Further Reading: If you like what you find in this post, you’ll like The Physician Philosopher’s Guide to Personal Finance even more! Buy your copy today.
The Pivotal MomentThe reason that the moment you start making a “real” paycheck is such a pivotal point in time is because the decisions you make right then will determine your trajectory. It can be very hard to change your course after those first three to five years. It’s possible, but it’s much harder. Either you set yourself on a trajectory for great financial success and early financial independence OR you choose a lifestyle that will leave you in shackles and working ‘til you can’t work anymore. The biggest problem here is that many of the choices you make are often binding. You cannot easily reverse a lot of decisions. For example, if you buy a $1 million dollar home with nothing down and then find you want to sell it a year later… you better believe that financial pain will be real.
A Tale of Two Doctors: The Set UpHere is how this post is set up. We will follow Dr. Jones and Dr. EFI as they make very different choices when they finish training. For each doctor we will discuss their lifestyle inflation after training, decisions on student loans, retirement planning, and their eventual trajectory. Let’s make some assumptions for both of them, though:
- Both doctors are 35 years old when they finish training.
- They are both married, and their spouses do not work.
- Both doctors have $250,000 in debt.
- They each have a starting annual salary of $250,000.
- Both made the smart decision to get term life insurance and disability insurance.
- They both got cashback deals when they privately refinanced their loans through The Physician Philosopher.
Doctor 1: Introducing Dr. JonesDr. Jones has waited long enough. She spent four years in undergrad, four years in medical school, four years in anesthesiology residency, a year in fellowship, and now she is ready to reap the rewards of a lot of hard work. Dr. Jones wants to live the doctor’s life she has always heard about. She doesn’t want to keep up with the Dr. Joneses. She is Dr. Jones.
Lifestyle Changes After ResidencyHer monthly take home paycheck is now $14,500. That’s $10,000 larger than her last residency pay check! After signing on to her new contract, she found the exact house that she wants. It’s only $800K with a 4% interest rate. With a 30 year fixed mortgage that makes for a monthly payment of $4,100. And the garage will fit the two new BMW’s she bought for her and her spouse perfectly. She got a steal with 3.5% financing for a monthly payment of $1,800 to cover both cars. Don’t forget the $200 monthly car insurance payment.
Student Loans & Retirement
InvestingShe understands that she could pay down her debt quickly or max out her 401K, but she just doesn’t see the need. Her employer has a mandatory contribution, and that sounds great! However, Dr. Jones didn’t see the benefit of chasing after an employer that matched or contributed above and beyond this in her 401K. Retirement is so far away! So, she puts in the required 2%, which is matched ($5,000 per year), but doesn’t see a lot of other reasons to save for a retirement that is 30 years away.
Student Loan PlanHaving said that, she also doesn’t want to keep her loans around forever. So, she refinanced. Her $250,000 in student loans are now being paid via a 10 year fixed plan with a 3.5% interest rate. The monthly payment on this will be around $2,500.
The Breakdown of Dr. Jones’ Paycheck
Here is how her monthly paycheck would break down.
$14,500 Take Home -$4,100 mortgage payment -$2,000 car payment + insurance -$2,500 student loan payment -$600 Disability/Life Insurance $5,300 remainingThis leaves Dr. Jones and her spouse with $5,300 for all of their other living expenses. This might include a country club membership, cell phones, designer clothes/jewelry, cable TV, premium gas for the BMW’s, eating out, vacations, utilities, etc. That doesn’t include furniture for the house she just bought. But that can all be financed or go on a credit card, right? All of her bonus pay will go towards the awesome vacations her and her spouse deserve. They’re working hard!
