfolio gets larger than $1 Million. Some “roboadvisors” even charge as little as 0.25% per year for asset management. Other asset managers will work for a flat annual fee. These are often in the range of $1000-$10,000 per year. Obviously, the larger your portfolio, the better it usually is to pay a flat fee instead of an AUM fee. Finally, some advisors work for an hourly rate. These rates are typically in the $200-500 per hour range. While that seems expensive, it is often the cheapest way to get financial planning advice. No matter how you are paying your fee-only advisor, be sure to add up the total annual fee you are paying and then determine whether you feel you are getting that much value out of the relationship.
Developing a written financial plan is an essential task for anyone interested in being financially successful. This will require you to determine your goals, measure your savings rate, assess the tax-advantaged accounts available to you, select investments, and minimize your investing costs.
Your Chore List
1.Write down an investing plan including your desired asset allocation
2.If using an advisor, determine how you are paying for financial advice
3.If using an advisor, calculate how much you are paying for financial advice
150 examples of a reasonable asset allocation
A brief description of how to be your own financial advisor
How to use future value to determine how much you need to save and for how long to reach your goals
An explanation of why you should invest in index funds
Describes the benefits, but also the difficulty, of using proper asset location to boost returns
How and why to rebalance your portfolio
How to build your portfolio if your 401(k) doesn’t offer low cost index funds
How to make sure you’re getting good advice at a fair price
You made it to the end of the longest step! Good job. You're two thirds of the way through bootcamp. Don't give up now. Get that investment plan written down and I'll see you next week!
James M. Dahle, MD, FACEP
Founder, The White Coat Investor
Tenth Email (Step 9)
WCI Financial Bootcamp Step # 9 Correcting Past Mistakes
Welcome to week nine of The White Coat Investor Financial Bootcamp. I hope you've been doing your homework as we go along. It doesn't do any good to learn about this stuff if it doesn't lead you to take action. Before we get into today's topic (fixing your past screw-ups), a word from our sponsor.
Step 9: Sponsor
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Step 9: Correcting Past Mistakes
Can I Skip This Step?
Do you own a whole life policy? Do you own an annuity? Have you mistaken a commissioned salesman for a financial advisor? Are you paying more than $10,000 a year for investment advice? Do you own any investments that you wouldn’t buy again? Have you failed to max out available retirement accounts in the last couples of years? If the answer to all of those questions is “no,” then you can skip this step.
What You Need To Know About Whole Life Insurance
There are some people in this world who believe whole life insurance is the solution to all or most of the world’s financial problems. Most of them sell whole life insurance. And most of those agents prefer to sell their wares to physicians more than to anyone else. In fact, it is rare to find a physician who hasn’t received a pitch to buy whole life insurance at some point, and a large number of them bought a policy, including me. A few years later, most physicians notice that this “investment” doesn’t seem to be nearly as good as the pitch they were given just a few years earlier.
Agents sell these products for several reasons. Perhaps the most significant, however, is that they want to put food on the table for their kids and they want to be financially successful. The commissions on a whole life policy are very high, typically in the range of 50-110% of the first year’s premiums. So if you bought a policy that costs $3,000 a month, the commission was somewhere between $18,000 and $40,000. Now you know why the agent was trying to sell it so hard and why he was so willing to give you “free” advice on other matters. In fact, it is often the same agent who sold you a product you actually needed, such as disability insurance. Now there are a few agents out there who are simply unscrupulous and sold you this policy simply to transfer money from your pocket to theirs. But most of them simply don’t know what they don’t know. All of their financial training came from their insurance company, and consisted primarily of sales techniques, not investing information. As a result of that training and years of practice, they are exceedingly skilled in selling whole life insurance to even the most skeptical.
Whole life insurance is a combination of a life-long death benefit and a slow-growing investment side account that you can borrow against, typically called the “cash value.” If you surrender the policy, you walk away with the cash value, owing ordinary income taxes on the gains in the unlikely event that you have any.
A typical whole life insurance policy is a terrible investment. It generally doesn’t “break even” (where the cash value is equal to the premiums paid) for ten to fifteen years, and even if held for 50+ years, the guaranteed return for a policy bought today is only about 2%, with a projected return typically in the 4-6% range. If you hold it your entire life, expect your returns to fall somewhere in between the guaranteed scale and the projected scale. It is critical to understand that the “dividend rate” is NOT your expected return on the policy. The dividend rate is only applied to the existing cash value, not the entire premium paid. So the dividend rate is ALWAYS higher than the actual return, and often MUCH higher, especially in the early years.
Buying a whole life policy, particularly when done early in your career, particularly when you still have student loans or a mortgage or when you are not maxing out your available retirement accounts including Backdoor Roth IRAs and Health Savings Accounts, is generally a mistake. Unfortunately, just because it was a mistake to buy it, doesn’t mean that holding on to it at this point is also a mistake. The poor returns of whole life insurance, mostly due to the large commissions and fees, are heavily front-loaded. If you have already had a policy for a decade or more, chances are good the return going forward isn’t too bad, and that’s the only return that matters to this decision.
I owned my own whole life policy for about 7 years. At that point, my overall cumulative return was still a NEGATIVE 33%. Luckily for me, it was a tiny policy and I got to learn this lesson on the cheap. For many physicians, this mistake costs them tens or even hundreds of thousands of dollars. Try not to focus on the “water under the bridge” but rather on what is likely to happen in the future.
You can hire an unbiased professional to help you evaluate whether to drop your policy or you can do it yourself. The key is to get a copy of an “in-force illustration” from the insurance company. Then you use the guaranteed and projected scales to calculate your return going forward. If that return is acceptable to you, then keep the policy. If it is not, then prepare to drop the policy. There are two considerations to dropping the policy. The first is that you may need to buy additional term life insurance first, assuming you can still get it at a reasonable price. The second is the tax considerations. If there is a gain on the policy (cash value > the total of premiums paid,) you will owe taxes at your ordinary income tax rate on the gains.
