• Revenue Cycle Management
  • COVID-19
  • Reimbursement
  • Diabetes Awareness Month
  • Risk Management
  • Patient Retention
  • Staffing
  • Medical Economics® 100th Anniversary
  • Coding and documentation
  • Business of Endocrinology
  • Telehealth
  • Physicians Financial News
  • Cybersecurity
  • Cardiovascular Clinical Consult
  • Locum Tenens, brought to you by LocumLife®
  • Weight Management
  • Business of Women's Health
  • Practice Efficiency
  • Finance and Wealth
  • EHRs
  • Remote Patient Monitoring
  • Sponsored Webinars
  • Medical Technology
  • Billing and collections
  • Acute Pain Management
  • Exclusive Content
  • Value-based Care
  • Business of Pediatrics
  • Concierge Medicine 2.0 by Castle Connolly Private Health Partners
  • Practice Growth
  • Concierge Medicine
  • Business of Cardiology
  • Implementing the Topcon Ocular Telehealth Platform
  • Malpractice
  • Influenza
  • Sexual Health
  • Chronic Conditions
  • Technology
  • Legal and Policy
  • Money
  • Opinion
  • Vaccines
  • Practice Management
  • Patient Relations
  • Careers

Financial Makeover: Finally earning "real money"—now what?

Article

This young pediatrician has a new house and a few bucks in the bank. But she and her husband have substantial debts and almost no retirement savings. Here's the fiscal blueprint our financial expert came up with.

Pediatrician Christine P. White of Austin, TX, faces a typical young-doctor predicament: For the first time in her life she's earning "real" money, and she's at a loss about how to handle it. "I have an IRA, but it just sits there," White says. "I've read a book and multiple articles about investing, but it's hard to know where to start."

White, 30, is one of two associates in a three-doctor pediatrics group. She began practicing last August and now earns $96,000. The money in her IRA totals about $21,000 and was rolled over from a residency 401(k). Most of it is in a money-market fund. "There's no pension or retirement plan at work, so I want to know how to invest it better and build for the future," she says.

The doctor's 31-year-old husband, David, earns $22,000 as a salesman in a bicycle shop. His salary will rise to $30,000 shortly, when he takes over as manager. David has $8,000 in retirement savings, divided between an IRA and a 401(k) from a previous position. The money is invested mostly in Janus Mercury Fund, Guardian Park Avenue Fund, and Compaq Computer stock.

Besides carrying a $148,000 mortgage, the couple still owes White's parents $20,000 from her medical school days. They haven't started reducing that balance yet; first, they're repaying the $15,000 White's mother lent her for the house down payment. They're giving her $1,000 a month and will clear up the debt in a year. White also recently wiped out an $8,000 credit card debt.

After mortgage and loan payments, their largest regular monthly expense is $420 for a leased Mitsubishi Montero Sport. They also own a 1994 Saturn SL1. When the Mitsubishi lease ends in July, they'll replace it with a purchased car.

This couple is hardly extravagant. They spend about $400 a month on leisure activities, which include eating out about three nights a week. They favor inexpensive restaurants: The check at a Mexican restaurant or sandwich shop usually comes to about $15 for both of them. On a special occasion, dinner might total roughly $40.

Infrequent splurges include cycling equipment for David and books for Christine. They go to movies or plays and "hang out with friends," Christine says. For vacations, they mostly visit her family in Kansas, and friends elsewhere. Those travel costs typically run about $2,500 a year. This year, though, a more costly short-term expenditure will be a trip to Greece, slated for September.

Long-term, they want to build a retirement fund and save for college for two or three kids. The Whites hope to start a family this year.

Christine and David wanted advice on how to tackle those goals. "I need to know what to do with money left over each month, and how to become a better investor," Christine says.

To that end, we introduced the Whites to Janet I. Briaud, a financial planner in Bryan, TX, and her then-associate Brian T. Hervey. We asked the planners to analyze the Whites' situation and devise a strategy to help them meet their goals.

What the planners told the Whites

"First, we commend you for getting out of credit card debt and for immediately looking toward your retirement and other goals. You're in the best possible position right now, with a good income and relatively low expenses."

