Five common financial mistakes physicians often make
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Last year, we wrote about the five top financial mistakes Dr. Bhatia has seen in fellow physicians, especially at the beginning of their careers. We covered this for our Forward Thinking column in Orthopedics Today, a Healio publication.
We thought this content was important and timely enough to bring to all Healio readers in 2021. We hope you find it valuable.
Taxes affect take-home pay
Understanding your true after-tax take-home pay as it pertains to your locality is fundamental to the all-important step of budgeting one’s finances. When coming out of residency, many physicians falsely believe that since their income is increasing by 5 to 10 times what it was when they were a resident or fellow, they can increase their spending habits by the same ratio. This ignores the impact of our progressive tax system where increased income levels are subject to higher tax rates. For many physicians in high-tax states, their marginal tax rate (the highest rate they will pay on their last dollars earned for the year) may approach 50%.
Overspending due to lifestyle creep
Lifestyle creep refers to the phenomenon where discretionary consumption increases on non-essential items as the standard of living improves. Nowhere is this more apparent than the short interval of time when a young physician jumps from residency or fellowship into the attending life. It also can certainly impact physicians at all stages of their careers, however.
There is a natural tendency to suddenly spend more than necessary on things, such as lavish cars and houses, high-end dining and luxury travel. With lifestyle creep, it is common for discretionary spending habits to be unconsciously linked to the spending habits of peers. In some cases, luxury items once perceived as a choice become viewed as a right or necessity.
Although spending hard-earned dollars on life’s finer things is truly a right, it is best to do so within your means to safeguard your financial future and harness the magical power of compound interest with investing. Once you know your after-tax monthly cash flow, a budget can be developed easily to keep on track.
As a general rule of thumb, fixed expenses should not make up more than 50% of your monthly cash flow. By the same token, variable expenses should not top 25% of the monthly cash flow. The goal each month should be to save 25% or more of after-tax take-home pay to adequately achieve financial goals and prepare for unexpected events.
Not investing take-home pay
Albert Einstein once said “Compound interest is the eighth wonder of the world. He who understands it, earns it and those that don’t, pay it.” Despite having familiarity about the power of compounding from medical school microbiology and student loan debt, it is amazing that many physicians fail to utilize this incredible force for supercharging their own wealth. Most physicians simply do not understand that the wealth generated by prudent, regular contributions to diversified and risk-optimized investment vehicles compounding over time will always dwarf even the most miserly of saving habits.
Quite often, the lack of investing mistake is not made by physicians because they fail to understand the power of compounding, but because they simply do not have funds to invest. This leads us back to mistake #2, which can often be the root of the problem.
False belief income will remain high forever
It is not uncommon for many physicians to falsely believe they will earn tens of thousands of dollars every month for the rest of their lives. For better or for worse, the COVID-19 pandemic and its associated economic downturn gave many physicians their first taste of a drastic drop in income. It is a scary but real possibility for any physician. Although many occupationally disruptive events, such as disability claims, can be insured against, many financially disruptive events, such as COVID-19, medical staff complaints or medical board suspensions, are not insurable and can occur unexpectedly with harsh outcomes.
Need to save for retirement, college
Anyone who has lost a job or been without income for several months knows how fast a checking account gets depleted when credit card bills, mortgages and living expenses continue to mount. This drawdown of wealth only accelerates as one enters retirement due to the permanent lack of occupational income, especially if passive income streams are unavailable.
Many physicians do not realize that to retire comfortably and successfully in their 60s, a multimillion-dollar nest egg is required to sustain their same lifestyle and spending habits well into their retirement years. It is shocking then to see that 25% of all physicians between the 60 and 64 years old have a net worth of less than $1 million, despite being on the cusp of retirement. These physicians may face the unfortunate reality of not having the ability to retire comfortably despite having had an upper echelon income for several decades.
Conclusion
Without careful budgeting and understanding of actual monthly cash flow, a physician’s high income can easily be mismanaged. Understanding spending habits, living within means and investing wisely will help you achieve financial independence comfortably and consistently.
References:
Medscape Physician Wealth and Debt Report 2019. https://www.medscape.com/slideshow/2019-compensation-wealth-debt-6011524
Wealth Planning for the Modern Physician: Residency to Retirement is available free in print or by ebook download by texting HEALIO to 844-418-1212 or at www.ojmbookstore.com. Enter code HEALIO at checkout.
For more information:
Sanjeev Bhatia, MD, is an orthopedic sports medicine surgeon at Northwestern Medicine in Warrenville, Illinois. He can be reached at email: sanjeevbhatia1@gmail.com.
David B. Mandell, JD, MBA, is an attorney and founder of the wealth management firm, OJM Group, www.ojmgroup.com. He can be reached at mandell@ojmgroup.com or (877) 656-4362. You should seek professional tax and legal advice before implementing any strategy discussed herein.
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