That’s an unusual scenario, however. If you’ve already held the policy long enough to have gains, then you’ve probably held it long enough that it makes sense to keep it. The typical scenario is a large loss. Unfortunately, the loss is not tax-deductible. You used to be able to exchange it to a variable annuity, where the loss was deductible, but even that loss is no longer deductible now. However, you can still make the exchange, and it can still be beneficial for a large loss. The best technique for dealing with a large loss on whole life insurance may be to exchange the cash value into a low cost variable annuity. The proceeds are then invested in an investment you would invest in anyway (such as the equivalent of a mutual fund inside the annuity), and when the value of the annuity grows back to the basis (i.e. the sum of the premiums), surrender it with no taxes due.
What You Need To Know About Annuities
If you have mistaken an insurance agent for a financial advisor and bought a whole life insurance policy, chances are good you may have bought an annuity as well. The vast majority of annuities are products designed to be sold, not bought. The commissions are also quite high and the tax benefits are heavily oversold. They sometimes offer guarantees of one type or another, but these guarantees are usually offered at too high of a price.
There is one type of annuity, a single premium immediate annuity (SPIA), that is often used by retirees to help them spend their nest egg more efficiently, but there is little reason for someone still in the accumulation phase of their life to own one of these expensive combination insurance/investment products. It is even worse when these products have been sold “for their tax benefits” or “asset protection benefits” to someone who owns them inside a retirement account that already has tax and asset protection!
Surrendering these annuities and investing the proceeds into low-cost index mutual funds is usually the right move, particularly if the value is close to the basis. Like with a whole life policy, if you have a very low value to basis ratio, you may wish to exchange to a low-cost variable annuity and let the investment grow back to its basis before surrendering. If you have a very high value to basis ratio, you may consider just holding the policy for a few more years and then exchanging it for a SPIA at some point in your 60s.
Firing Your Financial Advisor
There are two good reason to fire a financial advisor. First, if you’ve mistaken a commissioned salesperson for an advisor, you need to fire them and move on. Second, if you’re paying more than the going rate for financial advice, you need to fire them and move on, or at least negotiate a much lower fee. The going rate for financial advice is a four figure amount per year, somewhere between $1,000 and $10,000. If you are paying more than $10,000 per year, even for good advice, you are overpaying no matter what the value they are providing is. That’s because you can get high quality financial planning and high quality investment management of any amount of money for less than $10,000 per year.
You have two options, and they’re not mutually exclusive. The least expensive option is to learn to be your own financial planner and investment manager. This does require some up-front learning, some ongoing learning, some attention to detail, some discipline, and a little bit of work. But many doctors have realized that by the time they know enough to recognize a good financial advisor, they know enough to do it themselves. You can make a lot of mistakes for what it costs you to pay for financial advice and still come out ahead. The second option is to find a lower cost financial advisor. There is a third option, of course. You can negotiate with your current advisor, as long as they’re giving good advice, for a much lower rate. You might be amazed how little they’re willing to work for if the alternative is to lose your business completely.
However, there is nothing wrong with using a financial advisor, as long as you are getting good advice at a fair price. You also don’t have to use an advisor forever. You can use one for a while, then take over yourself when you know enough to do so. You can also use an advisor a la carte, helping you design your plan up front and then checking in every year or two to make sure you’re still on track. But the key is to only pay for the services you really need and want.
If you are going to become a do-it-yourself investor, first make sure you’ve got a written financial plan and know what you are going to do with your money once you move it away from the advisor. Then contact the institution that will be holding the money going forward and arrange for them to “pull” the money from wherever the old advisor had it held. You don’t even have to tell the old advisor unless your contract with her says otherwise. They’ll figure it out when they get the Vanguard rollover paperwork. It might be your first time sending this paperwork, but it isn’t their first time receiving it. If you are going to use a new advisor, they can take care of all this for you. But make sure you do a better job choosing this time. Focus on the following when selecting a new advisor:
- How they get paid (hourly rate > annual retainer > asset under management fee >>> commissions)
- How much they get paid (the less the better)
- What services they offer (the more the better)
- What designations they hold (CFA, CFP, ChFC, and CPA/PFS are meaningful, others may have little value)
- Their experience level (any gray hair? Were they managing money in the 2000 and 2008 bear markets?)
- Their investment philosophy (portfolios should be composed mostly of index funds)
- Past behavior (check their ADV2 government disclosure form for any “disclosure events.”)
Some investors, particularly do-it-yourselfers, are prone to become investment collectors. Instead of first designing a coherent, simple, straightforward, intelligent portfolio, they buy a little of this and a little of that. They may have dozens of individual stocks and bonds and a bunch of overlapping mutual funds, often with high expense ratios. Cleaning up these collections is an important part of getting your financial house in order.
The first thing to do with an investment collection, at least once you figure out what you wish you had invested in instead, is to determine where the investment is held. If it is inside a tax-protected account such as a 401(k) or a Roth IRA, great! You can sell it without any tax consequence and then move the money into your designated investments.
However, if the investment is held in a taxable account, you need to determine what its basis is. Remember, basis is what you paid for the investment. If the value is less than the basis, great! Just sell it and buy what you wish you owned. You can use those losses to reduce your tax bill. Similarly, if the value is similar to the basis, you can sell it with minimal tax consequences. However, if your value is much higher than your basis, you ought to pause and consider your options.
A great option if you frequently give to charity or would like to start, is to simply donate the shares to charity. Most churches and other large charities are well set up to receive a transfer of stocks or mutual funds as a “donation-in-kind.” If they’re not, you can give via a Donor Advised Fund.
Another great option if you are already elderly is to simply hold the shares until your death. At that point, your heirs will receive a step-up in basis to the value on the date of your death. They can then sell the investments without any tax consequences.