Initial steps. "Together you take home about $7,800 a month, after taxes. After living expenses and debt payment, you have $3,700 to save and invest.

"Start by building an emergency fund equal to at least three months' living expenses, about $12,000. Put 15 percent of your monthly pre-tax income—about $1,500—into a money-market fund such as Vanguard Prime (800-662-7447). Until recently, you've been spending that much to pay down the credit card debt, so this should be relatively easy. You can make it even easier by having the money automatically deducted from your checking account each month. Once you've established your emergency fund, you're ready to begin investing for retirement. More about that later.

"Next, let's look at your short-term goals. The trip to Greece will cost about $4,000. Obviously, that will eat up a lot of your extra cash for a few months. You also want to buy a car and are considering a late-model used one. You can probably afford a new one, if you wish. To test how your budget will stand a car payment that's higher than the $420 you're spending on the lease, set aside an amount each month that's equal to what you'd like to spend on the car.

"Save for short-term goals in one or more separate accounts. Which type depends on how far off your goals are. Money for expenses within the coming year, such as the fall vacation, for example, should be in a money-market fund. Save for expenses coming up in two to five years—home renovations, for instance—in short-term securities such as a short-term bond fund. One of our favorites is Vanguard Short-Term Corporate Bond Fund (800-662-7447). It's low-cost and had a 10.6 percent return over the past 12 months.* This fund has a $3,000 minimum initial investment, which you'll need to accumulate in a money-market fund first."

Kids and college. "Since you're starting to plan for children, we recommend beginning a separate account for a college fund. You plan to send them to public schools and colleges. A state college in Texas will cost about $31,800 per year 20 years from now. We suggest that as each child is born, you begin to save $2,760 per year for that child, so you'll put away enough to cover college costs for four years. Instead of using a custodial account, we recommend that you keep the investment in your name. This allows you greater flexibility and control over the savings. Opt for a tax-efficient fund with few or no taxable distributions. Stock index funds are ideal for this.

"Another way to build up a college fund is through a 529 plan sponsored by a state. Your state's plan, the Texas Tomorrow Fund, is a prepaid tuition program that locks in today's tuition rate. You invest a certain amount monthly; it earns a return equal to the inflation rate for college costs—now about 5 percent. When your child starts college, the state transfers the funds to the school each semester. However, we prefer the college savings plans available in other states. The Learning Quest program in Kansas, for example, is available to residents of any state, and your child can use the funds at any college in the US. Currently, you may contribute up to $127,000 per child. The money is invested in American Century funds and grows tax-deferred. The earnings portion of the withdrawals is taxed at the student's rate.

"If you don't opt for such a plan, we recommend investing in an education IRA, to supplement your other college savings. Start when each child is born. Although you may save only $500 per year this way for each child (rising to $2,000 in 2002), the investment builds tax-free and the distributions aren't taxed when used for qualified education expenses. If your $500 annual contributions earn 8 percent annually over 18 years, they'll grow to more than $19,000. Although that's not nearly enough to cover the expense you'll face, we still think the education IRA is a good investment because of the tax-free gains."

Mortgage management. "Since you bought your home last July, interest rates have fallen. You're paying 8.6 percent on a 30-year loan. If you refinance at a lower rate—say, 6.25 percent for 30 years—you'll reduce your current monthly payment of $1,423 by about $200. You'd recoup the estimated $3,000 closing cost in less than three years, and you could divert the monthly savings to your retirement or college fund.

Another option is to switch to a 15-year loan. If you were to get one at 6.75 percent, you'd pay about $160 extra a month, as well as closing costs. But by the time the loan is paid, your oldest child would be just a few years away from college. You could then divert the mortgage money to the college fund or to short-term savings, to cover additional expenses when the kids are in school.

"Because you're young, paying off the mortgage early may not be a big goal. But you can afford the higher payments now, so it's worth giving the idea some thought."

The very distant golden years. "Once your emergency fund has reached a comfortable level, you should divert that automatic $1,500 monthly investment into a fund earmarked for retirement. We recommend you begin with a no-load, low-expense index fund, such as Vanguard Total Stock Market Index Fund (800-662-7447). This is based on the Wilshire 5000 index of large, medium, and small US stocks. It boasts a 13.4 percent average annual return for the past five years, barely edged out by the Standard & Poor's 500 Stock Index.

