[Editor's Note: This article was originally posted at ACEP NOW. I've been writing for ACEP NOW for several years now. This article addresses the critical importance of optimizing your behavior when making decisions about your personal finances.]
Q. Why are some physicians more financially adept than others? What are the keys to success?
A.
There is an old adage that states, “Personal finance is both personal and finance.” That is to say, there are two components to success: behavior and math. Most experts agree that 80 percent of success in personal finance is due to optimizing your behavior and only 20 percent is due to learning the rules of the game.
But I Can Make The Payments
Many physicians appropriately struggle with the decision of whether to direct additional income toward investments or debt reduction. This becomes particularly problematic when the debt is at a very low interest rate, such as some student loans and many mortgages. It seems mathematically obvious that, even with some additional risk, the investor is likely to outperform the guaranteed 1–3 percent return from paying off low-interest-rate debt.
However, what often happens is money that would have gone toward the debt is spent rather than invested. After a while, you’re “borrowing at 2 percent” to pay for your Caribbean vacation, that ski trip, and the Tesla in the driveway. This “I can make the payments” mentality actually slows the accumulation of wealth despite being, theoretically, mathematically superior.
Snowballing vs Avalanching
The best way to combat this natural behavioral tendency is to have a written plan for debt elimination, such as paying off student loans within three years or your mortgage within 10 years. Paying off even low-interest-rate debt early is a good idea, but you don’t want to be foolish about it.
For example, it would be silly to send extra money to the mortgage lender when you are not contributing enough to your 401(k) to get the entire employer match.
When trying to eliminate or reduce debt, the mathematically correct thing to do is to pay the minimum on all the debts in order to avoid additional fees and penalties, then use any extra income to pay down the debt with the highest interest rate.
Despite that fact, financial coaches have advocated a different approach for years, putting the additional income toward the smallest debt regardless of interest rate. What these “soldiers in the trenches” have learned, which was recently confirmed by a Harvard study, is that people are more likely to get out of debt faster when they feel they are making progress.
Behaviorally, it feels like you are making more progress when you have fewer debts and are writing fewer checks each month, even if the total debt is slightly larger. This is often called a “debt snowball” because as the number of debts decrease, borrowers feel they are gaining momentum and are more likely to complete the task simply because they stick with the task longer and put more money toward the debt rather than spending it.
Avoid Gambling With Investments
Another area where bad behavior trips up investors is in investment selection. The psychological rush that some people get from gambling can be re-created by selecting a winning individual stock, an actively managed mutual fund, or a hedge fund. However, this is not only a losing strategy mathematically (since most stock pickers, mutual fund managers, and hedge funds underperform the market over the long run), it is a losing strategy behaviorally.
By focusing on choosing investments, the investor doesn’t focus on what matters most: saving more money, using an appropriately risky asset allocation, minimizing fees, and paying less in taxes. Investing primarily in boring old index mutual funds will help the physician investor not only mathematically but also behaviorally.
Artificially Maintain a Gradually Increasing Standard of Living
Happiness studies show that we rapidly acclimate to a higher income and higher levels of spending. The best strategy for maximizing happiness is to have a constantly increasing standard of living throughout life. However, this does not line up well with a typical emergency physician career and earnings pathway. Therefore, wise physicians will create this scenario artificially by growing into their attending income as slowly as possible after residency. Having to decrease spending in mid to late-career in order to accumulate an adequate retirement nest egg is psychologically painful. Of course, that pain would be less than a dramatically decreased lifestyle in mid-retirement due to running out of money!
Prepare For An Income Drop
Finally, it is critical for physicians to realize that the future may not resemble the past. For example, Emergency physicians currently make one of the highest hourly rates in the entire house of medicine. Over the past decade, many specialties in medicine have seen pay cuts of 25 percent or more. Emergency medicine could be next.
The current and potential financial pressures on the incomes of emergency physicians cannot be ignored. All physicians would be wise to “make hay while the sun shines” by maintaining a high savings rate, eliminating debt early in their careers, and investing wisely. If you expect a 25 percent drop in income halfway through your career and it doesn’t materialize, you’ll be that much better off. If you don’t plan on that increasingly likely possibility, you may find yourself working far more night shifts than you prefer in your 60s.
Personal finance is both personal and financial. Be sure you attack it from both behavioral and mathematical perspectives.
What do you think? In what ways have you ignored the mathematical ramifications in order to improve your own behavior? How do you “make hay while the sun shines”? Comment below!
One way that I focused on debt repayment right out of residency was to make my computer login passwords a debt reduction goal and a year to reach it, like DebtFree2020! or $NoBallAndChain2018, with some combination of upper and lower case letters and money signs or exclamation points. (Not my real passwords, which have all been changed, anyway). This small, daily reminder kept this idea constantly somewhere in my mind. It also used these types of passwords on logins that I shared with my wife, so that it was a family goal.
I like this password strategy. It’s like daily affirmations for the digital age.
Great idea!