However, if neither of those scenarios applies, there will be more work involved. You’ll need to figure out just how much it will cost you in taxes to sell each investment and then look at each of them individually and determine if it is worth it. Sometimes, an investment isn’t ideal, but it is good enough to keep in the portfolio for tax reasons. For example, a mutual fund composed mostly of US stocks can be retained and you simply hold less of your favored US stock index fund than you otherwise would. You can even build around a few individual stocks if they don’t make up too much of your portfolio. And if the tax cost isn’t too high, perhaps you should just sell it anyway and chalk up the extra taxes as your “tuition in the school of hard knocks” or the “price of your investing education.” A good financial planner can assist you with these difficult decisions even if you plan to become a do-it-yourself investor eventually.
Are you maxing out your retirement accounts? A surprising number of high-income investors don’t even know about all the retirement accounts available to them. Preferentially investing in these tax-protected (and in most states asset protected) accounts can save you thousands of dollars over the course of your lifetime. Unless you’re already financially independent, make a commitment now to learn about all of the accounts available to you, and max them out every year.
Even if you aren’t saving enough to max out all those accounts, if you have a lot of investments in a taxable account, you can move that money into your retirement accounts. You can simply live off the taxable investments while directing more of your income into retirement accounts. In addition, doing Roth conversions of retirement accounts accomplishes a similar function. You’re exchanging tax-deferred plus taxable money for tax-free money.
Your Chore List
1.Determine if you should drop your whole life insurance policy. If you should, consider doing so by exchanging the value into a low-cost variable annuity.
2.Stop investing inside annuities.
3.If you are getting conflicted advice or paying too much for advice, find and hire a reputable, reasonably-priced financial advisor. Alternatively, if you are ready to start managing your money yourself, contact the new custodian and have them move your money away from the old advisor.
4.Evaluate your investments for any collector’s items. Sell those inside a retirement account, those with a loss, and those with a minimal gain. Develop a plan for dealing with any others.
5.Commit now to max out your retirement accounts going forward.
Need an unbiased education about whole life insurance? Here you go.
A broad overview of annuities and why they make for lousy investments
\Lots of great annuity tips in this review of the best book about annuities
An extensive overview of how to fire your financial advisor
A brief description of how to be your own financial advisor
How to make sure you’re getting good advice at a fair price
How to stop being an investment collector
An explanation of why retirement accounts are so valuable
You made it to the end of Step 9! Good job. You're 3/4 of the way through bootcamp. Don't give up now. Get your mistakes corrected and I'll see you next week!
James M. Dahle, MD, FACEP
Founder, The White Coat Investor
Eleventh Email (Step 10)
WCI Financial Bootcamp Step # 10 Saving For College
Welcome to week ten of The White Coat Investor Financial Bootcamp. I hope you've been doing your homework as we go along. At this point you should be starting to feel empowered toward being financially successful. This week we're going to talk about college savings, but first, a word from our sponsor.
Step 10: Sponsor
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Step 10: Saving For College
Can I Skip This Step?
Have you started saving for the college educations of your children? Are you confident that your plan is highly likely to enable you to reach your college goals? If so, you can skip this step.
The Four Pillars of Paying For College
When it comes to paying for college, I recommend you build your plan on four pillars. These pillars are:
- School selection
- College savings
- The child’s contributions
- Your cash flow
There are two things that you should notice about those four pillars.
First, as a physician or other high income professional, you need to realize that it is unlikely that your child will qualify for any need-based financial aid. The Free Application for Federal Student Aid (FAFSA) formula dictates that your Expected Financial Contribution (EFC) is composed of about 30% of your annual income and 6% of your non-retirement assets. Since your EFC is generally higher than the Cost Of Attendance (COA) of most colleges in the country, they won’t qualify for need-based grants, scholarships, or even loans. So you’re on your own.
Second, there is no pillar marked “debt.” There is no reason that you or your child needs to borrow for an undergraduate education. While one family might lean more on one of the pillars than another, there is no excuse for a high-income professional family to actually need to borrow for college.
# 1 School Selection
The most important of the pillars, and the one that, if done properly, allows for a debt-free education, is proper school selection. Most seventeen-year-olds need significant parental input in choosing a college. They simply make dumb decisions, like choosing a school because they like the buildings or trees on campus. Or wanting to go to the same school as a friend. A teenager doesn’t understand the difference between $10,000 and $100,000. It’s all Monopoly money to them.
Value matters, and the more expensive the purchase, the more it matters. I always find it amazing to scan down the annual college ranking lists and find two schools right next to each other on the list, but see that one school costs 4-8 times as much as the other. Choose a school that you and your child can afford to pay for without debt. There will be plenty of opportunity for that if they decide to go on to professional school.
# 2 College Savings
Some parents try to save up the entire cost of a college education in advance. In fact, some well-to-do parents start saving even before the child is born or front-load the savings shortly after birth. It is entirely possible to be done saving for college long before the child enrolls. Most of us have too many other competing uses for our dollars to do that. However, we still need to save something for college.
If you are going to save for college, you might as well do so in a way that reduces your tax burden. You can save for a child in their own investing account, typically called a Uniform Gift for Minors Act account (UGMA), but that requires you to give up control once they turn 18 (or 21, depending on the state,) allowing them to spend the money on anything they like. A better choice is to use a college-specific savings account. A Coverdell Education Savings Account is one option, but is hampered by a low annual contribution limit (just $2,000 under current law, and potentially going away completely.) A better choice for most is a 529 account. These state specific accounts have much higher contribution limits ($15,000 per year per parent) and can even be front-loaded with a five year contribution ($75,000 single, $150,000 married). In addition, they often come with a state tax deduction or credit. But both ESAs and 529s allow the money invested to grow in a tax-free manner, and as long as the money is spent on legitimate education expenses, to come out completely tax-free. In addition, the parent remains in control of the ESA or 529. The child can’t take it out and buy a Camaro and drugs. If one child decides not to go to college at all, the money can be rolled over to another child’s account.