"This fund is tax-efficient; it generates few capital gains, because there's little turnover in the portfolio. Unless you sell shares, therefore, your annual taxable distributions will be low. This is a significant advantage because as your income grows, tax saving becomes more important. Plus, this form of tax deferral adds greatly to your total return.

"If you continue to save 15 percent of your income this way, you'll have about $2.2 million in the account by age 60. That assumes annual returns average 8 percent and your salaries rise only at the rate of inflation. And because Total Stock Market Index is so broadly diversified, you don't have to worry about other types of investments until you build a significant stash. Maybe in about five years, you could look to real estate or other types of funds.

"To further reduce taxes on investments and income, you should put part of your retirement savings into Roth IRAs, as long as you're eligible. At your current income levels, you're each allowed to contribute the $2,000 annual maximum to Roths—currently $2,000, but that will rise to $3,000 next year and to $5,000 by 2008. When your combined adjusted gross income reaches $200,000 (scheduled to rise with inflation) that maximum will begin to phase out. At your age, however, this can be an incredible savings vehicle. You put in after-tax money; the earnings aren't taxed as the investment grows, and neither are withdrawals made after you've had the account for five years and reach age 59 1/2. At an 8 percent annual rate of return, each account could grow to over $200,000 by the time you're 60.

We recommend an aggressive international fund for the Roth accounts, such as Artisan International (800-344-1770). An aggressive fund is usually volatile, so we suggest it for very long-term portfolios. Because you're not required to start withdrawing money from the Roth by a certain age, this may well be the last money you'll ever use.

"In the meantime, you should redirect your current combined retirement investments of $29,000. About $18,500 is in a money-market fund. With retirement so many years away, you can safely keep a much higher portion of your assets in stock funds. The market is weak now, which makes this a good time for new investors. If you start investing today, you'll get stocks at low prices.

"We'd be comfortable with an overall portfolio that's 80 percent in equities (60 percent domestic funds and 20 percent international) and 20 percent in fixed-income investments such as bonds. Your emergency fund could serve as the fixed-income allocation until you accumulate a larger stock portion.

"You might revisit your investment mix in about five years, at which point you could add a bond fund. When the $9,500 you currently have in domestic equity funds grows to $10,000, we recommend that you move it into international portfolios such as Longleaf Partners International (800-445-9469), a young fund that earned 24.4 and 25.9 percent in its first two years. That fund has a $10,000 investment minimum.

Another good choice is Tweedy, Browne Global Value (800-432-4789), with a five-year annualized gain of 15.7 percent. Both these funds invest in undervalued foreign and domestic stocks. Having money in overseas companies provides further diversification and a hedge against drops in the domestic market."

Insurance. "You've wisely chosen to carry high limits on your auto insurance. You should check with your agent to be sure your homeowners coverage would provide enough to rebuild your home in the event of a catastrophe.

"Neither of you has life or disability insurance; these are serious gaps. At your ages, 20-year term life policies covering 60 percent of your income wouldn't be expensive. Disability coverage will cost more, but it will protect you if you're unable to work. We suggest you also purchase umbrella insurance, which covers losses in excess of the limits on both your homeowners and auto policies. This is inexpensive but worthwhile."

Your estate. "You don't have wills, but you should. We recommend that you each draw up a will, a living will, a health care power of attorney, and general power of attorney. These will be especially important after you have a child."

Looking ahead. "You asked whether you should have a financial planner. If you have the self-discipline to put away 15 percent of your income every month, you probably don't need to pay a planner to manage your investments at this point. Spend wisely and build a nest egg over the next few years. Starting early and developing the saving habit will put you in control of your financial future.

"As your assets grow, you may find that you'd prefer to have someone else manage your investments. It's like working out: We can all go to the gym and exercise, but some people prefer to have a personal trainer, to guide them and keep them on a steady program. A planner can play the same role in a financial regimen."

*All returns in this article through June 12, 2001.

Related Videos