Take Home for Dr. Jones Over The Next Ten YearsThe take home here is that Dr. Jones is living large. She bought the house, the cars, and is not being aggressive with her student loans… she is really going to get behind the eight-ball. How far behind? Let’s see. Given Dr. Jones’ lifestyle, she would probably want to have $200,000 each year in retirement. If she retired at 65, she would likely need $200,000 x 25 = $5,000,000. If this current plan continues, and we assume an 8% interest growth on the $10,000 she is saving each year ($5,000 contribution + $5,000 employer match). After ten years (age 45), she will have an unimpressive $141,621 saved for retirement (TPP: corrected from previous math where I forgot the employer match). At that point her debt would be gone. Maybe I am not giving her plan enough credit. What if she started saving after her loans are paid off in 10 years? Let’s say she changed jobs and found an employer with a good 401K after she realized how important that was. So, she started maxing out her 401K and with her employer’s contribution and additional voluntary matching, she started investing $56,000 (max for 401K in 2019) for the next twenty years. At age 65 how much would she have still assuming 8% growth? The answer is a little more than $2.7 million. Taking 4% of that each year for retirement, she would only have ~$108,000 per year. Remember, because of her lifestyle, she needed $200,000 per year. So, that’s half of what she wanted for retirement and she is now 65. Unless things change drastically for her, she will likely never get to that goal. This is a story of big lifestyle inflation after you finish training. Don’t do it.
Doctor 2: Introducing Dr. Early Financial IndependenceFortunately, there are better examples and Dr. Early Financial Independence (Dr. “EFI”) is going to show you that. Dr. EFI knows better. She has completed her four years of medical school, four years of anesthesiology residency, and also did a one year fellowship. However, she wants to start off on the right foot. She has done her homework and knows enough about personal finance to do it herself. And she knows where to get financial help, if she ever needs it. With a more moderate approach to the lifestyle bump after residency, Dr EFI is not going to chase after a house three times her income right now, but she is going to buy a great house. Eventually. Before she can get the house she is going to make some good financial decisions. She will still enjoy a bump in lifestyle after finishing training, but Dr. EFI is going to limit lifestyle creep through The 10% Rule. Let’s see how she does compared to Dr. Jones.
Lifestyle Change After Residency for Dr. EFIBecause she maxes our her 401K (pre-tax $19,000) her take home pay is $13,700 utilizing the same federal and state tax assumptions as Dr. Jones. Dr. EFI followed The 10% Rule when she saw her paycheck increase dramatically. So, she took about 10% of that increase and decided to bump her lifestyle. She has earned that. She moves into a small rental home for $1,000 per month. It’s slightly bigger than the $750 apartment they were staying in during her fellowship year. She drove a beater all during her years in medical school and residency to keep costs as low as she could. But she really likes the new Toyota Prius (Touring edition for $30,000) because it gets almost 60 miles per gallon. Making the same assumption as we did for Dr. Jones, she decides to surprise her spouse with one, too. Despite the advice from other personal finance blogs, she finances a car. At 3.5% for 5 years, this will cost her approximately $1,000 per month for both cars, including insurance. Dr. EFI wants to keep this plan in place for three years after she finishes. Once her student loans are gone, she will be able to finally reap the real rewards. How can she have so much discipline? Well, she understands how important these beginning years are to her financial success.
Student Loans and Investing
InvestingDr. EFI decided to take a job with a good 401K plan. She maxes out her 401K to take advantage of her employer’s 2% required match, 4% voluntary match, and employer contribution. With everything included, she is maxed out to 401K limit of $56,000. Dr. EFI’s take home pay is $800 less each month ($9,600 for the year), but because of her employer match up to the 401K limit she is saving $46,000 more each year than Dr. Jones despite only contributing $14,000 more than Dr. Jones. That’s a steal right there. She and her spouse also max out the $12,000 each year for their first backdoor Roth. All in all, she is investing $68,000 by contributing $31,000 of her own money. Oh, and after her student loans are paid off… she will have even more going towards investments, likely in her employer’s excellent 457 account and a taxable account. More on that below.
