I love climbing. Part of what I love about it is the opportunity to be highly focused on relatively simple things. Like breathing. When you're taking four breaths for every step, you would be surprised how much you think about the simple process of moving oxygen into your chest and bloodstream. Maybe you're intensely focused on your partner connected to you by a lifeline fifteen stories above you. Perhaps you're focused on the tiny area illuminated by a headlamp, or on the microhold keeping you from falling past that tiny piece of purely psychological protection connecting you to the cliff 25 feet below you. All other concerns evaporate, and that allows you to accomplish incredible things.
This power of focus is very real. Many of us make New Year's Resolutions every January. If you're like me, you've learned that if you only have one or two of those, you're likely still working on them come February. If you have twenty-five, you probably accomplished nothing. It is the same with any financial goal. What you focus on is what you achieve. If you focus on it, you measure your progress toward it.
The simple act of measurement increases the likelihood of success. I am convinced that a lack of focus causes a lot of doctors to f
ail underachieve financially. For example, a doctor who is focused on maxing out retirement accounts is unlikely to undersave. A doctor who is intensely focused on paying off student loans is unlikely to be suckered into buying an ill-advised whole life insurance policy. Many of the smaller financial goals in our lives can be accomplished very quickly if we focus only on that goal. Here are a few examples:
- Saving up an emergency fund
- Paying off credit card debt
- Paying off a car
- Saving up for a car
- Saving up a reasonable undergraduate college fund
- Saving up a down payment
Now admittedly paying off $400K in student loans or saving up a retirement nest egg is going to take a while, but many of those other goals should only take a doctor a few months if they are focused entirely on the goal. Once the goal is accomplished, confidence increases, mental wellness increases, and momentum is built as the doctor moves on to the next goal. However, if you spread your efforts over a half dozen or more goals, it is easy to feel you are making no progress and give up on the goals. This can happen when paying off multiple debts if you are trying to pay them all off at once or even if you simply start with the larger debts.
Even if you do not believe there is GREAT POWER in focus, you must admit that there is SOME value in focusing on one goal at a time. But how much is that power of focus worth? Let's consider the potential costs of focusing on just one goal.
Potential Costs of Intense Financial Focus
I can think of at least five potential costs of focusing on a single goal at a time. Let's go through them one by one.
# 1 Interest
Let's say you have a bunch of debts you want to pay off and in order to maximize the power of focus, you decide to pay off a $4,000 2% debt before a $20,000 8% debt. You're a doctor making $20K a month and you figure you can dedicate 35% of your gross income ($7,000/month) toward wealth-building activities. How much interest does it cost you to pay off the smaller debt before the larger debt? About $20 for every month you are paying on the smaller debt instead of the larger one. In this case, about $13.
Obviously with larger debts, longer terms, and a greater difference between interest rates, the higher the interest cost you will pay in order to focus yourself. But I would encourage you to do the math. You will likely realize that the actual cost of “favoring math over behavior” is pretty small compared to the difference in motivation you experience when focused. Most of the time, I think people are probably better off with the improved focus a “debt snowball” (smallest debt first) approach provides over a “debt avalanche” (highest interest rate debt first) approach, especially people with such a small amount of financial discipline and literacy that they have many different debts.
# 2 Employer Match
Some doctors coming out of training do not invest at all until they have paid off their student loans. If their employer provides a 401(k) match, they give this up in order to be focused on the debt. It is painful for me to see people not receiving their match, since I view it as leaving part of their salary on the table. But lots of people never actually do the math to see how much their match really is. A typical match is 3% of salary. If a typical doctor makes $200K, that's $6,000 per year, or $500 per month. That's certainly a lot more than the $20 a month discussed above. Is that enough money to be worth splitting the power of focus a bit? I think it probably is for anyone receiving a match.
# 3 Taxes
The IRS provides a lot of tax benefits to those who spread their financial resources around rather than focusing them. For instance, a relatively low earner may be able to deduct the interest on their student loans. A higher earner may be able to deduct mortgage interest. The higher your tax bracket, the more immediate tax savings can be found in contributing to a 401(k) or other tax-deferred accounts, and that's not including decades of tax-protected growth and a potential arbitrage between your tax rate at contribution and at withdrawal. A contribution to a tax-free account may also provide decades of tax-free growth. Contributions to 529 accounts and health savings accounts also provide substantial tax benefits. Missed contributions can never be recovered, despite the fact that the higher post-age 50 (55 in the case of an HSA) contributions are called “catch-up” contributions. (To be fair, some 403(b)s actually do have a true catch-up feature.)
