One of the challenges of being in a high-earning profession of healthcare is making smart financial decisions. This holds true in today’s financial crisis more than ever. You might feel more stressed during this time with so much unknown as the world continues to be focused on fighting a global pandemic. Financial stress is also increased with furloughs, layoffs, and now businesses being understaffed across the country. Even during times of crisis or emergency, there are steps you can take to improve your financial situation and plan for the future.
When traveling by airplane, sunny skies and smooth weather make for a decent flight plan, but when the weather turns, you can tell when you have a good pilot who was prepared to navigate safely. Just like when times are good and paychecks are plentiful, it is important to begin your financial plan with a solid foundation.
Your financial plan, much like a pyramid, must be built from the ground up, with the most important goals forming the foundation of your plan and then working up. If you try to build a pyramid with only half a base, ultimately that pyramid will crumble.
We believe that to build a solid financial future, you should start with an emergency fund, before working toward paying off your credit card debt and student loans. Furthermore, while building your financial foundation it’s also important to protect your assets by purchasing disability income insurance, life insurance, and auto and homeowners insurance. These foundational pieces will keep you protected while you address your short-term goals (paying off any debts).
Once you have a foundation that addresses how you will cope with an emergency situation with liquid assets and insurance and a plan in place for paying down debt, only then should you move to the next level in your pyramid. The next level is for longer-term planning including college savings and retirement savings.
The last piece of your pyramid of financial priorities should be addressed only when the other areas are taken care of: legacy planning, a vacation home, or any other goals you might have for your future.
The first step to creating a solid financial plan is identifying your short-term and long-term goals. You may have some dreams or ideas in your head, but laying them out will help you visualize them and help you turn those goals into an action plan. In order to do this, you’ll need to gather some information to begin evaluating possible strategies. While there are myriad data points that can be relevant, there are two key pieces of information that are vital to creating a plan.
The first data your financial plan needs is calculating a net worth statement or balance sheet. A Net Worth Statement shows in one consolidated place two of the remaining financial decisions you’ve made. In a balance sheet, we can see everything that you OWN and everything that you OWE.
What you own includes everything in savings, checking, value in a house or car, retirement accounts, Roth IRAs. And when you subtract all of your debts, the result is called your Net Worth. Often at this stage, the amount you’ve borrowed may be more than what you’ve saved or accumulated in which case you’ll have a negative net worth. That’s obviously not ideal if you’re working toward retirement, but it’s very, very common while in residency and the key is to have a plan to build your net worth.
The second key piece of information is a budget, also sometimes called a cash-flow statement.
I know the word budget may send shivers down your spine, but a budget is essential to understanding your complete financial picture. In just one budget document, you can see information related to three of the 6 types of money decisions: you can see what you earn, where you spend your money, and where you give your money. Now let me clarify something: there is an important difference between a cash flow statement and a budget. A cash flow statement is a report showing historical information about where you have spent money in the past. But a budget is a forward-looking document that shows where you plan to spend money in the future. When you look at a bank statement or your accounts online, you only get to react to where the money went. By creating a budget, you get to tell your dollars where you want them to go in advance.
You may be thinking “I don’t make enough to budget! I’ll wait until I have more money.” But I can promise you: More money is not essential...it is actually easier to learn to track what comes in or what goes out when you have less. That way, when you have a few more zeros in your paycheck, you already know how to track income and expenditures. We routinely begin working with physicians later in their careers in planning for retirement and you would be amazed at how difficult it is for them to save what they need to be saving – and it’s not because they don’t make a good income. It’s because they’ve spent 20 years developing the habit of directing their money to other lifestyle choices – and we all know: the hardest thing to change with our money, is our behavior.
There are two categories of expenses that show up on a budget or cash flow statement: fixed and variable. An example of a fixed expense is your monthly rent or mortgage payment, which is the same every month. Variable expenses would be your gas or electricity bill since that changes every month, due to weather or other factors. Which do you think it’s harder to estimate for a budget – fixed or variable expenses?
Variable expenses are the hardest to plan for because they fluctuate from month to month. With that said, let’s take a look at our example case study, Dr. Sarah (in residency) and Caleb, who are beginning to think about financial planning.
