[Editor's Note: Today's post originally published at ACEPNow and discusses metrics to use in your financial life that allow you to “keep score” as you work toward your financial goals. Use these metrics once a year to compare your year to year performance.]
Question. I am an emergency physician who recently completed residency. How can I make sure I am as successful in my finances as in my clinical practice?
Business expert H. James Harrington once said,
Measurement is the first step that leads to control and eventually to improvement. If you can’t measure something, you can’t understand it. If you can’t understand it, you can’t control it. If you can’t control it, you can’t improve it.
As an emergency physician, you have become intimately familiar, perhaps too familiar, with business-related metrics (eg, door-to-doctor time, physician satisfaction rating, and percentage of downcoded charts). There are also metrics for your financial life that can be measured and allow you to “keep score” in working toward your financial goals. Of course, the purpose of keeping score is not to compare yourself to anybody else but to compare your performance from year to year and against your own financial goals. This article will discuss four of the most important ways to measure your financial goals.
4 Measurements to Track Your Financial Goals
#1 Your Net Worth
Perhaps the most important measurement someone seeking financial success can monitor is net worth. Net worth is the sum total of all your assets minus the sum total of all your liabilities. Assets include bank accounts, retirement accounts, investments, home equity, and the cash value portion of life insurance. Liabilities are primarily debt, such as student loans, mortgages, auto loans, and credit card debt.
Financial professionals find it amazing that so many physicians have no idea how much they owe in student loans. It can be scary to add it all up, but it is hard to reach any reasonable financial goal if you don’t know your starting point.
Pour yourself a tall drink of your favorite beverage, sit down with all of your student loan paperwork, and actually add it all up and write it down. Chances are good that, if you have never done this, the total is quite a bit more than you think given the relatively high student loan interest rates. Most physicians graduate from residency with a negative net worth due to high student loan burdens. One of their first financial goals should be to get back to a net worth of $0 (#livelikearesident) as soon as possible. Many doctors find it more difficult to get to $0 than to go from $0 to $1 million in net worth!
Exploring Capitol Reef, the Utah National Park no one goes to.
#2 Your Savings Rate
Another important financial metric is your savings rate. This is the percentage of money saved in a given year toward your long-term financial goals, such as retirement or college, divided by your gross income. While there are many different ways to measure savings rate, because you’re “competing” only with yourself, it only matters that you are consistent with your method. I suggest you count retirement account contributions and other investments as well as paying down debt as “savings”. If you are unsure what to count as income, keep it simple and use your total income from your tax return. In 2020, it can be found on Form 1040, line 7b.
I generally recommend physicians save 20 percent of their gross income toward retirement. While 15 percent may be enough if you work long enough and don’t make too many investment mistakes, and 25 to 40 percent may be required for a very early retirement, 20 percent is a good starting place for most doctors. However, 5 to 10 percent is almost surely going to be inadequate. Measure your savings rate each year, and if it is too low to reach your goals, find ways to boost it throughout the year.
#3 Your Tax Rates
I am often surprised to find that physicians have no idea how much they actually pay in taxes. There are really two tax rates worth keeping track of.
Effective Tax Rate
The first is your effective income tax rate. To calculate this, add up your federal income tax, state income tax, and payroll tax, then divide that sum by your gross income.
For me, this number has varied quite a bit throughout my earning years. It was as low as 5 percent during my time in residency and the military, but in 2014 it was around 23 percent and since 2017 has been over 30 percent. If you find your effective income tax rate is similarly high, it may be worthwhile to seek out ways to legally lower that burden, such as contributing more to tax-deferred retirement and health savings accounts, keeping better track of potential deductions, or moving to a state with a lower tax burden.
Marginal Tax Rate
The second tax rate worth knowing is your marginal tax rate. This number is generally significantly higher than your effective tax rate. The easiest way to calculate it is using tax software upon finishing your taxes each year. Simply add $1,000 of hypothetical income and see how much your tax bill rises.
#4 Your Annualized Investment Return
Many investors have no idea what their investment returns are. That makes it very difficult to know if you are on track to reach your goals. It is best to calculate your returns on an after-expense, after-tax basis. The most accurate way to calculate your investment return is using an internal rate of return (IRR) function in a spreadsheet or a financial calculator.
