Credential Check

iStock_000083053785_Small;Physicians can spend over a decade working on their credentials. While their financial planner need not go to medical school, they should go through some sort of accreditation process. Whether you’re hiring an advisor or back checking your current one, the following four areas are a good place to start:

  • Utilize the resources of regulatory agencies to ensure they have a clean record. Look up Registered Investment Advisors (RIAs) and brokers.
  • Experience – What kind and how much? The planner should have at least five years of actual planning experience working with individual clients.
  • Don’t get lost in the vast sea of credentials and designations. Focus on the three that matter – CFP®, CFA and CPA.
    • Certified Financial Planner (CFP®) – Requires 18 to 24 months of coursework followed by a rigorous 10-hour exam. Three years working as a financial planner. Bachelor’s degree or higher. Thirty hours of Continuing Education (CE) every two years.
    • Certified Financial Analyst (CFA) – More technically oriented than the CFP®, but equally valuable. Rigorous studies, testing and CE requirements.
    • Certified Public Accountant (CPA) – Having tax planning help on hand is hugely beneficial. Rigorous studies, testing and CE requirements.
  • Transparent fee structure. My advice? Align the economic incentives.
    • Fee only – Fee is based on the amount of money managed (i.e., 1% of a $1 million portfolio). Economic incentives aligned in the sense that if the account grows, everyone is happy – 1% of $1.5 million is greater than 1% of $1 million and, most importantly, you have more money.
    • Commission based – Fees are associated with specific products and transactions. Client/advisor incentives misaligned. The more your advisor trades the account, the more they will make. They’re also incented to sell expensive “fee-centric” products.
    • Fee based – Fee only plus Commissions. Not ideal.

Do your due diligence. You, your significant other, your heirs and any charitable benefactors of your estate will all thank you.

Money on the Table

iStock_000071727009_XsmallAny good football coach will tell you that you want players at their best position. A 350-pound football player is built to anchor the offensive line, not play wide receiver. A kicker is there to kick extra points and field goals, not quarterback. In this way, a team is intentionally built to leverage its collective parts in the most productive fashion.

In much the same way, it’s important for physicians to locate investment assets to their most tax productive vehicle. Here are some examples:

  • Use tax-free municipal bonds in taxable investment accounts.
  • Real Estate Investment Trusts (REITs) and Treasury Inflation Protected Securities (TIPS) are tax inefficient and belong in tax-sheltered accounts such as 401(k)s, IRAs, and Roth IRAs.
  • Use tax-managed funds in non-tax-deferred accounts.

Effective asset positioning lowers your tax burden and translates directly into higher investment returns. Otherwise, you’re leaving money on the table.

You’re going to score fewer points if your kicker is throwing passes to your wide receiver. In this case, effective asset location will put more points on the board and allow you to reach your retirement goals sooner.

The Holy Grail of Investments

iStock_000055382254_XSmallWouldn’t a risk-free 15% annual return be nice? You could sleep safe and sound while your investments grow at an amazing clip, and nothing, not the stock market, the real estate market, some political mess, etc., could take it away from you. Physicians in particular get incredibly creative in seeking such returns.

Here are just a few examples of where physicians look for what I refer to as the Holy Grail of investments – an extremely high-risk free rate of return:

  • Funding a clinic pension with an orchard. Yes, the kind with trees, fruit and a harvest. A company did this only to discover that a few years later the orchard had lost significant value and needed to be sold at a fire sale price to provide liquidity for an exiting partner.
  • Individual stocks. Remember, Apple and Microsoft are the rare exceptions, not the rule. About 99% of individual stocks don’t even come close to doing what those companies have done.
  • Sector plays. Physicians are smart and can conjure perfectly rational arguments for investing in biotech, gold, etc. But, no one is smarter than the collective wisdom of the market. It’s a force not worth fighting, especially in the information age. In that sense, all you’re doing is taking concentrated risk in a sector. You may get lucky, but probably not.
  • Falling prey to downright scams. There are countless cases of scam artists working their way into a physician group and selling them on a guaranteed 15%+ return. If it sound too good to be true, it is – period.

The search for the Grail will continue due to one very fundamental rule of finance. Risk and return are related – a higher expected return comes with more risk, and less risky investments come with a lower expected return. In economic terms, there is no free lunch.

But, do we even need the Grail? If U.S. large cap stock returned 10.1% and U.S. small cap stocks returned 12.3% annually over the past 86 years, maybe we don’t. Accepting what the market gives us and using the evidence to craft a globally diversified portfolio is a fine solution. While nothing is guaranteed, I for one much prefer the idea of investing with evidence. Searching for something that doesn’t exist at the expense of your retirement goals, and everyone who is depending on you to make the right decisions, is a risky venture. Proceed with caution.

The Personal Exemption Phaseout

The Personal Exemption Phaseout (PEP) is back. Physicians and other high-income earners need to consider its impact. Below you’ll find the general guidelines, an example of how it works and finally, creative ways in which you can help manage or negate its impact.

PEP phases out the personal exemption by 2% for each $2,500 that a person’s adjusted gross income (AGI) exceeds the threshold.