# 3 Child’s Contribution
Another important contribution to the cost of education should come from the student themselves. If they have to sacrifice and work for their education, they will appreciate it that much more. This category consists of merit-based scholarships, the child’s own savings (which may go into the 529 as well), summer work, and a part-time job during the school year. Some parents fear that having their children work will cause their academic performance to suffer, yet when I survey groups of physicians, the majority of them worked during their undergraduate years. So it seems unlikely to have a dramatically negative effect, and the effect may even be positive. Some work experience makes them more attractive to future employers and certainly gives them valuable experience managing money and understanding the value of a dollar. If that means they miss a few keg parties, that’s probably not a bad thing.
# 4 Cash Flow
Most high-income professionals are still working, at least part-time, while their children are in college. They can assist using their current cash flow. A doctor grossing $200,000 a year can certainly afford to pay for some of the college expenses as she goes along.
In summary, if the annual total cost of attendance is $25,000, and the child has a scholarship worth $5,000, earns $5,000 during the summer, earns $5,000 during the school year, and you contribute $5,000 a year, their college savings account need only total $20,000 to allow them to get through undergraduate without debt. If you manage to save up more than that, they can go to a more expensive school or the remaining amount can be put toward their graduate or professional school.
Which 529 To Use?
The 529 system is one of the best programs the government has ever put in place. It forces states to compete with one another for investor dollars, and that competition has caused prices to fall, investment options to improve, and tax benefits to increase over the years. There are now many states with excellent programs.
The first place to start is with your state’s program. If your state offers a tax deduction or credit, use your state’s plan, at least up to the amount where the deduction or credit is maximized. If your state doesn’t offer a state income tax benefit, or if you already received the maximum, consider going with another state’s plan. The Utah, Nevada, and New York 529 plans are always found in the top 5 of any rank list for best 529s.
How Much to Save?
As you can see from the above information, how much to save for college can be a very personal question. It really comes down to how expensive of a college you are willing to pay for, how much you can put away for college, and how much can be covered by the student and your cash flow. However, it is a good idea to have a goal and work toward it. That goal can be a “defined contribution” goal, or it can be a “defined benefit” goal. With a defined contribution, you contribute a set amount each year, such as the amount that maximizes the available state income tax deduction. With a defined benefit goal, you decide how much you want available in the account when your child reaches college age. Either way, you can use a financial calculator or a simple spreadsheet to make projections.
For example, consider a family who plans to save $4,000 a year from birth to age 18 because that is the amount that maxes out their state income tax benefit. How much can they expect to have in the account at age 18? The answer to this is reached with a Future Value Calculation. You already know three of the four variables in the equation, so you just need to make an assumption about what the return of the account will be. I typically use 5% real (after-inflation) for calculations like these. Plug this formula into Excel or a similar spreadsheet:
=FV(5%,18,-4000,0) = $112,529
$112K should allow you to withdraw close to $30,000 a year for college expenses. In the formula, the 5% is the assumed rate of return, the 18 is the period or number of years of contributions, the 4000 is the annual contribution (note it is always a negative number), and the 0 is the amount of money you have saved for college already (also a negative number.)
If you’ve decided to use a defined benefit goal, you use a related but similar formula, Payment (PMT) whose output is the amount you need to save each year. In this case, let’s assume you only have 10 years left to save, you already have $10,000 saved, you expect a 5% return, and you want to have $150,000 in the account on the day the child enrolls. How much do you need to save each year?
=PMT(5%,10,-10000,150000)= – $10,630 per year
In this case, the 5% is the rate of return, the 10 is the period or years left to save, the -10000 is the amount you now have saved (always negative), the 150000 is how much money you want at the end (always positive), and the -$10,630 is the amount you need to save each year (always negative.) Bear in mind that if you are subscribing to the defined benefit method, and your expected returns don’t materialize, you may need to contribute more to the account in order to reach your goal.
How Aggressively to Invest
There are two schools of thought when it comes to investing your 529. The first school of thought, to which I belong, suggests you invest aggressively. In fact, my 529 accounts are invested much more aggressively than my retirement accounts because the consequences of shortfall are so much less dramatic. If market risk shows up, I simply make up the difference with the other three pillars. In fact, there is no rule that says you have to use your college savings evenly over all four years. If there is a big bear market the year your kid enrolls, you can cash flow more of it while you let the 529 recover for their junior and senior years. On the other hand, if your aggressive investments pay off, you can either cash flow less, they can go to a more expensive school, or you can save more of the 529 for professional school.
The other school of thought is that you shouldn’t take more risk than you need to. Investors who subscribe to this school gradually make their investments less aggressive as they approach enrollment. In fact, many 529s offer an option to do this automatically. This may be a good approach for an investor who plans to pay for all or most of the education using money saved in advance or who plans to be retired and unable to help much from current cash flow.
Whichever school of thought to which you subscribe, 529 investments will likely make up a major pillar of your college plan. Occasionally you will run into someone who advocates an alternative method of paying for college, such as using whole life insurance or real estate investments. Those advocating the life insurance are generally selling the product, and can be readily dismissed. Real estate investments can be a viable option, but do require significant expertise (and often additional risk) compared to simply investing in index funds inside a 529 account.
Your Chore List
- Open a 529 for each of your children. First read up on your own state plan (Google your state name combined with the words “529 plan” and determine if your state offers an income tax benefit and how much it is. If there is no benefit, open accounts with the Utah 529 found at http://uesp.org.
- Determine your goal for college savings. This should either be a defined contribution (how much you will contribute each year) or a defined benefit (how much you will have in the account when the child graduates from high school.)
- Share your plans with your teenage children. Emphasize the importance of their contributions.
More discussion of the four pillars of college savings
A ranking of 529 plans for both residents and non-residents
Discussion of how to choose a 529 plan
The Utah 529
The New York 529
The Nevada (aka Vanguard) 529 plan
Discussion of how much risk to take with a 529
How real estate can function as a college savings plan
A good discussion of why saving for college using whole life insurance is a bad idea
You made it to the end of Step 10! Get those 529s open this week and I'll see you next week.
