When you dedicate years to studying and practicing medicine, you learn that certain steps are required to maintain good health and prevent illness and disease. However, the concept of systematically and proactively cultivating good habits applies to many aspects of life, including your finances. You may be headed for a career in which you expect to earn a high income after residency, but that’s not enough to insure financial health today and in the future. That’s where many residents (and physicians) get stuck. In this post, I describe five steps you can take to achieve strong financial health.
How to Start Thinking About Your Financial Health in Residency
Medical professionals tend to rely on the promise of a high income, but you shouldn’t wait until you're practicing to make financial moves. Don't fall into the trap of thinking that you can’t proactively build financial success until you start receiving the big paycheck. You can start right now, even in residency. In fact, starting now is critical to achieving your long-term goals and financial success. By beginning to think about your budget, savings and investments, and other important financial factors, you can build a foundation of financial knowledge and habits you’ll need for the future.
The Five Action Items on Your Financial Health Checklist
What does building a strong financial foundation with good money habits look like? It’s all about taking the right steps -- and in the right order. If you want to set yourself up for financial success today and in the future, use the following checklist to ensure you make all the right moves:
- Build a budget and savings plan
- Create a loan repayment strategy
- Fund retirement accounts
- Protect yourself with the right insurance
- Consider your financial future
1. Go Back to Basics with a Budget and Savings Plan
It’s tempting to go straight to the complex part of a financial plan and overlook the basics. But, personal finance is all about the fundamentals. If you don’t nail these, you’ll struggle to achieve long-term financial success and find yourself plagued by little mistakes that add up to have a big (and often negative) impact. The basic building blocks towards good financial health in residency include building a budget, sticking to a spending plan, and expecting the unexpected.
Building a Budget
When you build a budget, you need to consider both your expenses and your savings. Expenses should cover both fixed and flexible costs.
Fixed expenses are costs that you don’t have much control over and must pay each month (e.g., rent or mortgage, student loan payments, and insurance premiums). You’ll want to keep these expenses to no more than 50% of your take-home pay (net income).
Flexible expenses are costs that you have more control over (from groceries to daily coffee purchases) and discretionary spending (e.g., entertainment and shopping). Try to keep your flexible spending to no more than 25% of your take-home pay.
If you realize you’re spending too much, focus on your fixed expenses first. Lowering these costs will have a bigger effect on your budget than cutting out the lattes. That said, you can also make simple changes in discretionary purchases to help you save (e.g., choose the $50 per month gym membership over the $150-month option).
The last 25% of your take-home pay should be allocated to retirement investments and savings. Contributions to your 401(k) or 403(b) accounts are made from your gross income and already deducted from your take-home pay. Consider also funding a Roth IRA, and if you qualify, a health savings account (HSA). You can also deposit some of this portion of your paycheck to a savings account earmarked for a big financial goal, such as a down payment for a house, but make sure to build emergency savings first.
Expect the Unexpected
Your budget is always susceptible to a blowout thanks to unexpected expenses. The fix is easy -- plan for emergencies and create an emergency savings account. Putting cash aside in a liquid, easy-to-access account will help you handle any bumps in the road without dipping into long-term savings or forcing you further in debt. I suggest an online high-yield savings account, which typically offers a better interest rate than traditional institutions. Remember that your emergency fund is for actual emergencies only. It’s not a source of bonus cash to use because you overspent and busted your budget.
2. Create a Loan Repayment Strategy
There’s no getting around the fact that as a resident, you probably have student loans -- a lot of loans. It’s best to face them head on and make plans for repaying them now.
First, consider Public Service Loan Forgiveness (PSLF) if you qualify and are interested in pursuing this route. Keep in mind that only federal Direct loans qualify for PSLF. The typical $0 payments in your first year of residency count as part of the 120 qualified payments required for forgiveness. Don’t forget to certify your eligibility every year and don’t procrastinate this step!