PEP for 2015

Filing Status Phaseout BeginsPhaseout Ends
Married Filing Jointly$309,900$432,400
Head of Household$284,050$406,550

Example: married filing jointly with two children

Personal exemption = $16,000. AGI= $360,000. AGI in excess of phaseout is $50,100/$2,500= 20.4, round up to 21. Multiply by 2% = 42% reduction on the initial exemption of $16,000. Reduction amount = $6,720. Personal exemption = $9,280.

If you are at the upper threshold of a $2,500 increment, take caution. A $100 increase in income could wipe out 2% of your personal exemptions.

Here’s how can you manage the impact.

Get your portfolio in shape

Realized gains in your investment accounts are included in your AGI and will impact the PEP. If your portfolio is in need of restructuring (in turn realization of gains) due to poor management and misallocation, there’s no time like the present to get it in shape. The benefits of a well-structured portfolio are more valuable than the personal exemption. And, if your income is going to stay the same, the net impact of the PEP will be the same whether you realize all the gains in year one, or, for example, over a two to three year period. That said, if your income is going to be significantly less next year, consider holding off.

Distribute your income elsewhere

IRA distributions are considered income. If your income is getting close to the phaseout, distribute elsewhere – a taxable brokerage account, for instance.

Consider your dividends

If your income is constant and your investment accounts distribute a significant amount of distributions, consider the following options:

  • Locate the dividend paying assets in your tax sheltered accounts,
  • Retool the investment strategy in your non-tax deferred accounts to minimize dividend-paying investments. PEP aside, asset location can be an extremely valuable tool for high-income earners.

Make the most of your deductions

Take advantage of your 401(k), 401(k) over 50 catch up, IRA, and Health Savings Account (HSA). Also consider your student loan interest, which is important for younger physicians who are still carrying the debt.

Manage your distributions

If you are in a partnership, manage distributions more effectively in high-income years.

5 Steps for Physicians to Create Their Retirement Critical Mass

These 5 simple steps to investing wisely will get you on track to enjoying your hard work and living fully.

Live like a resident and save big

The earlier you can amass money and let the power of compounding interest work for you, the better. If you start to max out ($18,000/year) your company sponsored retirement plan at age 30 at 8% interest, you will have accumulated $260,758 by age 40. Assuming no other contributions, 8% interest and retirement at age 65 this $260,758 would grow to over $827,168. Alternatively, if you wait until age 40 to begin saving, holding the other factors constant, the result would be just over $488,738 at age 65. Those ten years made a huge difference – you made twice as much and you didn’t have to save a dime more. Your future self will thank you.

Pay off and manage your debt

For new physicians, student debt is a burden that continues to grow. At 7-8% interest, getting it under control is paramount. As a general rule of thumb, the higher interest rate debt takes priority. If you have a 9% loan and a 5% loan, focus on the former. That said, mentally, paying off smaller amounts can be rewarding. Assume you have a loan with a balance of $10,000 and one with a balance of $200,000. Even if the former has a lower interest rate, there is a mental benefit to paying it off – namely, making the $200,000 gorilla seem manageable.

Tip: Manage real estate debt with caution. I recently interviewed a physician for my upcoming book whose enthusiasm for the real estate market was palpable. This same physician bought at the peak of the market in 2006 and got burned. He was also on the brink of retirement.

Here are three red flags to watch out for.

  • Leverage works two ways. It feels great when the real estate market is humming along, and when things pull back, just the opposite
  • In retirement, you want liquidity. Selling real estate takes time. Selling a mutual fund takes a day.
  • Concentrating the majority of your wealth in one asset is risky. Diversification can not only reduce portfolio risk. If done correctly, it can increase your expected return.

Figure out how big of a nest egg you will need

Spending $150,000 per year in retirement and using a 4% annual distribution puts the figure at $3,750,000. Income sources such as Social Security and pensions will impact this figure. Also take into consideration expenses that will be expiring in retirement, such as your mortgage.

Draft and investment policy statement

Your investment policy statement (IPS) should, at minimum, contain the following:

  • Asset allocation
  • Risk tolerance
  • Liquidity requirements
  • Portfolio strategy

The IPS is the core of your long-term investment plan. All investment ideas should be filtered through your IPS. If the idea is not congruent with the plan, scrap it.

Protect yourself

Life, disability, umbrella and malpractice insurance are a must for physicians. Millions of dollars can vanish in the blink of an eye, and your retirement prospects right along with it, if you are inadequately insured.

Life insurance is particularly important for younger physicians who, in the event of their passing, would need to pay off a mortgage and replace years of lost income for their family. The good news is that a 20-year term life policy will not break the bank.

Disability is important for physicians for all stages of life. Making sure your income stream is protected in the event of a long-term disability is crucial. Your earning power is a huge asset. Typically, physicians are covered in part through work and should consider a supplemental policy. Umbrella policies cover excess liability beyond your home and auto coverage. A two million dollar policy typically costs less than $1,000 per year. This is cost effective coverage that’s status quo for nearly all financial plans. Malpractice insurance is an obvious must for physicians and is self-explanatory.