Let’s look at the Monte Carlo analysis and what it has in common with your financial plan.
Introduction
The life of a physician is a busy one. You spend twelve-plus hours running back and forth between multiple patients. You add notes to their charts, order diagnostic tests, and request consultations. No wonder you hardly have any time for yourself, especially when it comes to your finances.
Physicians certainly face a set of unique financial challenges that are becoming more pronounced. Declining reimbursements, taxes, rising liability costs, technology needs, and the list goes on. All are creating significant headwinds on your ability to reach financial independence. Addressing your wealth management needs is more important now than ever.
The Wisest Investment Decision (and How You Can Make It)
As a physician, you’re making life-or-death decisions every day. You know the best way to make decisions under pressure is a combination of relying on your clinical experience and consulting the latest research available. That’s the nature of evidence-based medicine: You combine both experience and research.
Evidence-based investing is no different.
To invest well, you need to focus on your needs as well as leverage the research that’s out there.
One Mistake to Make Sure You Avoid
If you’re going to invest, you need a strategy. You likely won’t succeed as an investor if you trade based on emotion, especially ones like fear or greed. Nor will you be likely to succeed if you trade based on the advice of friends and family. As a result, you should never make decisions based on emotions or speculation.
Perhaps the worst starting point is to try to outperform the market. The problem with outperforming the market is that it is impossible to predict the market. By the time you learn of new information, it’s already been factored into the market price.
And, historically, when a sector of the market performs well, a lot more people want to invest in it. This influx of investor capital may result in the sector generating lower returns in the future.
This is why the majority of top-100 fund managers aren’t able to maintain a top-100 ranking year after year. In fact, only about 14 percent of top- 100 fund managers stay in the list from one year to the next. Less than a handful make it beyond two consecutive years1.
Often, market-timing and security-selection strategies generate returns that are lower than what the market itself produces. That’s a lot of time, energy and higher costs that ultimately results in lost opportunity, not expanded wealth. Instead of trying to beat the market like it’s your adversary, try treating the market as your ally.
If you aren’t making decisions based on emotions or speculation, then to what end are you making decisions?
A Question You Need to Ask Yourself
To what end are you investing? If you are investing toward retirement, you should envision the ideal retirement. How much money will that require? Once you’ve come up with a number, you have a concrete figure toward which you can begin to save.
With that number in mind, you can also determine the kind of investment strategy that will work best for you. Risk and reward are related. Having a plan in place keeps you from taking on more risk than necessary.
The questions you ask should always be true to your life. It’s impossible to know what trends will emerge in the market six months from now. But you can know how much you would like to save in the next three years. Investing outside the context of an actual plan will lead you down paths of frustration and undue risk. Stay focused on what you need.
How You Can Have the Market Work for You
You want to construct a portfolio that will deliver the highest expected long-term returns for a particular level of risk. You want to construct a portfolio that will deliver these returns at the lowest possible cost.
The trick to accomplishing this is research.
Research in capital markets has advanced tremendously in the last 50 years2. Objective and high-quality academic research is available to inform investor decisions about which investment approaches are likely to succeed and which are more likely to fail. A high probability resides in remaining globally diversified, avoiding market timing or security selection, and keeping costs low.
Don’t Just Sit Back Idly
Just because you’ve invested doesn’t mean you should sit back idly.
While it isn’t necessarily advisable to check your assets daily — a constant review of your assets can lead to too many trades and thus compromise your long-term approach — it is a good idea to regularly review your overall allocation.
Your investments should be long-term. Expect that during this time your needs will change. Your allocation should be modified to address those circumstances, not what you think the market is doing and/ or going to do next.
Make sure you have an advisor who will dialogue about an approach customized to your situation and in line with your goals.
Investing is Just the Beginning
You know how important evidence-based medicine is: You optimize your decisions by relying on clinical experience and academic research. Likewise, if you’re looking to participate in the market, evidence-based investing is backed by academic research, not emotion or speculation.
But investing is just where you begin. You’re building a portfolio to reflect your life, not whatever is going on in the market. For that reason, there are other financial fundamentals you need to consider.
Four Tips Toward a Proper Understand of Finances
Here’s a key to success: Maximize cash flow while paying less in taxes. A shortage in cash flow can send you into survival mode, and improper understanding of tax deductions can cause you to miss out on opportunities for a break.
Here are four tips to keep in mind as you further your success:
1. Eliminate Present Burdens on Your Cash Flow (and Future Drains)
As cash flow comes in, make an outline for how these dollars will be allocated. As revenue/income grows, this outline will keep you focused and will help you avoid being frivolous.