As a rule, if you want to earn loan forgiveness through PSLF, the best repayment options are usually the pay-as-you-earn (PAYE or REPAYE) repayment plans. You’ll probably want to avoid the income-based repayment (ICR) plan. Student loan repayment programs for residents can get complicated, and making one wrong move can jeopardize whether you qualify. It’s well worth reaching out to a professional to help you strategize the best way to manage your student loans while in residency.
3. Fund Retirement Accounts (including a Roth IRA)
The sooner you start investing, the easier it will be to reach your financial goals. That’s why you should begin during residency. You lose valuable time if you wait. Thanks to compound interest, time is often an even bigger contributor to financial success than the amount of money you contribute to the accounts. Compound interest can help increase your nest egg exponentially if you give the compounding effect time to work for you.
Start by contributing to your employer’s 401(k) or 403(b). Check whether your employer offers a 457(b) plan, a tax-advantaged account available to government or tax-exempt organizations. The 457(b) plans work similarly to 401(k)s and 403(b)s. If you have access to both types of accounts, you can contribute the maximum to each -- that’s $18,500 in each account for 2018. Then, take the next step and max out your contributions to a Roth IRA -- the current limit for individuals younger than 50 is $5500 per year.
When it comes to choosing a specific investment, start with index funds. Index funds are designed to track specific segments of the market (e.g., the Dow Jones Industrial Average or S&P 500 Index) or the entire market. Index funds are a good starting place for residents because they tend to be well-diversified and undergo low turnover, helping to lower the expense ratios of the fund (especially when compared to other funds). Also, index investing is a form of passive investing, a strategy that research shows is the most prudent for long-term investors wanting to create and grow wealth.
4. Protect Yourself with the Right Insurance
Insurance can help protect your family, your possessions, and your assets. Life insurance helps protect your dependents (or anyone who depends on your income) if something happens to you. If you don’t have dependents, you likely still need some form of life insurance so that your family will have funds to repay your student loan debt. When looking for life insurance, seek out term insurance. These affordable policies offer protection for a specific period. If you die during this time, the insurance company will pay your beneficiaries the face value of the insurance policy.
Except in very rare circumstances, you’ll want to avoid whole-life, variable, or universal life insurance. Physicians are often targeted by insurance agents, so be careful and consider working with an objective third party to help vet a policy before you buy it.
The most important point to remember about any type of insurance is that it’s insurance. It is protection for a specific purpose. It is not an investment, although some insurance salespeople may try to convince you that it is. You are not “investing” when you purchase insurance. Investing is a process by which you can increase your assets. Insurance is a product that helps you protect those assets (including future earnings). That’s why you may also want to purchase disability insurance.
5. Consider Your Financial Future After Residency
Taking these steps will put you on a path to financial health, both during residency and beyond. The “beyond” years also warrant some consideration. In addition to taking these steps to get your finances on the right track today, consider what you want your financial future to look like and what it will take to get you there.
One smart option to consider is to work with a fee-only financial planner who can serve as your fiduciary. Fee-only planners receive fees directly from their clients, not from commissions or kickbacks. Your financial situation will only get more complex, and you have the potential to build a lot of wealth as a physician. Don’t squander the opportunity, let things fall through the cracks trying to manage everything yourself, or trust the wrong professionals. Unfortunately, the financial advice industry knows that physicians come out of training with low financial literacy and little time to devote to improving it, making you prime targets for salespeople who call themselves advisors and try to sell you insurance you don’t need.
A proper financial advisor will discuss your goals, budget, and student loan repayment, want to provide comprehensive advice for your specific situation, and will not sell you products. Understanding the benefits of a financial planner early in your career can save you untold thousands of dollars in expensive mistakes. However, it’s not necessary to hire a financial advisor or planner while in residency. It makes the most sense to find a fee-only advisor who specializes in physician finances to work as your fiduciary during your final months of training or just after completing your residency program. That transition time is critical to your financial success and having an independent third party who can assist you can make a world of difference.