James M. Dahle, MD, FACEP
Founder, The White Coat Investor
Twelfth Email (Step 11)
WCI Financial Bootcamp Step # 11 Estate Planning
Welcome to week eleven of The White Coat Investor Financial Bootcamp. I hope you've been doing your homework as we go along. You're almost done. This week we're going to talk about estate planning, but first, a word from our sponsor.
Step Eleven Sponsor
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Step 11: Estate Planning
Can I Skip This Step?
Do you have a will? Do you have a revocable trust? Have you met with an attorney who specializes in estate planning within the last five years? Are you sure you have the right beneficiaries listed on all of your insurance policies and investment accounts? If the answer to all of these is yes, then you may skip this step.
The Three Purposes of Estate Planning
Estate planning evokes an image of a rich, old dude trying to control his heirs from the grave and may seem superfluous to young, healthy, poor people like most early career physicians. However, there are critical aspects of estate planning that should be taken care of now. In addition, you need to be aware of the basic purposes of estate planning so you know when to get more help with it.
There are three reasons why people engage in estate planning. The first is to control where their minor children and their assets go when they pass. The second is to minimize the amount of assets that go through the probate process. Finally, estate planning may also potentially reduce both estate taxes and income taxes.
The Purpose of a Will
A will is a basic legal document that dictates who will take care of your minor children, who will manage your assets on their behalf, and where your assets will go when you die. If you have minor children, you must have a will. Check with trusted family and friends to see if they would be willing to function as the guardian of your children in the event of your untimely passing. You will also need someone to manage the assets you leave for the care of your children. This can be the guardian, a different friend or family member, or even an attorney or other professional. It can make a lot of sense to install some checks and balances by having the money managed by someone different than the guardian and if your family is like most, the best parents aren’t also the best at money management tasks!
Your will can also dictate the formation of a “waterfall trust” which is formed at your death. This puts off the initial cost of trust formation and eliminates the ongoing expenses of trust management before the trust is needed. However, it does prevent assets from going through probate.
When you die, your will is adjudicated by a judge in the process known as probate. This process has three major downsides. It is public, so anyone can find out what you owned. It is time-consuming, requiring up to a year before your heirs get what is coming to them. It is also expensive, often costing upwards of $20,000. So a major goal of estate planning is to minimize the amount of your assets that must go through the probate process. This is primarily done with two techniques.
The first is to designate beneficiaries. Most of your accounts can have a primary and secondary beneficiary. This includes retirement accounts, insurance policies, annuities, bank accounts, and investment accounts. You may also be able to use a “pay on death” designation that avoids probate as well. Some families simply add the heirs’ names to the accounts. A similar technique can be used with real estate by adding the heirs to the title. However, you need to use extreme caution with this technique. Not only can the heir clean you out before you die, but the heir may end up with some undesirable tax consequences. For example, with real estate or an investment account the heir will lose the step-up in basis at death that they would have received if the deceased were the only owner.
The second major method of avoiding probate is the use of a revocable trust. Revocable means you can take assets out of the account at any time. A revocable trust has little asset protection benefit, so its main use is to pass assets to heirs without having to go through probate. A trust allows you privacy (no one else gets to know about what you owned), allows heirs to get their inheritances immediately, and may even be cheaper than having a will go through probate.
When should you get a revocable trust? Well, before you die. There is some expense and hassle involved, and chances are good it will have to be adjusted a number of times during your life, so it doesn’t need to be a priority in the early years of your career. But by mid-career you will want to sit down with an estate planning attorney in your state to get it done.
Estate Tax Reduction
The final reason to do estate planning is to minimize estate and inheritance taxes. The typical high-income professional can eliminate these completely. It is also important to avoid making mistakes that increase the income tax burden of your heirs unnecessarily.
Most high-income professionals will never have to pay federal estate tax. That’s because there is an exemption equal to $11 Million ($22 Million married). If your net worth at death is less than that, you can leave it all to heirs without paying any estate taxes. Those numbers are indexed to inflation.
However, there is another concern with estate and inheritance taxes. Many states, typically “blue” states in the Northeast but others as well, assess their own estate and/or inheritance taxes and often with far lower exemption amounts, sometimes less than $1 Million. So even if you will not owe federal estate taxes, it may be worth taking a few steps in order to reduce your state estate tax burden.
If you are coming up against the estate tax exemption limits, the primary technique used to reduce that tax burden is to give your stuff away before you die. You can give any amount to charity (and get significant income tax benefits for doing so) and you can give up to $15,000 per year to anyone you like without using up any of the estate tax exemption. Your spouse can also give up to $15,000 per year. This strategic gifting technique can really add up. For example, if you are married, have three children that are all married, and they each have three children that are all married, you could give away $720,000 per year without using up any of your exemption.
If you don’t want your heirs to be able to use the money until after you pass, you can put it into an irrevocable trust, which removes it from your estate and protects it from your creditors. Of course, that comes at the cost of not being able to use it yourself! Since trusts are taxed at relatively high rates, many who use an irrevocable trust for this purpose use very tax-efficient assets such as stock index funds, municipal bonds, or even cash value life insurance in the trust.
Estate planning attorneys also frequently advocate that you get a general power of attorney, a durable power of attorney, and a living will in place. These are generally fairly inexpensive, although their utility may be somewhat limited for many people. For example, if you’re married and comfortable with your partner making these decisions for you, a discussion about what you would like done if you are incapacitated is likely dramatically more beneficial than the actual paperwork. But if you are single or have an unmarried partner, you would likely benefit from having these documents.
Your Chore List
- Get a will.
- If you are over 50 or have a net worth of $1 Million or more, make an appointment with an estate planning attorney.
- Look up your state’s estate and inheritance tax laws.