If you’re looking for one specific area where you should allocate as much money as possible, it’s toward your debt.
Debt is not foreign to any medical school graduate student, but making debt reduction your priority will greatly enhance your cash flow, long-term.
Remember, compounding interest on your debt adds more zeros to the end of what may be an already-long number.
Start with your smallest debt and/or one with the highest interest rate. Accelerate payments to that encumbrance. Once that encumbrance is eliminated, add its recurring payment to the one you’ve been making on your next biggest and/or highest-interest loan.
By accelerating payments and applying recurring payments onto new debts, you will experience a snowball effect that will make dramatic improvements to your overall financial standing.
2. Put Aside Money Toward Your Future
Whether you choose a traditional IRA, a Roth IRA, 401(k), or a cash balance plan, you should begin putting aside a portion of your income toward retirement. You should choose an amount that works for you, proportionate to your cash flow. Qualified retirement savings not only accelerate savings but can lessen your overall tax burden. Do your best to maximize savings into a qualified retirement plan on an annual basis.
3. Save Money on Taxes
You should learn what opportunities are available to you as they pertain to taxes, so that you can save the most money you possibly can on taxes.
For example, you can write off expenses that are considered ordinary and necessary for you to perform your job. According to the Internal Revenue Service (IRS), expenditures that are common or accepted by the industry are tax-deductible3
Make sure to keep documentation for anything you might submit to the IRS as tax-deductible. This could be for expensive medical equipment; it could even be for the couches in the waiting room outside your office, or for mobile phones for you and your staff.
Whatever you plan to write off — whether scrubs, in-office computers, malpractice insurance — make sure you have documentation for it.
4. Research What is Tax-deductible
Make sure you understand the difference between what is tax-deductible and what is not. For example, you deduct the miles you put on your car that are attributable to business. In 2015, the business-purpose reimbursement rate was 57.5 cents per mile4. However, commuting to and from work is not considered business use and is not tax-deductible.
Being a physician requires dedication to patients and extensive clinical knowledge. To manage your practice effectively, you need to have good financial skills. By paying off debt, accelerating savings, and writing off tax-deductible expenses, you can increase your probability of success.
Once you’ve achieved this success, you need to learn how to protect it.
Ensure You’re Insured: How Protected is Your Wealth?
It takes courage to be a physician. Not only are you making life-or-death decisions for some of your patients, you run the risk of a lawsuit if the patient or the patient’s family isn’t satisfied with your treatment.
That’s why you have to take the appropriate measures to protect your wealth. Here are a couple of questions you should ask:
Are My Retirement Savings Safe from a Lawsuit?
Your first step should be to protect yourself. It is crucial that you have retirement savings in place that cannot fall victim to a lawsuit.
Many investors have individual retirement accounts (IRAs). While these are easy to establish and invest in, they have two weaknesses: They have a low allowed threshold of annual savings, and the tax-deductibility of contributions phase out after a certain level of income.
The reason an IRA account might not be protected is because it is not qualified under the Employee Retirement Income Security Act (ERISA). ERISA applies to employer-sponsored plans like 401(k)s and 403(b)s. These plans are federally protected and cannot be “assigned or alienated”5. They are certainly not as easy to set up nor to maintain as IRAs. You should work with a personal financial advisor to establish a quality investment vehicle (plan type) and limited investment options.
Do I Have the Appropriate Amount of Coverage?
Once you’ve established a protected retirement savings account, you need to make sure you have an appropriate amount of insurance.
Nobody likes to ask these questions, but it is important to consider how protected your family would be in the event that you passed away.
Additionally, as a physician, your job requires you to use your five senses. If you were to lose one of those senses — say, your eyesight — chances are that you might not be able to perform your job effectively. If you are the sole provider for your family, this could be devastating, if you don’t have enough savings or insurance to cover the cost of your ailment and replace your income.
The odds of becoming disabled are actually surprisingly high. According to the Social Security Administration, one out of every four 20-year-olds will become disabled before they retire6.
As a result, you should evaluate purchasing life insurance and disability insurance.
The Two Primary Types of Insurance to Consider (and How They Work)
Life Insurance
There are basically two types of life insurance: term life insurance — which would pay a benefit in the event you passed during a specified period of time — and whole life insurance — which can accumulate a cash value that can be accessed if need be. Whole life is permanent insurance and will remain in place so long as premiums are paid.
Term insurance costs much less for coverage and protection than whole life insurance. Be sure to work with a trusted advisor to determine what’s best in your situation. You don’t, after all, want to make a choice based solely on what will put the biggest commission in an agent’s pocket!
