Q. In medicine, it is best to learn from the mistakes of others, as evidenced by morbidity and mortality conferences. What are the big mistakes doctors make when it comes to their finances?
A. Physicians earn relatively high incomes, but that doesn’t make them immune to financial missteps. Avoid these 10 errors:
1. Financial Illiteracy
The biggest mistake doctors make is simply not paying sufficient attention to their finances. In our 401(k) world, we each have a second job as a pension fund manager, whether we like it or not and whether we’ve been trained to do it or not. You (together with your partner) are your family’s chief financial officer(s). Your family is like a business, with various sources of income and various expenditures. If you manage it well, it will be profitable and will support you long after you’ve stopped working. If you do a poor job, you will reap the consequences. The cavalry isn’t coming. It’s up to you.
2. Growing Into Income Too Quickly
This is a real problem for emergency physicians, who generally hit their maximum lifetime income shortly out of residency. If their spending grows just as quickly as their income, they have missed out on the very best way to build wealth as a doctor—that is, living like a resident for the first two to five years out of residency and using the difference between attending and resident incomes, and the accompanying lifestyle, to pay off student loans, save for a down payment on a dream house, and catch up to their college roommates with their retirement savings.
3. Not Saving Enough
Even after the “live like a resident” period, a typical physician should save approximately 20 percent of their gross income for retirement. No amount of fancy investing can make up for inadequately funding the portfolio. An adequately funded portfolio, on the other hand, can make up for a plethora of investing mistakes.
4. Inadequate Insurance
Physicians should insure well against financial catastrophes, such as professional and personal liability, illness, injury, disability, death, and loss of expensive property. Too many physicians with family members relying on them financially carry inadequate term life and disability insurance. Too many doctors only carry the state-required minimums on their auto liability policies. Bad things happen regularly, and they can happen to you.
5. Mistaking Whole Life Insurance for an Investment
Nearly every physician will have whole life insurance pitched to them at some point in their career. All too often, the physician falls for it. Although there are some niche uses for this insurance product, it was inappropriately sold to the vast majority of physicians who have purchased it. The ongoing high premiums prevent these doctors from utilizing better investments, paying off their student loans, and sometimes even carrying an adequate amount of term life insurance! Treat the purchase of whole life insurance like you would evaluate a potential spouse. It’s either until death do you part, or it’s going to cost a lot of money to get out.
6. Choosing the Wrong Adviser
Most physicians want and need at least some assistance from a high-quality financial adviser. However, the key is to get good advice at a fair price. Good advice comes from a competent fiduciary, fee-only adviser who understands the unique financial situations physicians find themselves in. A fair price is a four-figure amount per year. If you are paying more than that, know that high-quality advice is available for less than you are paying. Keep looking until you find it, even if your current adviser is a good friend or family member.
Remember that business school professors refer to bad investments as “deals that can only be sold to doctors.”
7. Not Understanding Their Retirement Accounts
It is critical you become an expert in the retirement accounts available to you. If you are an employee or in a partnership, actually read the 401(k) plan document the employer is required to provide you if asked. Know how the plan works, whether there is an employer match, what the investment options are, and what fees you can expect to pay. Your employer may provide other retirement accounts such as a 403(b), 457(b), or defined benefit/cash balance plan. Also become familiar with a personal and spousal backdoor Roth IRA and a health savings account. Independent contractors and those who moonlight should use an individual 401(k) instead of a SEP-IRA and can even consider using a personal defined benefit/cash balance plan. These retirement accounts lower your taxes, boost investing returns, facilitate estate planning, and, in most states, protect your assets from creditors.
8. Buying Individual Stocks
Investing in individual stocks is an example of uncompensated risk. Any risk that can be eliminated through diversification is by definition uncompensated. Mutual funds provide diversification (plus liquidity and professional management) and therefore less risk than individual stocks. Physicians are very unlikely to select stocks well enough to beat the market averages in the long run and are generally best served by using low-cost, broadly diversified mutual funds.
9. Using Actively Managed Mutual Funds
The literature is quite clear that, over the long run, a low-cost, passively managed (index) mutual fund will outperform 80–90 percent or more of its actively managed peers. Trying to beat the market is a loser’s game; you actually win by not playing. Each year, some mutual fund managers will beat the market, but you are just as unlikely to succeed at choosing those managers a priori as they are to repeat their past performance.
10. Getting Burned by Exotic Investments
Physicians, as accredited investors by virtue of their high income, can invest in many investments not available to the general public. Each investment must be evaluated carefully on its own merits. A physician need not stray from boring old stock and bond index mutual funds to succeed financially, but should you do so, the principles of cautious due diligence and diversification still apply. If it sounds too good to be true, it probably is. Remember that business school professors refer to bad investments as “deals that can only be sold to doctors.”