In our case study, featuring Dr. Sarah and Caleb Smith, Sarah is a resident and they’re sitting down to take a serious look at some of their goals, and here’s what they’ve come up with:
Once you’ve identified your goals, the next step is to prioritize them. What’s most important? It’s not always easy to decide this. Ask yourself: if I could only accomplish one goal, which one would it be?
For Sarah and Caleb, the thing that felt most important was minimizing credit card debt in the next twelve months. They feel that if they can’t do that, they shouldn’t be thinking about a house at all.
With that said, let’s start with minimizing credit card debt. Let’s take a look at their balance sheet and then their budget.
Here’s their balance sheet. Again, a balance sheet (or net worth statement) outlines all of their assets and liabilities.
So, what observations do you have? Think there’s anything missing?
Usually, people don’t omit things on a balance sheet as easily as on a budget. But, since a balance sheet only shows values at a specific point in time, it’s very important to know how these figures are changing.
For example, what was the balance in their checking account 6 months ago? Was it higher and they’ve been slowing using up their surplus or was it lower and they’ve slowly been building some cash reserves?
Now that we have these figures in mind, let’s take a look at their budget, which will give us a more complete picture of their expenses.
So here we have Sarah and Caleb’s budget. Take a look at their expenses. What observations do you have? Are there any expenses they might be forgetting but should plan for?
They haven’t yet accounted for vacations/travel, gift, or haircuts. Remember, even though these are variable expenses and often lower on the spending priority unless you plan to completely cut them out, you need to account for them in your budget (this is an area where many people’s budgets fall short). So now we’ll need to adjust some of the other items to accommodate these expenses.
By subtracting their Total Expenditures from their Total Net Income results in their Surplus (or Shortage). After adjusting their budget to include their additional variable expenses, Dr. Sarah and Caleb's surplus is around $100. This surplus is the tool that we have to help them build their net worth. Keep an eye on their budget and net worth and let’s go back to their goals.
Looking at Dr. Sarah and Caleb’s Balance Sheet and Budget can help them align their goals to an action plan to meet them. The couple’s primary short-term goal is to pay off their credit card each month. Looking at the information above, the couple has $1500 in credit card debt, and about $100 surplus of discretionary funds leftover each month. They also have a Roth IRA with $1000 in it. Using this information, here are three possible strategies to help the couple pay off their credit card:
(1) Stop putting any additional expenses on the credit card and slowly pay it off using $50 of their $100 discretionary cash flow (possibly roll balance to 0% interest card). Use the remaining $50 a month to build an emergency fund. (slowest payoff time)
(2) Stop putting any additional expenses on the credit card and slowly pay it off using the full $100 discretionary cash flow (possibly roll balance to 0% interest card). This will pay down the credit card debt a bit faster, but won’t help them build an emergency fund to pull from.
(3) Liquidate Roth IRA to pay off most of the existing credit card balance right away, pay down the rest using their discretionary funds. Perhaps they can even forgo eating out for a month or so and use the extra to pay off the remaining balance. To ensure they do not rack up new debt, they should be very careful that future use falls within planned budgeted expenses. (fastest payoff time)
Each of these options comes with its own pros and cons and it’s important for Dr. Sarah and Caleb to weigh them against each other to decide which is best for them. Once they see their chosen strategy working toward the credit card debt, then they can more confidently make decisions about what the best repayment strategy is for student loans (based on discretionary income) and begin building savings to TRANSITION expenses and buying a HOUSE.
Remember, the objective here is PROGRESS, not perfection!
Need more help with financial decisions?
Download the “5 Steps to Organize Your Finances Checklist” to ensure that your finances are organized to assist you in meeting your financial goals today!
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John Dameron has been a financial planner and partner with Spaugh Dameron Tenny since 2002. With the help of the SDT team, John created a lecture series called Physicians Financial Focus, authored a book entitled The Residents and Fellows Financial Survival Guide, and has coached hundreds of physicians from residency/fellowship into practice. His expertise has also been featured on KevinMD.