Disability insurance
It is expensive, but the right amount can protect you from worst-case scenarios. By purchasing a long-term disability income insurance policy, you can receive cash payments to meet expenses ranging from groceries to debt. Even if this benefit is provided through your group or employer, it oftentimes makes sense to get an individual policy in addition.
It’s important to protect your wealth. You can be proactive by protecting your retirement savings, by purchasing adequate life insurance and by purchasing long-term disability income insurance. A financial advisor can make you aware of the options available to you, as well as help set up a good financial plan for the future.
A Plan for Your Estate: Steps Every Physician Should Take
You’re probably familiar with this life: As soon as you begin your 12-hour shift, you’re shuttling from one patient to the next, hoping for enough of a lull to snatch a fast-food bite or maybe a couple hours of sleep.
Balancing work with your personal life is one of the most difficult tasks for physicians. As a result of long hours and little free time, physicians are notorious for procrastinating on important financial decisions. The most detrimental of the postponements is, perhaps, estate planning.
Without a proper plan in place, you could leave your loved ones scrambling to take care of you, incurring exorbitant legal fees court costs. This often requires an outrageous amount of time at exactly the moment they are most vulnerable. Without a proper plan, your family might face a legal battle to control your assets or to control unnecessary legal costs.
You need to plan for your estate.
The “Big Three” (and Why You Need to Take Care of Them First)
The purpose of estate planning, for most, is two-fold: to designate a person who will act on your behalf if you are incapacitated, and to leave the maximum amount of your assets to your family and/or charity tax-free.
Even if you are young and don’t have many assets, you should consider the three essential documents that go into estate planning: a will and/or trust, a power of attorney, and a health care proxy.
A will lays out how you want your assets distributed. This could create a trust containing assets that become available to your children when they reach a certain age. By having a will, you choose how your assets are passed on to your family. Otherwise, a state-specific formula is applied.
A Power of Attorney is a document identifying somebody who will handle your finances if you are incapable of doing so. If you don’t designate a power of attorney, chances are your spouse or one of your children will have to go to court to be named as a guardian or conservator for you — an expensive and time-consuming process.
Once you’ve designated a power of attorney, you should communicate with them on all the different places your assets are held — from savings and checking accounts to investment accounts and real estate.
A health care proxy is a document that identifies somebody who will make life-or-death health decisions if you are incapacitated. Ironically, physicians — people who make a living treating illnesses — are notorious for not appointing somebody to make these kinds of decisions for them. This is a mistake. If you don’t execute a health care proxy, you could be putting your life in the hands of lawyers and courts.
Once you have these three out of the way, it’s time to figure out how to leave the maximum amount of your assets to your family and/or charity tax-free.
Figuring Out a Method for Distributing Your Money
Usually, when you distribute money to heirs, it’s in the form of a gift. Depending on your total assets, there are several avenues to consider.
Each individual can make tax-free transfers of up to $5.43 million at death in 2015. This procedure goes by several different names: the basic exclusion, the unified credit, the estate tax exemption. The names may be different, but they are one and the same.
You want to keep two things in mind with this procedure: If you don’t use this transfer when you pass away, it is either transferred to a surviving spouse or lost forever. If you go over your $5.43 million limit, your heirs may be taxed at 40 percent.
If your estate is worth more than $5.43 million, you can always leave unlimited assets tax-free to your spouse, so long as your spouse is a United States citizen. However; this spousal transfer only defers taxes. Your surviving family may still face a tax liability at his or her death.
As a married couple, you can always create a trust that utilizes your exclusions, so you can pass on an estate to your children estate-tax free. This trust also goes by many names: credit shelter trust, A/B trust, bypass trust.
Depending on your retirement goals and the value of your assets, you can also consider transferring assets during your lifetime. Individuals can gift up to $14,000 (2015 allowance)7 a year to an unlimited number of beneficiaries without gift tax implications.
Five Considerations That Can Make the Ideal Retirement a Reality
You’ve used evidenced-based investing for your assets, you’ve maximized cash flow and minimized taxes, you’ve taken steps to protect the wealth you’ve accumulated, and you’ve put together a plan for your estate that includes a will, a power of attorney and a health care proxy. If you’ve planned well by doing all this, retirement should be a chance for you to sit back and relax.
Here are five final considerations in planning for the ideal retirement:
1. Figure Out the Cost of Retirement, Starting From the Right Perspective
Retirement is a long-distance haul, and it requires strategy. Planning for a long period of time can be daunting, but the best place to begin is by considering your individual needs.
Begin by asking these questions: What do I want out of retirement? What are the passions or hobbies I would like to pursue? How much will that cost?