Student Loan Plan (Turned to investments)Dr. EFI wants to be done with her student loans as quickly as possible. So, she refinanced her loans to a 5 year variable because she knew this would offer her the best rate. She averages 3.25% interest and she decides to pay $6,000 per month in student loans. This way, her loans will be gone in 3.5 years with no additional payments. If she takes any extra bonus money she receives and, according to The 10% Rule, puts the other 90% of her bonus pay towards her loans; her loans would likely be gone in less than three years. After her student loans are paid off, which have been costing her $6,000 per month, she plans on taking about a third of that money ($2,000), combining that with her current home rental payment ($1,000) and putting it towards her mortgage on a new “doctor” house ($3,000 mortgage payment on a $550,000 home). She will take the other $3,000 remaining from her previous student loan payments that are now gone and put it into a taxable account. That will total an additional $36,000 per year to take her annual investments to $104,000. We have accounted for $5,000 of the previous $6,000 monthly student loan payment. What about the remaining $1,000 per month? That, my friend, is for pure enjoyment on whatever she wants to spend it on. She could put it towards her mortgage and pay it off in 20 years instead of 30. Or she could take two $6,000 vacations each year. It’s up to her and her spouse, but they’ll find success because they know how to be intentional with their money decisions.
The Breakdown of Dr. EFI’s Paycheck
$13,700 Take Home Pay -$1,000 rental/apartment payment -$1000 car payment -$6,000 student loan payment ~$900 Post-tax Backdoor Roth money -$600 Disability/Life Insurance $4,200 remainingSo, Dr. EFI has $4,200 (post-tax) left to spend each month compared to the $5,300 that Dr. Jones has. Though, it is worth mentioning, that $4,200 is definitely more than she made on a resident or fellow salary. So, despite buying two new cars for her and her husband and living in a slightly better place than in residency, she still has more money than she did as a resident to spend on eating out, going to the movies, or catching a ball game.
The Next Ten YearsWhat does Dr. EFI get for the $1,100 sacrifice she is making per month compared to Dr. Jones? Well, ten years out from training she will be able to accomplish all of the following (compared to Dr. Jones who definitely won’t):
- Dr. EFI’s student loans will be paid off in three years (compared to 10 + a lot of extra interest paid for Dr. Jones)
- At ten years out of training, she will have accumulated $1,250,000 in her investment accounts (compared to the ~$141,000 of Dr. Jones)
- She will have a very positive net worth (compared to Dr. Jones’ very negative net worth)
- She will be well on her way to financial independence and retiring early (Dr. Jones will never be able to retire at her current lifestyle)
Take Home for DR. EFIDr. EFI is making some real progress! She and her spouse get together and realize that once all of their debt is gone (no more car loans, mortgage, college for kids if they have any) they could live very comfortably on $120,000 per year in retirement. Since they want to retire early they need it to last a little longer. So, they multiply their desired annual number by 30 (instead of 25 for traditional retirement). They will need $100,000 x 30 = $3,000,000 to retire. If they take out 3.3% ($100,000 per year), that should last as long as they need it. Assuming she doesn’t change anything about her investments above, she will get to that number by age 52. If she were to increase her investments in her taxable account by $1,000 per month (say, when those car loans are paid off after five years), she would reach that goal a year earlier at age 51. Not too bad! Retiring at age 51 would be swell. This all assumes no increase in pay, no additional money from bonuses towards investments (which she would obviously make), and that her spouse never works or has retirement accounts of their own. If any of those things happened, they would likely meet their goals in their mid to late 40s. At that point, Dr. EFI could choose to be a doctor and work because she wants to, and not because she has to. All the while, Dr. Jones would not be able to retire even at age 65 (fifteen years later). And that remains true even if she really turned it around after 10 years of making mistakes. Yikes. Compound interest is wonderful, but it takes time! That’s why your savings rate early on are so important.
The Big PictureI should mention that there is a middle ground where you save 20% of your AGI each year and comfortably retire at 60 or 65. That said, you can get there much sooner, if you want. Who knows how much you will love your job in twenty years? The big picture here is that you can have an increase in lifestyle immediately after you finish, but you have to keep it in check. You can have most anything (except the huge house), but you can’t have everything all at once. Otherwise, you’ll be like Dr. Jones who looks wealthy on the outside, but will be working until she can’t work anymore. Unfortunately, this is not as uncommon as you’d like to think. The take home? Residents, fellows, and newly minted attending doctors… take a small bump in lifestyle when you finish. I suggest 10%. Then, put the rest towards building wealth for two to three years. Your future self will thank you later.
What do you guys think? What approach did you take (or will you take if not there yet)? Did I leave anything out? For those further along in the journey, what would you have recommended to yourself? Leave a comment below.