The only data needed to do this are the amounts and dates of contributions and withdrawals (including any dividends not reinvested) to the account. Since the contributions will not be regular, you will need to use a function called XIRR, or the internal rate of return with nonperiodic cash flows. This function provides an annualized rate of return as opposed to an average rate of return. It is important to know the difference since the only return you can spend is an annualized one.
By way of comparison, the average annual return of the S&P 500, with dividends reinvested, from the years 1927 through 2014 was 12.1 percent. However, the annualized return during that time period was just 10.1 percent. This effect is due to the volatility of investment returns; in short, you need a 100 percent gain to make up for a 50 percent loss. The more volatile your investment returns, the greater the difference between your average returns and your annualized returns. A tutorial showing how to use the XIRR function to calculate your return can be found here.
Keeping score by calculating these simple financial metrics once a year can provide you with the knowledge and motivation you need to reach financial success.
What do you think? Which metrics do you keep track of in your financial life and why? Comment below!
What are the options if one’s effective tax rate is over 30%?
If your effective rate is above 30% it means you are earning a lot of money. The high earners are hit the hardest with our taxation system. The rich people that receive most of their income passively don’t have this problem as capital gains are taxed differently. That is why Mitt Romney and other businessmen had such a low tax rate. You have been phased out of most of the tax breaks, so take the ones that are still available to you. Home mortgage and charitable are the two main ones. Also work on your 401(k), including the safe harbor profit sharing provision that lets you increase the pre-tax amount to $53,000 instead of the typical $18,000. $5,000 can be added to an HSA account pre-tax.
Tax deferred accounts, like a 401(k) can be handled later in a couple of ways. You can donate them to charitable organizations and neither you nor the beneficiaries will ever pay taxes on that. Also, in years of low income or early retirement you can gradually convert that money into a roth IRA, paying much lower tax rates.
If you have a bad year in the markets you can tax loss harvest, too.
HSA is $3,350 for an individual and 6,650 for a family.
Even home mortgage interest and charitable contributions start getting phased out at a certain income level, although the phaseout is very gradual compared to most.
You are absolutely right about the HSA amounts. I was thinking of my deductible for the HSA insurance.
Perhaps the best way to get out from under the heel of the government is to get your savings high enough to become financially independent so that you can retire early and live off of other income sources. And by retire, I mean retire from the rat race. You can still keep doing what you love, just on your own terms. From what I have been told work takes on a whole new meaning when you work because you want to, not because you have to. That is something I hope to someday experience.
As of today I just calculated that I have saved 33% of my gross income for the year so far, almost all of it towards my loans (just recently got rid of the last of my 6.5% loans and am left with under 40k at 4.5%t 2 years out of residency)–not bad since I took 3 months off for maternity leave and am not technically working full time! I finished residency with 220k in debt and have upped my comfort level/lifestyle slowly. I still have a nagging sense of feeling “behind” because I am funneling so much towards student loans–however, from your article it still sounds like that 44k counts because the money went towards debt, right??
My husband has quite a bit more than me in retirement, so I am hoping that after I kill those loans this spring I can really ramp up my retirement savings.
I jumped to using personal capital for net assets, great website. I have been lucky to have made some good decisions (whole life wasnt one of them), just by pure luck. I am 39 and net worth is 1.7.
My goal is to buy a Tesla model X when I reach 2 million. Probably another 2-3 years. (I know another bad decision).
Savings rate is around 30-35%. But not all goes in stock, some is cash too as I am trying to save for Tesla and few other green projects for home.
Marginal Tax rate is 39.6%, effective tax rate around 34-35%.
Ok my annualized return rate: I am not calculating that, dont have that much free time with little ones running around and few pulling and few pushing. But personal capital gives you a “you index” and does compare that you S/P.