A broad overview of estate planning
Information on revocable trusts and their uses
List of states and their estate tax exemption limits
Information on irrevocable trusts and their uses
Discussion of what to put in your irrevocable trust
A review of a great book about revocable trusts and why you should have one
You made it to the end of Step 11! Get that estate planning done and I'll see you next week.
James M. Dahle, MD, FACEP
Founder, The White Coat Investor
Thirteenth Email (Step 12)
WCI Financial Bootcamp Week Twelve
Welcome to week twelve of The White Coat Investor Financial Bootcamp.You've made it to the end.This week we're going to talk about asset protection, but first, a word from our sponsor.
Step 12: Sponsor
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Step 12: Asset Protection
Can I Skip This Step?
Do you have your house titled properly? Are you maxing out retirement accounts? Do you know your state’s asset protection laws? If so, you can skip this step.
Fight Paranoia with Facts
Doctors who manage to accumulate some wealth often become paranoid about protecting it from potential creditors. Unfortunately, that occasionally leads them to do dumb things. A better understanding of your true risks with regard to your creditors is useful to eliminate the paranoia and allow you to make more rational decisions.
For example, the biggest liability for most high-income professionals, particularly physicians, is professional malpractice. This fear of being sued not only drives the expensive and sometimes harmful practice of defensive medicine, but also leads to expensive, complex, and sometimes ineffective asset protection plans.
Consider the facts:
In any given year, the risk of a physician being sued is 7.4%, although it ranges from 19% for neurosurgeons to less than 3% for psychiatrists. The risk of there being a payout from that suit is 1.6%. These numbers are from a 2011 article in the New England Journal of Medicine, and they have fallen (along with malpractice insurance rates) in the years since publication.
Of that 1.6% where there is a payout, the vast majority are settled prior to trial, for an amount less than policy limits. Of those that go to trial, the doctor typically wins, but even when she loses, the payout is generally less than policy limits. And if it is above policy limits, it is usually reduced to policy limits on appeal.
In reality, it is extremely rare for a physician to ever lose any amount of personal assets due to malpractice. Despite knowing hundreds of doctors, I’ll bet you can’t think of a single one who lost personal assets. I calculate the risk in my specialty of emergency medicine to be about 1/10,000 per year. Because this risk is so low, it doesn’t make much sense to spend a lot of money and hassle to protect against it.
Your Biggest Risk
In fact, you are far more likely to lose a significant portion of your assets to your spouse than you are to the thousands of patients you will see in your career. The timeless advice of “One House, One Spouse” and the slightly more sexist advice of “It’s Cheaper to Keep Her” apply in spades. Weekly date night is far better asset protection than a complicated system of family limited partnerships, limited liability companies, and overseas trusts.
On that same note, if you are marrying later in life (after accumulating some assets), remarrying, or blending families it is essential to get a pre-nuptial agreement. You should also be careful using the classic technique of putting assets in the name of the non-physician spouse.
A Reasonable Asset Protection Plan
Thus, the best asset protection plans are simple and relatively inexpensive. Your first line of defense is liability insurance. This includes professional malpractice insurance (going bare is usually a mistake) as well as the dramatically cheaper personal liability insurance. Your auto, homeowner’s, and renter’s insurance policies generally contain liability insurance that will cover all kinds of non-professional liabilities.
Unfortunately, too many people, including high-income professionals, are carrying liability limits that are way too low. Your state may only require you to carry $50,000 in auto liability insurance, but that’s not even enough to replace the Tesla you could hit, much less the cost of medical treatment and disability for the occupants. Raise those limits into the hundreds of thousands and then stack an “umbrella” policy (excess personal liability) on top of them. A total liability limit of $1-5 Million is appropriate. The good news is that an umbrella policy probably only costs 1/100th as much as a comparable malpractice policy. For example, my $1 Million malpractice policy runs something like $16,000 a year. But my $2 Million umbrella policy only costs about $300 a year.
Asset Protection Law Varies by State
After insurance, the key is to realize that asset protection law is very state specific. Techniques that work in one state may not work in others. You need to understand what assets are protected in your state and to what level. For example, some states protect all of your home equity and others protect none. Some states offer the same protection to your “ERISA” retirement accounts (like 401(k)s) as your IRAs, while others offer less protection to IRAs. Some states protect life insurance cash value and annuities and others do not. So before doing anything else, review your state laws using the resources at the end of this email.
As a general rule, retirement accounts receive a great deal of protection in nearly every state. Thus, maxing out your retirement accounts is not only a great move from a tax, investment, and estate planning perspective, but also from an asset protection perspective. However, if your state offers significantly less protection to IRAs when compared to 401(k)s, you may wish NOT to rollover a 401(k), even if you could get slightly lower fees and slightly better investments.
Homestead laws are also highly variable. In states like Texas and Florida, with very strong homestead laws, it can make sense to preferentially pay down a mortgage instead of investing in a taxable account. In a state like my home state of Utah, which only offers $40,000 of home equity protection for married couples, that move may make less sense from an asset protection standpoint. In fact, there are some situations where it could even make sense to take out a home equity loan and put the proceeds into a protected vehicle.
Life Insurance and Annuities
In previous chapters, we discussed the problems with investing in life insurance products like whole life insurance and annuities. However, in some states these vehicles offer significant asset protection. If asset protection is a bigger concern to you than your investment return, you may wish to place a portion of your money into these vehicles.
Separate Toxic Assets
Another important principle of estate planning is to separate toxic assets from non-toxic assets. A toxic asset is one that is likely to bring significant liability, like a rental property or a boat. If that asset can be justified as part of a business, a common technique is to place it into its own limited liability company (LLC) or corporation. In many states, and particularly if there are multiple members or shareholders in the corporation, this technique reduces both internal and external liability. Internal liability is liability resulting from the asset itself, such as someone slipping and falling on the walk at an apartment building you own as an income property. Even if this liability exceeds the insurance limits, your losses are limited to the contents of the LLC. External liability refers to a creditor from something else in your life (such as your professional practice) being able to seize the contents of the LLC. In many states, a creditor of a multi-member LLC is limited to a charging order. That means they can’t get the assets unless the LLC chooses to distribute them. But since an LLC is usually a pass-thru entity tax-wise, you can actually send the creditor a tax bill without giving them any assets! This sort of protection will often induce a creditor to settle for policy limits rather than pursue a charging order.
