Completing your residency and fellowship and successfully landing your first position is a great success. This time can also be chaotic and full of changes. Many times you have relocated to your first position and are experiencing financial changes as well. Now that you have steady earnings, you should create a plan for your finances.
It is far easier to get off to a good start and follow a winning plan than it is to adjust bad habits and face regret years from now. We have created a general checklist to help you get started, please note that these guidelines are not a one size fits all solution. Coordinating with your CPA or financial planner is always an integral part of financial planning.
The Golden Rule: Spend Less than You Earn
Year of hard work deserves reward, as a new physician you have likely spent countless years living modestly and are excited to reap the benefits of high income levels. Enjoying the fruits of your labor is a very different experience than jumping into a lifestyle of your colleagues that have been working physicians for 10 years. It is important to avoid “lifestyle creep”.
Lifestyle creep might covertly enter your post-medical school world as a few nicer things here and there, however slow and cautious improvements are in order. Perhaps a new vehicle, first home, family vacation and the ability to occasionally dine out may be part of your new lifestyle.
Often times, these changes can get out of hand when they morph into sports cars, extended or luxurious trips, a seven-figure home, or constant entertainment and fine dining nights out.
What are the pitfalls of overspending? In a word, freedom. Once you adjust your standard of living upward it can be very difficult for you and your spouse to later cut back and bring down that standard of living. If you regularly spend your bank account down and credit cards up, you will be dependent upon the next paycheck to keep afloat. Lifestyle creep will restrict your professional and personal flexibility. Long term, it will impede your ability to retire.
How do you accomplish the goal of spending less than you earn? While not fun to hear, you should create a budget to spend similarly to what you did in medical school during the first few years of practice. The long term benefits of these few years of modest lifestyle increases are numerous. You can utilize this additional cashflow to pay down credit card debt and student loans as well as starting your retirement contributions (often with employer matching). This will put you on the path to long term financial freedom.
Do Understand Your Cash Flow
Young professionals run into trouble when there is simply no mechanism to see how much comes in and how much goes out of their bank accounts each month. Lack of visibility leads to spending everything that seems available. This can result in absence of saving or worse, spending too much and running up credit card balances.
How do you manage your spending? Start by setting up your paycheck to take advantage of retirement matching benefits being offered by your company. Then set up withholding based on your CPA’s advice or estimate. What you can then see is what your monthly net paycheck or inflows to your household account will be as a result.
Write down the fixed expenses you know you’ll have to pay each month: rent or mortgage, auto loan payment, phone, cable/internet, average utilities, student loan payments, and other minimum debt payments such as credit cards. Once you have a good view of this category consider spending an afternoon renegotiating a cable bill or rebidding car insurance to tighten this category as much as possible.
Subtract this expense total from your monthly take-home pay. This leaves you with variable expenses, these are the expenses that change from month to month. These expenses need to last you a four week period. Over the four weeks of the month you will incur and cover variable expenses, such as gas, groceries, eating out, entertainment, investment savings, additional principal payments on debt and surprises. You’ll quickly get familiar with your weekly figure available and how much goes toward those needed items like groceries and gas and find ways to cut out optional over spending such as eating out or entertainment. If you are lucky enough to find yourself at a comfortable amount of spending with excess cash available, opt for savings or extra debt payments.
Generally the first two years in practice are spent as an employee. This is prime time to set good spending habits and create a savings structure to benefit you and your family long term. Over time, earnings increases as you become a partner in your practice and establish yourself in the community. As this happens your monthly discretionary or variable spending bucket results in a surplus, then you can look to add on an upgraded car payment, country club membership or other splurge in monthly spending.
Regardless of what you choose to adjust, awareness of your cash flow will drive better decisions.
Understand your Tax Liability
Once of the largest expenses you will contend with as a high income earner is your tax liability. Understanding how much you pay, and why, will serve you well for the rest of your professional career and beyond. Start by finding a good advisor to walk you through the process.
Many physicians find themselves as business owners within a few years of starting their career. Training on how to be a successful business owner generally isn’t part of the curriculum in becoming a physician. Walking through the process of how income and taxes are handled for physicians that own a business is very different and often times more advantageous than paying taxes as an individual. As a business owner you have the ability to tap into the power of the pre-tax dollar vs an after-tax dollar.
Most physicians have a high enough income level to place them in the highest tax bracket. If a person has the ability to pay for expenses with pre-tax dollars a business owner is getting a 40% discount on everything they buy. Understanding how to position yourself to provide medical services through a business, at least in part, can be highly beneficial to your long term financial health.