Each of these tax benefits can be quantified and must be weighed against the power of focus. One of my first posts on this blog attempted to quantify the value of a 401(k). It varies by the situation, but the benefit is substantial. It is almost certainly worth paying some extra interest on loans in order to capture those benefits. But is it worth the loss of the power of focus? Well, it's hard to say, because that focus is worth a different amount to different people. But this is one reason why I often tell people to pay off student loans and even mortgages before investing in a taxable account, but not before investing in retirement accounts.
This is also one reason why the “Live Like A Resident” plan works so well. You spend such a small percentage of your income that it allows you to split your efforts between two or three goals and still accomplish them all in a short period of time. You can max out your retirement accounts, save up a downpayment, and STILL pay off your student loans within 2-5 years of finishing your training.
# 4 Asset Protection
Another benefit of retirement accounts is that they receive significant asset protection in the event of an admittedly very rare above-policy-limits judgment. What is that asset protection worth? Probably not much. Even a great potential loss isn't much money when multiplied by a tiny risk of loss. It gets even more confusing when you consider the asset protection benefits of various goals in different states. For example, paying down a mortgage in Minnesota instead of maxing out a Roth IRA can be a great asset protection move since there is an unlimited homestead exemption but a $30,000 limit on IRA asset protection. In most states, the opposite would be true.
Personally, I think the power of focus is worth a lot more than getting a little extra asset protection.
# 5 Compound Interest
This is another major factor. Consider somebody with ten financial goals:
- Save up a $20K emergency fund
- Save up a $50K down payment
- Pay off a $6,000 15% credit card debt
- Pay off a $10,000 6% personal loan
- Pay off a $6,000 2% car loan
- Pay off a $20,000 3.5% car loan
- Max out a Roth IRA
- Max out a 401(k)
- Invest $10,000 in a 529
- Buy a rental property
It's relatively easy to pick off a few of those smaller goals and knock them out. Wouldn't it be great to have five goals you're working toward instead of ten? Much easier to focus, right? But if you go pay off that 2% car loan instead of maxing out a Roth IRA, it could cost you some money. If you pay off the car loan this year instead of making that Roth IRA contribution you'll be (9%-2%)*$6,000 = $420 behind. But in 30 years at 9%, that difference will compound into $5,572.
A 15 Step Plan For Those Who Need Focus
Most people will try to strike a balance between the power of focus and the mathematical benefits of spreading your resources across multiple goals while trying to maximize the benefits of interest, the employer match, taxes, asset protection, and compound interest. It's really a spectrum with the very focused people on the left and the “math geeks” on the right. Most of the time in the personal finance blogosphere, we delve into the details of maximizing the mathematical benefits of each little option, catering to those on the far right side of the spectrum.
Today, I'm going to turn the tables and focus on those who find themselves on the left side. It isn't that there is anything wrong with being on the left. In fact, if you belong on the left, having a plan that acknowledges that will lead you to far more financial success than trying to “kick against the pricks” and “forcing a square peg into a round hole.”
So here is a simple 15-step focused financial plan for those who get great benefit from focusing their efforts — which is more of us than you might think! For convenience, we'll assume this person is just leaving their training with no money to their name and hundreds of thousands of dollars in debt. Adjust the plan to your own circumstances.
Phase One – Planning
There are four steps in this phase and they can be accomplished in just a matter of hours, although most people will probably take a few weeks and maybe even need to pay for some assistance.
Step 1 Figure Out Where You Stand
A map doesn't do you any good if you have no idea where on the map you are. So step one is to find out where you stand. List all of your assets including properties, bank accounts, investment accounts etc. Add up all your debts. List them by amount you owe, interest rate, monthly payment, tax treatment, and purpose. Calculate your net worth (assets minus liabilities). This is your balance sheet.
Now let's turn to your income sheet. Write down all of your sources of income by amount and type. Now look at your bank account, credit card, Paypal, and Venmo records for the last 1-3 months and figure out how much you spend and on what. What's the difference between your income and your outgo? This is your savings rate. Net worth and savings rate are critical concepts to understand, measure, monitor, and improve.
Step 2 Determine the Length of Your “Live Like a Resident” Period
Next, you move on to your financial goals. For a typical new grad, the most important thing to do at this period is to live like a resident. But none of us went into a high-income profession in order to live like a resident for the rest of our lives. This is supposed to be a very temporary period where you deliberately live not just below your means, but dramatically below your means for a few years in order to build wealth.
This is a period of time where you do not upgrade your lifestyle (or only upgrade it minimally) in order to use your newfound high income to pay off your debts, build an emergency fund, get a great starter nest egg, and maybe even save up a house down payment. The “Live Like a Resident” Period encompasses Steps 5-11 of this plan. You are not replacing things that are not broken. You are driving basic transportation. You are not going on fancy vacations. If you own a home, it is a very inexpensive one and you are probably renting for at least a while. Make this period at least two years but no more than five. Student loan burden will be a major factor, but not the only one, in choosing the length of this period.
