One of the challenges of being in a high-earning profession like healthcare is making smart financial decisions. You might feel more stressed now than ever as the country continues to combat inflation, furloughs, and high interest rates, to name a few.
But even during uncertain times, there are steps you can take to improve your financial situation and plan for the future — namely, creating a financial planning pyramid of priorities.
One of the things that we have found over decades of working with clients is that often, the main hurdle to reaching your financial goals is distractions and figuring out the right timing.
For example, one of the most basic questions people commonly ask is, “How should I find the balance between paying off student loans versus saving and planning for the future? Is it good to do both at the same time or is it better to do one at the exclusion of the other and follow these in sequence?”
Other financial planning questions that clients often ask include:
All of these questions have given rise to what we call the pyramid of financial priorities. This pyramid helps us align our clients’ goals when we begin the six-step process of creating a financial plan.
This financial pyramid of priorities is a way of looking at the types of decisions that need to be made and when it's best to take those actions to lay a solid foundation for your future.
Let’s walk through the different pyramid sections to help you understand this concept further.
When you begin to create a financial plan, most people know financial planners encourage clients to build an appropriate emergency fund. This is pretty common territory but often overlooked.
Take note that putting money in your 401k, accelerating the repayment of student loans, or even buying a house is not the first financial planning priority. This is because building a cash foundation is really one of the most important priorities to start with.
Here's an example: Let’s say you budgeted for a trip to Barbados, but you accidentally miss your flight and end up spending an extra few hundred dollars to make it to your destination. Then, after your vacation, another surprise expense arises when your car breaks down on the way to work.
Without an emergency fund, you may be in trouble when these expenses pile up. In other words, until you have an appropriate emergency fund, most other financial objectives should be placed on hold.
Once you've started an emergency fund appropriate for your situation, then we begin to look at things like tackling the high-interest debt you owe. Usually for physicians, this type of debt comes in the form of credit card debt and student loan debt.
It's prudent to have the right strategy for managing these types of debt. Typically, if it’s credit card debt, the strategy is to try to get paid off as quickly as possible.
If it's student loan debt, you’ll want to make sure you have the right student loan repayment plan in place. Whether you are considering Public Service Loan Forgiveness (PSLF), refinancing, or another option, there are many nuances you must be aware of when making decisions about your student loans. The wrong student loan decision can cost you thousands of dollars.
What student loan repayment option is right for you? Take our quiz to find out.
Beyond your emergency fund and paying off debt, playing defense and protecting your assets should be your next step. It’s critical for you to protect your biggest asset, which is you. This can be done by having the right:
Protecting your assets by purchasing insurance that aligns with your debts, goals, and income projections will keep you protected while you address your short-term goals and pay off any debts.
The first four pieces are important to the pyramid puzzle because they protect you in the present or from what could happen to you tomorrow. An emergency fund and asset protection lay a solid foundation that can give you the ability to look into the future with confidence.
Now that you’re prepared for emergencies, you have extra cushion to consider things like college savings and retirement savings. By creating a savings plan, you’ll be able to make a better financial plan to meet those goals.
Once you build your financial foundation with the above pieces of your priority pyramid, you’re at a place where it often makes sense to consider alternative investments, such as:
These types of purchases or investments often come with higher risks that can be dangerous without a thoughtful financial plan in place.
Many purchases can be a distraction from or obstacle to your financial goals, especially if you haven’t laid a solid foundation with an emergency fund and asset protection. But how do you determine your top financial priorities in the first place?
The first step to creating a solid financial plan is identifying your short- and long-term goals. You may have some dreams or ideas in your head, but laying them out will help you visualize them and turn them into an actionable plan.
To do this, you’ll need to gather some information to begin evaluating possible strategies. While myriad data points can be relevant, there are two key pieces of information — discussed below — that are vital to creating a plan.
The first data point you need for your financial plan is 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 your checking and savings accounts, the value of your house and car, retirement accounts, and Roth IRAs. 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. This isn’t ideal if you’re working toward retirement, but it’s very common while in residency.
The key is to have a plan to build your net worth. An experienced financial planner can help you iron out all the details.
The second key piece of information is a budget, which is sometimes called a cash flow statement.
Two categories of expenses show up on a budget or cash flow statement: fixed and variable. Fixed expenses are the same every month, while variable expenses change from month to month. Because they fluctuate, variable expenses are the hardest to plan for.
The word budget may send shivers down your spine, but creating one is essential to understanding your complete financial picture. In just one document, you can see information related to three of the six types of money decisions:
Keep in mind that 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.
We recently sat down with Dr. Sarah and Caleb Smith, who are beginning to think about financial planning to eventually buy a house. Sarah, who’s in residency, and Caleb came to us with the following questions:
The pair identified their most important goal for the next 12 months as minimizing credit card debt. They felt that if they couldn’t do that, then they shouldn’t be thinking about buying a house at all. With that said, let’s take a look at their balance sheet and their budget.
Here’s their balance sheet, which outlines all of Sarah and Caleb’s assets and liabilities.
Usually, people don’t omit things on a balance sheet as easily as they would 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 six months ago? Was it higher, and they’ve been slowly 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.
Take a look at Sarah and Caleb’s expenses. What observations do you have? Are there any expenses they might be forgetting but should plan for?
They haven’t yet accounted for things like vacations, gifts, or even haircuts. Remember that 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.
Now, we’ll need to adjust some of the other items to accommodate these expenses.
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 what we’ll use to help them build their net worth.
Looking at Dr. Sarah and Caleb’s balance sheet and budget, we were able to help them create an action plan to achieve their goals.
The couple’s primary short-term goal is to pay off their credit card each month. Looking at the information above, they have $1,500 in credit card debt and about $100 surplus of discretionary funds leftover each month. They also have a Roth IRA with $1,000 in it.
Using this information, here are three possible strategies to help the couple pay off their credit card:
Each option has pros and cons, so Dr. Sarah and Caleb had to carefully weigh them against each other to decide the best plan of action.
Once they saw their chosen strategy working toward paying off their credit card debt, they were able to make more confident decisions about what the best repayment strategy would be for their student loans (based on discretionary income). They were then able to begin transition planning and work toward buying a house.
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 financial pyramid with only half a base, ultimately, it will crumble.
That said, building a financial plan can be tricky to get started on your own. That's why we created a checklist to help you get started. It all starts with a plan and getting organized, so take the first step with this free download:
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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.
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