This is a decision I struggled with when I first started to receive attending paychecks. I was “lucky” to have large student loan debt that was locked in at <2% interest rate, so I decided to let it ride with the minimum payments and instead put that money toward retirement in taxable accounts.
As you said, it's 80% behavioral, and I have found that the joy of watching my retirement nest egg grow over the years has not been diminished by the relative glacial erosion of my debt. I do periodically reassess how the debt "feels" and yep, I still don't mind it. Once I hit my nest egg number, I plan to switch immediately to debt reduction mode and pay off those loans in a year or so.
We have a small amount of money in our overall money I treat as moon shot money. It gets invested in individual stocks I view as the future. I know mathematically my odds are higher with an index fund, however this small portion of my overall portfolio keeps me from tweaking the portfolio proper, so it’s worth the tradeoff.
RETIREMENT contributios should trump debt reduction in my humble opinion
I don’t think that’s what he’s arguing. WCI agrees that in a perfect world, contributing to a taxable account that would make 5% real over 30 years is better than paying off a 2% loan. But in the real world, people don’t always contribute the full amount of “debt payoff money” to their retirement goals. Instead, they fund Caribbean vacations or buy Teslas.
I choose the math and its long term implications over any super debt pay down. It can make sense in certain situations, and isnt an excuse to get deep into all kinds of debt. The other great thing about this choice is that should a situation arise where I want to pay down the debt all the sudden, I can do that as well, I have options.
I really dislike the, “but you wont invest it” line of thinking. Its highly illogical that someone who is unable to control themselves to invest will somehow manifest this awareness if it is simply labeled debt.
Zaphod. It is only human to consume possessions for pleasure and to put off future needs.
Money is like water. Unless you give it a container you won’t be able to find it later. Debt reduction is a marked container that allows people to focus on a goal that can be seen as a need for survival as well as a luxury to be done with it. It is highly motivating where saving money in investments is putting off the satisfaction of use for later and boring. The alternative to reduce debt or save is to spend and there is much instant reward in this. Spending can start off satisfying a small feeling of need and roll into bigger NEEDS easily and quickly.
Shining example of why doctors will remain below average “investors”
Still, go for debt reduction and follow general advice. Will come out fine and live a happy life.
To be exceptional though, Zaphod is correct.
Sorry not taking any “define exceptional” BS questions currently. For further commentary can read Zaphod’s many excellent posts on irrational debt aversion.
See ya!
Im sorry retirement accounts arent marked containers. The irrationality and illogical non sequitur nature of this argument doesnt want to die.
One needs only figure out the basics for the mental realization to occur. If you decided you want to get your house in order, great, your there. Choosing net worth over any specific itemized money goal isnt any different in this regard. Why cant our nest eggs be viewed this way instead of the debt, especially considering the opportunity cost?
I personally find great reward building up my retirement and tax advantaged accounts. One just needs to get their mind in the correct place.
Personal finance is personal and finance. Know math but also know yourself and know the average personal behavior.
My argument isn’t illogical if you incorporate character into success. Financial technique and mathmatics has less to do with success than behavior. This is what the Harvard study highlights. We are not financial dummies, we are behavioral dummies. Most people can get on board by curbing character flaws first and then success through overall financial gain will follow.
Zaphod has perfect character so he can move onto perfect financial technique. The average person has financial difficulty because there are many reasons to veer from perfect financial methods. Welcome back to reality. This is all hypothetical but I would choose my method of debt repayment first over a computed financial method because I am human and my financial history is a reflection of my personal story of blunders along the way.
Whether you dislike it or not, and whether it is logical or not, I see it all the time.
Are these people also paying down their debt though? Or are they in an overall bad behavioral place? That is, is this “i’ll invest it” simply a narrative along with others to explain away their spending? There is a correlation is not causation aspect to this that is highly impacted by the nature of the seeker and the advice giver.
I’d bet that most people that come knocking dont have any side of the equation in order. The rest is simply our interpretation and personal biases being painted onto the situation. Especially if one person (I know you do not) views these as mutually exclusive, there is no opportunity to see how they would do otherwise and therefore our anecdotes are riddled with selection and methodological bias.
Im not saying people dont do it. Im saying assuming if people can and do get themselves in order its a fallacy to assume its under only one condition. Nothing can be done until they realize its an issue and want to address it. However, at that point I would presume if given many different options and a reasonable explanation of their pros/cons people would and could choose from among a spectrum of full debt payoff to max investing. Most would be in between and fewer on the ends.
The issue is its much simpler and less risky (professionally, rep wise, etc…) and likely taken better by the audience to give a hard line simple binary prescription. This is what mostly happens, not a nuanced assessment and plan. Not an explanation of how your position on the spectrum effects liquidity, opportunity cost, net worth, mobility, FI now vs. later, etc….
I agree with the need to “make hay”. I have many non medical friends who struggle to understand my contention that, in my forth year of real work, I probably make more in real dollars than I will ever make again. With reimbursement declines, regulations, and healthcare reform it seems unlikely to be any other way. Wrapping my head around that idea was key to my eventual financial awakening.