Step 3 Insure Against Catastrophe
Step 4 Map Out the Student Loan Plan
Once you become an attending, this is a relatively simple task. If you are not directly employed full-time by a non-profit, you should refinance your student loans into a 5-year variable rate loan. This is the lowest possible interest rate you can get because it involves the least risk for the lender. But it doesn't involve much risk for you either because you are committed to living like a resident from now until the loans are taken care of.
Let's say you have $200,000 in student loans and you have decided your “live like a resident” period is going to be three years long, so you need those loans out of your life in three years, or 36 monthly payments. Maybe you refinance the loans to 4%. Using a simple spreadsheet calculation, you can see that you will need to pay
=PMT(4%,3,-200000,0,0) = $72,070
per year in order to pay off the loans in 3 years. Divide by 12 and that's $6,006 per month. A very simple plan. Step 1 refinance. Step 2 pay $6K a month for 36 months. Easy peasy.
If you are directly employed full-time by a 501(c)3 (non-profit employer), you likely want to go for Public Service Loan Forgiveness (PSLF). That doesn't make any difference in the amount of money you should be dedicating each month toward this step compared to the person paying off their loan. You still need to dedicate ~$6K per month toward this goal. Part of that $6K goes to the loan servicing company and the rest goes toward your PSLF Side Fund. In 3 years, your student loans are “taken care of.” Even if they don't actually disappear for four more years, you could wipe them out at any time using the side fund and can move on to your next step.
Phase Two – Live Like a Resident
The next six steps in the plan are of critical importance, but can actually be accomplished relatively quickly–usually within just 2-5 years from the completion of training. If you are an orthopedic surgeon making $500K with $100K in student loans, this phase may only last 2 years. If you are a family practice doctor making $170K with $400K in student loans, this phase may last the full five years.
Step 5 Save Up a 1 Month Emergency Fund
A key part of getting out of debt is to not take on any more debt. Once you realize you are in a hole, the best thing to do is stop digging. A great way to do that is to save up a relatively small amount of money that can be used in a true emergency like a car repair, a broken appliance, a health insurance deductible, or a plane ticket to a funeral. This amount should be equal to one month's worth of your mandatory expenses. For a typical doctor living like a resident, it should be something like $4-5K. This money isn't going to be earning anything. In fact, it's probably just going to sit in your checking account. The point of it is to allow you to not borrow any more money. No car loans. No credit card loans. No personal loans. Instead, you spend the emergency fund. And if you spend it, you put Steps 6+ on the back burner and start over again on Step 5.
Lots of personal finance folks recommend you get a 3-6 month emergency fund. That's great, but let's be honest. That will take a long time and will cost you a ton of money in interest, lost employer match, and taxes to do that. You will likely lose focus somewhere en route. Dave Ramsey recommends this “starter emergency fund” be only $1,000. But Dave Ramsey's audience doesn't make $20K a month. If you're living like a resident, you should be able to save up a one-month emergency fund in, well, one month. Then you can move on to Step 6.
Step 6 Get Your Employer Match
Go see the human resources person at your job and ask for the retirement plan documents. If your employer offers a 401(k) or 403(b) “match”, you need to make sure you put enough money into the account to get the entire match. This is part of your salary and not getting it is like burning thousands of dollars a year just for fun. Maybe your match is $3,000 per year and you have to put in $6,000 to get it. So put in $500 a month, invest it in some reasonable way (just stick it in an S&P 500 index fund if you don't yet have a written investing plan,) and move on to Step 7.
Step 7 Snowball Your Piddly Debts
Take that list of debts you made in Step 1. Remove a mortgage if you have it and your student loans that you already have a plan for. List the rest smallest to largest. Now, dedicate EVERY DOLLAR that you have carved out of your budget toward that debt. If you're like most docs, you've got a handful of these. They should fall very quickly. Like one or two per month. If you find one that is particularly large, like a $30,000 auto loan, sell the car, buy a $5,000 car (even if you have to on credit) and pay it off the next month. This isn't the time to be driving a $30,000 car. You should be able to move through this step in just a few months.
Step 8 Max Out Your Retirement Accounts
Okay, maybe it is now Halloween or so after residency completion. Your only debts are your student loans and possibly a small mortgage and you have a well-thought-out plan for those student loans. You have a little bit of emergency cash set aside. Now is time to start investing.
The best place to invest is inside your retirement accounts where the money is generally protected from both taxes and creditors. You can do a Backdoor Roth IRA for yourself and a spouse. You can now max out that 401(k) or 403(b). Maybe you also have a 457(b), a defined benefit/cash balance plan, an HSA, or an individual 401(k). Understand what is available to you and max it out. You likely only have until January to max out the employer's plans, but you have a little more time if you are self-employed and of course, you have until tax day for the Roth IRAs.