There are hassles and expenses associated with forming LLCs and corporations, and these must be weighed against the protections available. But the strongest protection comes from having each toxic asset in its own LLC. Some states offer “serial LLCs” that offer the same protection for a lower price. Some real estate investors also compromise by placing 2-3 properties into a single LLC.
Tenants By The Entirety
Another slick trick if you are married and your state allows it is to title your home as “tenants by the entirety.” This phrasing means that you, personally, own your entire house AND your spouse, personally, owns your entire house. So if there is a lawsuit judgment just against one of you, they cannot take your house away because your spouse owns the whole thing. In some states you can also title taxable investment accounts and bank accounts in this manner.
Giving Money Away
Another great method of asset protection is to simply not own anything. The less you own, the less a creditor can get. There can be a lot of creativity in this department, but the bottom line is that if you have a great deal of liability in your life, and a family member does not, and you were going to give them an amount of money or an asset anyway, then you might as well do it now. If you want to delay the gift, use an irrevocable trust. At that point it is no longer your asset and can’t be taken by your creditor. There are limits to this. You can’t give something away AFTER you incur a liability, and some state laws even offer a 1 year look back period, but for the most part, if you don’t own it they can’t take it.
No Magic Bullet
Many novice investors want to maximize asset protection, estate planning, investment returns, privacy, and convenience while minimizing taxes. Unfortunately, there is no magic bullet that does all of these things, although retirement accounts seem to come closer than anything else. As you gain more asset protection, you are often giving up something else such as investment returns or convenience.
Complex Asset Protection Plans
There are firms and attorneys that specialize in complicated asset protection plans that involve family limited partnerships, multiple LLCs, and even overseas trusts. There is a great deal of controversy in this area with regards to what works and what doesn’t. A good general rule is that if you can’t stand in front of a judge and give her a good reason for why you have this set-up besides asset protection, it probably isn’t going to hold up. The key is to have a business or estate planning reason that also happens to improve your asset protection. Obviously, there is little reason to even consult with an attorney about this topic until you have significant assets that aren’t protected in some other way.
Finally, a few words ought to be said in favor of simply reducing your liability. Practice good medicine and be nice to patients and their family members. Don’t engage in criminal behavior. Perform careful maintenance of rental properties or don’t own them at all. Avoid toys like boats, motorcycles, ATVs, snowmobiles, trampolines, pools, dangerous breeds of dogs, second homes, and race cars. Lock up firearms and ammunition. Treat your neighbors kindly. Drive the speed limit, use a designated driver, and practice defensive driving. Obviously a balance needs to be struck here, so practice moderation in all things.
Interested in getting the 12 Step Boot Camp course (and a whole lot more) in book format? Consider picking up The White Coat Investor's Financial Boot Camp: A 12 Step High-Yield Guide to Bring Your Finances Up to Speed from Amazon today!
- Get an umbrella policy.
- Review your malpractice policy and keep a copy on file.
- Make sure your home is titled “tenants by the entirety” if you are married and your state allows it.
- Look up your state’s asset protection laws.
- Max out your retirement accounts before investing in taxable accounts.
Malpractice risk by specialty
A basic guide to asset protection
Information on irrevocable trusts and their uses
A discussion of controversial portable offshore asset protection trusts
A discussion of asset protection for MD/JD Doug Segan
A list of states that offer tenancy by the entirety
Congratulations! You made it to the end of WCI Financial Bootcamp, the 12 step email course. If you would like to increase your knowledge about these topics and get a step by step guide to designing your own written financial plan, consider taking the WCI Online Course entitled “Fire Your Financial Advisor.” Spending 8 hours with me may be one of the best investments you ever make. It includes video, screencasts, worksheets, quizzes/tests with full explanations and more!
Welcome to The White Coat Investor community. Remember that I'm not the only white coat investor around here; you are too!
James M. Dahle, MD, FACEP
Founder,The White Coat Investor
Other White Coat Investor Resources
Thirteen weeks ago you trusted me with your email address. It might seem a small thing, but I take it seriously. Providing me your email address also represents a commitment for you to your own financial well being. Over the last three months I've tried to provide you as much value as I can and I hope you found the twelve Financial Bootcamp emails useful. (If you missed some of the emails, you can find them all here.) Today, I just wanted to let you know about the other resources available to assist you in reducing financial stress as you move toward financial success. Most of these are completely free thanks to our sponsors, but we do charge a reasonable price for a few of them (and then provide them ad-free.) Everybody learns differently and we're trying to meet you where you're at and get you this information in whatever form you prefer.
The blog is how The White Coat Investor began, way back in May 2011. Blog posts are 100% free and you can even sign-up to get them in your email box so you don't even have to come by the website. There are thousands of them in the archives, so feel free to go back and check out what you missed. Be sure to check out the classic posts.
The White Coat Investor Podcast is relatively new, started in January 2017, but has been immensely popular. It is also completely free. Doctors and other high-income professionals are busy folks, but they often have lengthy commutes. The podcast is a great way to turn that commute from drudgery to enlightenment. We try to keep it light, do a few interviews, and answer questions from listeners. You can subscribe to the podcast anywhere you get podcasts. We release a new one each Thursday and now publish show notes for each one so you can listen to them right from the website itself.
The Original Book
The White Coat Investor: A Doctor's Guide to Personal Finance and Investing is the best-selling book of its kind and has remained popular since its publication in January 2014. It is available in paperback (around $20), e-book formats such as Kindle ($9.99), and audiobook on Audible ($14.95).