What I found was I will never do as good as S/P or as bad as S/P, cause of international index funds, bonds and cash in my portfolio. Though lately have you noticed most markets are more or less mirroring S/P. Needless to say WCI gave me confidence to invest right and get rid of the whole life too. Slowly my Edward Jones portfolio has whittled down, while Vanguard has gone up. 🙂
Thank you WCI…..ever thankful to you…..you have literally saved me millions, made my savings rate go up, gave me confidence to go on own and avoid 1.25% AUM, get rid of whole life and be there whenever some one comes along with an S/P beating strategy.
WCI and others- since taxes were brought up- since many of you handle your own investment plan, do you also do your own personal tax planning and fed/state returns with software such as TurboTax, researching any particular issues?
I have an accountant do it for me, three states, one federal. Just too much hassle, but I know so many people who do it themselves. I do go over it line by line with him though.
I do.
I just calculated our effective tax rate and got 34%. We get our taxes done through a firm hired by our practice and they are reportedly very good. Between my wife and I, both physicians, we make slightly higher than mid 6 figures so not sure if that’s what’s causing the skew. I’m contacting our accountant to make sure the #s I’m calculating are correct and if there’s anything we should be doing to improve on that rate, although I doubt they’re going to offer much. We are in NY so that also sucks tax-wise.
That sounds about right given your state and dual high income. Once you cross a certain threshold of income/tax rate the large amount subject to the higher marginal rate really starts to make a large contribution, and at the same time your deductions all but disappear.
If you’re a 1099, you can look into a defined benefit pension plan as thats likely your best option if not already doing so.
Also, while your effective tax rate is 34%, your marginal tax rate might be 50%+, and when you contribute to a retirement plan (such as custom designed 401k, and/or a Cash Balance plan), any income that you contribute comes off of the top, so your immediate tax savings are at your highest marginal tax brackets.
NY. High income. Not surprised you got to 34%. Retirement plans are the key to getting that number down. Between two docs you could potentially defer $200K+ in retirement plans relatively easily.
Right now we are getting about 73K in retirement plans (my practice 401k, both backdoor Roths, and my wife’s individual IRA through her job). Not even close to 200K. I am putting another 70-75K in a year in taxable accounts and hope to double that in a year or so after we are done paying off our student loans. (I’ve slowed on the student loans as they are now 2.75%) How do you get 200K? Anything i’m missing? I am trying to get my practice to transition to high deductible HSA, but that will take a little time if it ever happens. Would love to get my wife’s employer to give her fully funded 401k, but she’s only part-time non-partner so that seems like a long shot, although her employer said she is open to suggestions on the retirement plans they have.
Does your practice have employees? Are there any other partners other than yourself? If you are at least 35 (and have no employees) or you are at least 38 and have employees, you can have a Cash Balance plan on top of your 401k plan. This can probably get you another $50k or so on top of what you can put into your 401k.
As far as your wife’s practice, the same question applies. We’d have to look at the census, ages, desired contribution amounts, and try to figure out whether adding a Cash Balance plan might be worth it.
Basically, a Cash Balance plan is a Defined Benefit plan. Here’s some more information with all of the gory details so that you are aware of what you are dealing with:
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How do you get to $200K? Well, let me tell you what I have, and you can double it since you’re a two doc family. Note that some docs can defer even more than me due to larger contribution limits on their defined benefit plan.
Partnership 401(k)/Profit-sharing plan – $53K
Backdoor Roth IRA- $5,500
HSA- $6,550
Defined Benefit/Cash Balance Plan- $30,000
Individual 401(k)- $53K
Spousal Backdoor Roth IRA- $5,500
I’m at $153,550 ($143,550 deferred) and that doesn’t include 529s, UGMAs, or taxable.
Granted, most employed docs, or most docs with only one job can’t do quite that much. But the potential is there. $73K for two docs is pretty poor IMHO and probably reflects two employed docs who can’t put much more than $18K into their 401(k)s. The job may be worth you having to invest so much in a taxable account, but if not, look around, as many employers/groups offer better plans and certainly there are much better options if you are self-employed.
WCI,
I have a Individual 401(k) with Fidelity for some side work ($30 – $40,000/year). It’s structured as a Sole Proprietorship. My PS contribution is limited to, roughly, 20% of net profits.