+1. I don’t know a medical specialty (except perhaps primary care) that expects significant increases in reimbursements in the coming years.
I repeat this adage on a weekly basis. I am 1 year out of residency and I expect these first 2-3 years to be some of my top earning years of my career. I’m used to working the long hours of residency, my family is still young, and who knows what will happen to medicine in the future.
I don’t feel like there has to be a strict decision between funding retirement accounts and paying off debt. If your shovel is large enough, there’s room to do both.
By making hay while the sun shines, in the first few years after residency, we’ve been able to:
– pay off all student loans
– closing in on paying off all mortgages (1 down, 1 to go, should be gone in under a year)
– amass a 7 digit investment account
– still increase our standard of living (spending nearly double what we spent as residents/fellows and don’t really feel like we are depriving ourselves of anything)
Well done. Obviously don’t discount the value of a rather high income!
I started my career with the expectation that I would never again have the chance to earn $150 to $200 an hour doing something I enjoy (I started out doing locums work http://whitecoatinvestor.com/lessons-from-locum-tenens/).
So I did it a lot and filled the barn with hay. Now that I’ve got all the hay I think we’ll need, I’ve decided to spend less time in the field. I enjoy making hay alright, but I’ve found life off the farm to be quite fun and less stressful. But I’m glad I worked hard as a young “farmer.”
Cheers!
-PoF
Sage and simple advice. I am a huge fan of debt snowball and used it to pay down all of my non-student loan/mortgage consumer debt. Now it is time to pay off the student loans despite being at only 3%.
If more of us were better at being behaviorally controlled we would all be making progress. Instead we keep up with the Doctor Joneses and buy bigger and fancier things. Some lead to improved happiness but most lead to stress.
Very interesting read, WCI! Just wondering, what’s the Harvard study you were referring to about the debt snowball being better than the debt avalanche for reducing debt? The debt snowball is apparently something that Dave Ramsey recommends very highly, even though mathematically it’s inferior to the debt avalanche where you pay down the highest interest debt first. What I don’t understand is, why do the financial gurus spend time on recommending things that feel good and not the strategies that actually are good. Wouldn’t people feel even better if they saw the debt avalanche work better? If someone just simply explained it to them?
Sorry about the rant!
Welcome to my world! This is what I keep saying, especially for smart rational professionals. We should be able to move beyond the “feels good” to assess the optimal, though tuned for individual goals solution.
Further, it should “feel” awful to be doing the suboptimal choice once you understand the fundamentals. Oh, well, I have tried but its nearly heretical to broach it so it doesnt seem to get even handed consideration by people.
This financial argument (most mathematically correct vs best strategy for compliance in a large population) is pretty similar to the medical conundrums that we face with patients – many would benefit from self-discipline (diet, exercise, compliance with medication) but we know that a majority won’t do those things, so we wind up using therapies that they might actually use, rather than the optimal ones…
Doesn’t make the optimal therapy less optimal, just not effective if people won’t follow it.
https://hbr.org/2016/12/research-the-best-strategy-for-paying-off-credit-card-debt
I assume he’s referring to this study, summarized in the Harvard Business Review:
https://hbr.org/2016/12/research-the-best-strategy-for-paying-off-credit-card-debt
While the debt snowball is less optimal than the debt avalanche, the snowball method has a higher compliance rate.
-WSP
Thank you for bringing up relevant conversation that encourage us. These psychobehavioral studies add to successful financial methods. Simple wins give emotional boosts and revive intentions to win.
I like the example of Watson and Crick in this related article.
https://hbr.org/2011/05/the-power-of-small-wins
I’m in the category of people not avalanching med school debt since I was lucky enough to consolidate at close to 2%.
I have automated transfers to both short and long term funds in investment accounts. If I did pay down my med school loans faster I’d lose liquidity. Thanks to stocking up some cash (beyond the emergency fund) I’ve been able to “roll with the punches” where unexpected expenses (both bad like car repairs or good like a spur of the moment vacation) are just cash flowed day to day.
I’ve heard calls to Dave Ramsey like this: caller is debt free except the house or some other low interest debt. They either have a lot of stockpiled cash OR received a windfall. Dave encourages them to take all this extra money and just eliminate their debt. He’ll say, “if you had no debt, would you take out 500k in loans and leave it in the bank?” This is a false equivalency in my mind. That’s not the choice that the caller (or someone like me) has to make. Since by the time I do knock out my med school debt I’ll still have my invested money whereas if I clear out my account I’ll just have my emergency fund and thats it.
Your last sentence is apples to oranges.
I think there’s a lot to be said for this post for those in EM. I know one EM physician that a 25% reduction has already impacted and see the same for us on the horizon. We are what I call “middle path” folks. We max out all retirement accounts (120k/yr), save, pay extra every year on our mortgage, have a taxable account, take lots of trips and still have low interest student loans, 8 years out of residency. But they’ll be gone in 2 years and that will feel nice since we do think EM pay will decrease. Maybe we don’t put as much into taxable in the future….the trips aren’t going anywhere yet!