The Boot Camp Book
In February 2019, I published my second book, The White Coat Investor's Financial Boot Camp. While the bones of this book are the emails you have already received, they were dramatically expanded and improved for the book. Dozens of real life, inspiring anecdotes from your fellow white coat investors were included as well as four useful appendices. The glossary alone is worth the price of admission. If you enjoyed the emails, you'll love the book. Also available on Kindle and Audible.
The Guide For Students Book
In January 2021, I published my third book, The White Coat Investor's Guide for Students. This book is specifically written with the medical or dental student in mind. It walks you through all of the major decisions you will face from the time you are a pre-med (or pre-dent) through your first year out of school. It is actually the longest of the three books because it also includes eight chapters at the end that constitute a course in Financial Literacy all by themselves. So not only do you get a step by step financial guide for school and into residency, but you also get the general information you need about investments, taxes, contracts, insurance, working with advisors, and financial history. Even an attending will appreciate the second half of the book. Also available on Kindle and Audible.
The Online Courses
The online course, Fire Your Financial Advisor, is our premium product, released originally in January 2018 and updated (now with CME) in February 2021. This is the closest thing we have to me coming over to your house, sitting down with you, and teaching you everything you need to know about personal finance and investing. This 8+ hour course includes videos, screencasts, worksheets, quizzes/tests with full explanations, and everything you need to not only become financially literate in as little time as possible, but also develop your own written financial plan. I can only do a limited number of speaking engagements a year, but you can take this course on your own time, on any device, and as many times as you want. Once you buy it, it is yours forever. Instead of charging you the thousands of dollars it would cost for you to hire a financial advisor to make a financial plan for you, I'll teach you how to do it yourself for far less. There is no risk as we offer a no-questions-asked, money back guarantee.
Once you have taken Fire Your Financial Advisor, you may wish to do some Continuing Financial Education each year. There's a course for that too. Our most recent one is called Continuing Financial Education 2020, compiled primarily from our 2020 live conference event (but also includes hours of material that wasn't at the conference). The best part about it is that it includes instruction from dozens of “stars” in the physician financial space and qualifies for CME, allowing you to use any dedicated CME funds from your employer, or write it off as a business expense if you are self-employed.
We also have numerous other courses available from partners, covering topics from negotiation to billing to telemedicine to real estate investing.
You're already subscribed to the WCI Monthly Newsletter if you're getting this. Once a month, on or about the 1st of the month, you'll get an email from me with WCI news, a market report for the previous month, a review of the best financial stuff on the web for doctors, and a special tip- a super secret blog post that nobody else gets. This is completely free.
Student Loan Advice
For those who have complex loan situations or just need confirmation about the path they are on, there is a solution. We want you to get the right student loan advice, so we started StudentLoanAdvice.com. For just a few hundred dollars, you can get a professional and personalized student loan plan and get on the right path today.
Some people learn best by interacting with others, asking and answering questions. The WCI Forum is a great place to do this. Completely free and anonymous, you can ask all the “stupid questions” you want and after a while, you'll also find you can provide a lot of assistance to newer forum members.
If you like Facebook Groups, we have one of those too. It's even more active than the forum. It's called White Coat Investors.
Prefer Reddit? We have that too. Here's The White Coat Investor subreddit (r/whitecoatinvestor)!
I'm also active on Twitter if you like your financial news in real time and I'd appreciate it if you would like our Facebook page, as it helps get this message out to others. We're also trying to figure out Pinterest and and Instagram, and although there is some great stuff up there, we don't update it nearly as often as the other social media stuff.
The Youtube Channel
Prefer to learn in video format? We are moving more and more in to video all the time. Subscribe to the White Coat Investor Youtube Channel to get all the latest and greatest. Also completely free.
We have periodic live conferences that qualify for Continuing Medical (and Dental) Education. The first one filled up (including 180 people on the waiting list) in just 7 days. The second one was held on March 12-14, 2020 at the Paris Las Vegas Hotel, and filled in 22 hours. You can purchase an online version of the 2020 conference, Continuing Financial Education 2020: The Latest in Physician Wellness and even still receive Continuing Education credit. Our third conference is a virtual conference March 4-6, 2021. You can still sign-up to boost your wellness, increase your financial literacy, and earn CME all at once!
We also make a special effort each summer to give back to The White Coat Investor community. We have a WCI Scholarship for current professional students where we give away over $90,000 in cash and prizes. We would love to have you participate as a sponsor or even a judge. Stay tuned each summer for details.
The Financial Educator Award
Just because you're now out of school doesn't mean you can't get some cash too. In 2019, we started a Financial Educator award for those who are helping their peers and trainees to become financially literate.
Thank you for spreading the word about The White Coat Investor message to your friends, family, and colleagues. One person at a time, we're making a difference and helping doctors and similar professionals to reduce financial stress so they can focus on their health, family, and practices.
The Real Estate Opportunities List
We have a special email group for investors who are interested in hearing about Real Estate Investing Opportunities. This group receives marketing information from White Coat Investor about available investment opportunities that have been reviewed by our team. In order to join, you should be an accredited investor (investable assets of $1M+ or an income of $200K+).
Recommended Financial Professionals
On the main website, we keep a prominent list of recommended, vetted financial professionals of all types. Yes, they're all advertisers, but they're also experienced in working with white coat investors. If you need a professional, we encourage you to consider these folks in your hiring process and send us your positive and negative feedback about them.
- Student Loan Refinancing Companies
- Physician Mortgage Lenders
- Insurance Agents
- Financial Advisors
- HSA, Self-directed IRA, Self-directed 401(k), and Practice 401(k) Providers
- Student Loan Advisors
- Attorneys and Contract Reviewers
- Tax Strategists
- Business Lenders
Thanks for being part of The White Coat Investor Community!
James M. Dahle, MD, FACEP
Founder, The White Coat Investor