Step 9 Pay Extra on Student Loans
If you still have extra money after maxing out your retirement accounts, turn back to those student loans. Just because your original plan was to pay them off over 3 years, that doesn't mean you have to take that long. Start throwing extra money at them every time you get it. It would not be unusual to see your “3-year plan” turn into a “20-month plan.”
Step 10 Increase Emergency Fund to 3 Months of Expenses
Now you're really building momentum. All your little debts are gone, your student loans are gone, and you're maxing out retirement accounts. Your net worth is rising rapidly and is now well into the positive. It's time to get a real emergency fund. Go ahead and direct your extra cash for a month or two toward that emergency fund. Build it up to three months of expenses, something like $10-20K.
Step 11 Save Up Down Payment
You're likely coming to the end of your live like a resident period now. For most docs, that will involve a housing upgrade. Maybe it is buying a house if you have been renting. Maybe it is selling your current residence and buying a new one. Maybe it is turning your current residence into a rental property and buying a new one. Whatever.
You will get the best loan terms now by saving up a 20% down payment. It's not necessarily bad to use a 0-10% down doctor loan to buy a home if you have a better use for your money like paying off 8% student loans or maxing out retirement accounts. But you're already doing that. So you should save up a down payment. Don't worry, it won't take long because you're still living like a resident and you have no payments. If you are exchanging your current home, go ahead and save up the down payment by paying down your current mortgage. If you don't have a home (or plan to use it as a rental property), then you'll need to save up the money in a safe, liquid investment like a high-yield savings account or municipal money market fund.
Phase Three – The Rich Doctor
Some people never get to this phase, which is sad, because it is a whole lot of fun. You see yourself making rapid progress toward financial goals while never having to deny yourself anything.
Step 12 End the Live Like a Resident Period
Now is the time when you upgrade your lifestyle. How much can you upgrade it? Well, you need to continue to save 20% of your gross income for retirement, in retirement accounts if possible, but in a combination of retirement accounts and taxable accounts if necessary. And you probably have some other financial goals like college, a boat, or a Tesla to work toward. So carve some money out for those goals. But this is where you upgrade your house to a “doctor house,” you upgrade your car to something you're not embarrassed to drive (pay cash, of course, you don't want to go back to Step 7), and you start splurging on a separate hotel room for your kids. If you already own the doctor house because you just couldn't resist, now is when you can furnish those empty rooms or do some renovations.
Step 13 Save for Children's College
Speaking of kids, this is where you start saving for their college. Decide how much you want them to get from you for college, then take their age and subtract it from 18. Divide by the number of years from now until age 18 and put that amount into a 529 every year. Perhaps at this point, you have a 6-year-old and a 1-year-old and you want them each to have $100K for college. 18-6 = 12 and 18-1 = 17. So put in $100K/12 = $8,333 ($694/month) and $100K/17 = $5,882 ($490/month) into their respective accounts each year.
Notice this step is way down here near the bottom. Don't make the mistake of trying to pay for your child's education before you've even paid for your own and remember that retirement is a far bigger priority than college. You can only help others from a position of strength. Even if you save nothing for college in advance, by having your financial ducks in a row you should be able to cash flow a substantial amount of the cost using your high income, especially with appropriate college selection.
Step 14 Build Wealth
Still have money coming out of your ears? Congratulations. You're going to become very wealthy. Take some of that money and invest it in a taxable account. That likely means assets like stock index funds, municipal bond funds, syndicated real estate, or directly owned rental properties. These investments will speed you along toward financial independence and give you great control over your work and the ability to help those you care most about.
Step 15 Buy Luxuries and Give
Take the rest of that “extra money” you've freed up by being financially disciplined and getting rid of all of your payments and use it for whatever you like. If you're like most, you will divide it among three things:
- Buying nice stuff and vacations you always wanted. Get a wakeboat. Go heli-skiing. Upgrade the kitchen. Burn stacks of benjamins for firewood. Buy whole life insurance. Whatever.
- Giving it to charities or family members
- Paying off your mortgage with it (which in turn, allows you to buy more nice stuff, give more money away, or just work less). Many docs would actually do this before investing in a taxable account and certainly before they start burning benjamins or buying things like whole life insurance. But there is room for disagreement here among reasonable people.
Many of us benefit from having a clear plan that we can focus on. If you will follow this 15 step plan, you will eliminate financial worries from your life very quickly.
What do you think? Would you find this 15 step plan useful? How have you used the power of focus to achieve your financial goals? When is it appropriate to divide our focus? Comment below!