Do you make enough through WCI to get to the $53k limit solely through PS or do you do something like Cash Balance on top of that?
Thanks.
I haven’t done a second cash balance plan above my partnership one. I should be able to max out the PS this year at a full $53K.
T,
We’re in the same boat – high tax state. Our effective tax rate is 37% despite maxing 401k/PS, HSA, 529, and a substantial cash balance plan contribution. It is much easier to sock away more tax deferred if you are an owner (vs employee) but after a certain amount, you will run out of tax deferred space anyway.
If you are an owner though and cash flow works, definitely consider a cash balance plan (but it has it’s pros/cons).
I don’t like the word “saving ” for retirement, because it is not really saving, it’s investing, with all ups and downs (and hopefully, not outs) and risks associated with it.
I would use the word “saving” if we are talking only about things like bank IRA’s.
That’s a great point. That’s why you really have to build a portfolio that can survive long term. A good part of it has to be bonds/fixed income, so that overall your return should hopefully beat inflation by a couple of percentage points, yet most of your return will come in the form of your actual savings and keeping most of your principal relatively safe. You can do this without buying insurance products, using plain vanilla money market/CDs/individual bonds/bond funds/stock funds. If your savings rate is high, your return does not have to be (so you can take significantly less risk long term).
My wife (and NP) and I are both salaried employees, so we have limited retirement options. We max out our work retirement plans, back door Roth IRAs, and my HSA.
We have no debt except our mortgage (our extra cash each month is going into an online savings account to save up a downpayment for a larger house). The rate on the current mortgage is only 3.375%, so paying that down faster isn’t the best return.
I make a tiny amount (a couple thousand per year) doing some side consulting for a company so wanted to know — what are thoughts on the best way to leverage that to try to increase retirement savings?
You could do an individual 401(k), but you’re not going to get much bang for your buck there if you’re only making $2K.
Newbie question: We are currently saving slightly over 20% gross by maxing out 401(k)/profit sharing, Backdoor Roth & Spousal Backdoor Roth, and HSA. This does not include what we are putting into the 504 and other sinking funds for home repair/car replacements as needed. We just finished paying off a HELOC and now have some money “left over” each month. Time to decide what to do with it. Which do you think would be the best option?
1. Pay down mortgage (current interest rate of 3.5%)
2. Cash flow medical expenses so that we don’t have to touch what is in the HSA (kids + sports = trouble)
3. Pursue saving in taxable account
4. Some other option I have not considered
Thank you in advance for weighing in.
I’m not sure what a 504 is. 529?
Congratulations! You’re doing great. Time for some more financial planning. If you can’t do it yourself, then hire it out. Financial planning is the process of writing down your goals, then deciding how much you need to put toward your goals to accomplish them, then deciding how to invest money toward those goals.
So I can’t really answer your question without knowing your goals. For instance, if your goal were to have your home paid off in 7 years, there’s a good chance # 1 is the right call. If your goal were to retire early, investing in taxable might be smart. If your goal is to see two new countries every year, perhaps spending the money on trips is what you need to do.
No right answer on the HSA thing, unfortunately. The key is to spend it on health care, the later the better, but if you’re worried your HSA will get “too big” to do that, or that inflation might go up making your receipts less valuable each year, might as well spend some of it on health care now. I’m starting to have that concern with mine. I now have an HSA worth 6 years of “max out of pocket”s. So we’re probably going to start spending from ours this year.
You could put more in the 529s or give more to charity too. Nice to have options isn’t it?
5. Cash Flow
Monthly and yearly passive cash flow from investments.
Cash flow from employment and/or business.
This is an additional vital point to track in my opinion.
Most of us call that “income”. Frankly I’d rather have a lower income from my investments, it just makes them less tax efficient since I don’t need that cash flow right now.
Effective tax rate in Florida for a couple is 18% on 300k and 20% on 400k
Very smart moves the president and 350k residents do every year by moving here
David Tepper is here as well-a billionaire hedge fund guy from NJ
I’m having a hard time finding how much payroll tax I paid. I can easily find FED and STATE tax. Is there a line on 1040 or an online calculator I can use to deterimine what this number is?
Look at your W-2.