Once you have a figure, compare this to the anticipated size of your portfolio and other income sources. Understanding your withdrawal needs, making allowance for future inflation and market volatility, and employing a tax-efficient distribution strategy are all critical.
You also need to understand how your retirement savings will be taxed: With a 401(k) and IRA, you can potentially deduct your yearly contributions from state and federal taxes, but future withdrawals are taxed at ordinary income tax rates. A Roth IRA doesn’t allow you a current tax break on contributions, but your withdrawals and earnings are generally tax-free.
If the amount you’ll need is greater than the amount you expect to have accumulated when you retire, you don’t necessarily have to cut back: You will, however, have to save to make up the difference.
2. Decide When You Want to Claim Your Social Security Benefits
When it comes to Social Security benefits, it’s smart to wait.
The earliest you can claim Social Security benefits is at age 62, but the amount will be reduced because you’ve filed a claim before your Social Security “full retirement age.” On the other hand, if you wait until you’re 70, you could raise your benefit check by as much as 76 percent8. Waiting to claim your benefits certainly helps alleviate the risk of running out of money in retirement.
3. Know How Your Distribution Strategy Will Affect You (And the Role Inflation Will Play)
As you prepare to withdraw from your assets, you should keep a few things in mind: Typically, withdraw first from assets that are taxed the least — cash — followed by fixed income and tax-deferred accounts. Studies have shown that a sustainable annual withdrawal rate is somewhere in the range of four percent of your retirement portfolio9.
However, inflation plays a major role in the purchasing power of your dollars. Depending on where you concentrate your purchases, that power may erode at varying speeds. Because of market fluctuations, it is imperative that you are flexible with your spending. You need to work closely with your advisor and accountant to best manage your distributions.
4. Consider the Cost of Your Health
A study10 recently projected lifetime health care expenses for a 65-year-old couple at $275,035 for men and $294,975 for women.
And this projection was just an average. It didn’t account for an emergency, which could mean you and your partner would have to save more than $600,000 in lifetime health care expenses alone.
At 65, you’ll likely be using Medicare for health insurance, so it’s important, as you plan for retirement, that you determine how much Medicare will actually help you11. There is no monthly premium for Part A of Medicare (which covers hospital visits and hospice care) for anyone 65 years or older if they are a U.S. citizen or if they’ve been a legal resident for five years. However, costs for Part B of Medicare (which covers doctors and tests) are based on a sliding scale according to income.
5. Have a Plan That You Can Stick to No Matter How Unpredictable Life Gets
As a physician, you know firsthand that life is unpredictable. Chances are, you will have to adjust your plans at some point down the line.
But when you start from the right place, you should be able to end where you want.
If you develop a plan that anticipates what you’d like out of retirement, and if you stick to those goals, you should be able to achieve your retirement dreams.
When it comes to retirement, the most important thing to keep in mind is to plan. Retirement can be daunting, but if you have a well-thought-out strategy and stick with it — a plan that factors in when you want to claim Social Security, how you want to adjust for inflation, and how you expect to cover health care costs — peace of mind is possible.
Conclusion
Financial planning should always begin with your life. When you invest, your portfolio should reflect your life, not whatever is going on in the market. Your finances should consider the big picture and weigh long-term impacts.
At Foster Group, our team has developed a culture of evidence-based investing. We specialize in holistic financial planning and can help you in paying off debt, accelerating savings, and writing off tax-deductible expenses. Not only can we increase your probability of success, we can help you protect your wealth and ensure you have an appropriate amount of insurance coverage. We will have your best interests in mind during the implementation and monitoring of your estate and retirement plans.
If you have any questions, contact an advisor at Foster Group.
1 https://www.savantcapital.com/Portals/0/Docs/Savant-Evidence%20Based%20Investing.pdf
2 https://www.suerf.org/doc/doc_3c59dc048e8850243be8079a5c74d079_1623_suerf.pdf
3 https://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Deducting-Business-Expenses
4 http://www.irs.gov/uac/Newsroom/New-Standard-Mileage-Rates-Now-Available%3B-Business-Rate-to-Rise-in-2015
5 http://www.dol.gov/ebsa/regs/aos/ao2001-06a.html
6 http://www.limra.com/uploadedFiles/limra.com/LIMRA_Root/Posts/PR/_Media/PDFs/2015%20DIAM%20FINAL.pdf
7 http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Frequently-Asked-Questions-on-Gift-Taxes
8 http://www.cnbc.com/2015/09/23/when-you-should-file-for-social-security-benefits.html
9 http://www.investopedia.com/terms/f/four-percent-rule.asp
10 https://www.hvsfinancial.com/PublicFiles/Data_Release.pdf
11 https://www.medicare.gov/what-medicare-covers/
