ONE: CONTINUE DELAYED GRATIFICATION
This is directed particularly towards new doctors.
After a decade of delayed gratification and a good salary coming in with long term prospects, isn’t it time to splash out a bit? There are however considerable financial benefits to be made by holding off longer. Think first about paying down your debts as soon as possible, be it your HECS debt or, more importantly, that high interest credit card debt. If you can pay down a credit card debt with a 20% interest rate, then next year you will be better off by that amount.
TWO: MANAGE CREDIT WISELY
A distinction can be made between good debt and bad debt.
Debt is considered good when it’s efficient - that is, it’s working to help you build wealth. There’s no better example of the old adage “it takes money to make money” than good debt. Good debt helps you generate income and increases your net worth. One of the most efficient ways to use debt is to borrow to invest in an asset, such as property or shares, which can generate income and grow in value while the interest charged on the debt is tax deductible.
Bad debt is categorised as inefficient because it generally costs money (interest charges) without helping to build long-term wealth. Items that fit into this category include all debts incurred to purchase depreciating assets. In other words, “if it won’t go up in value or generate income, you shouldn’t go into debt to buy it.” Some particularly notable items related to bad debt include car, clothes, consumables and other goods.
Beware of The Ratchet Effect: A luxury once experienced becomes a necessity. Knowing this, many successful investors will focus on building their good debts and controlling their bad debts.
THREE: PAYING YOURSELF FIRST
With a greater income shouldn’t one be better able to save?
Many Doctors, however report they have very little left from pay check to pay check. There are of course the utility bills, car loan, insurance, mortgage and so on. Typically, the salary is adequate enough to easily cover those things. There is something else in operation here though. It is a generally observed behavioural quirk that no matter how much you save, you will find ways to spend it. It is almost as if excess incoming money creates an internal representation of an empty room which must be filled with purchases and other forms of expenditures.
There is a simple principle to follow here and it is not budgeting. You pay yourself first. Before you pay your car loan, utility bills or mortgage, pay yourself a set amount. You will find that you will readjust your spending with little effort. In essence, you are simply making the empty room smaller that you cognitively feel must be filled. Of course, you need the discipline to pay yourself first, which is the focus of tip four.
FOUR: AUTOMATE YOUR SAVINGS
Set up an automatic withdrawal of money from your pay into your savings account. Make sure that this account is separate to your daily or monthly expenses account. After all, out of sight out of mind. Within a short time, you won’t think about the reduction and will have comfortably adapted to the available money.
The secret to creating lasting financial change is to decide to Pay Yourself First and then Make It Automatic. David Bach (author of “Automatic Millionaire”) claims that if all you do are these two things, you will never have to worry about money again, you can forget about budgeting and forget about get-rich-quick schemes.
FIVE: MAKE TIME WORK FOR YOU
When asked “What do you, Mr Einstein, consider to be man’s greatest invention?” Albert Einstein is alleged to have replied “Compound interest”.
EXAMPLE: Assuming you are 25 years old and would like to invest $1,000 per month for one year ($12,000 in total) with no further savings after that year. The return from your investment is 5% p.a. and you reinvest this return each year (before tax).
How much money will you have after 10 years? $19,547
How much money will you have after 20 years? $31,840
How much money will you have after 30 years? $51,860
How much money will you have after 40 years? $84,480
In 1924, a Vermont newspaper used Christopher Columbus as an example in an article titled “The Marvels of Interest.” They calculated that had Columbus put away his “dollar” in 1492 with interest compounding semi-annually at 4%, it would have grown to $1,842,679,000.
In order to reap the rewards of compounding and dramatically expand your investment portfolio (inside superannuation and/or outside superannuation), a systematic, disciplined approach to investing needs to be followed. You want a system that has a 20-year horizon rather than 20 days. Begin to take advantage of the miracle of compound interest by starting now to save those cents.
SIX: DON’T PROCRASTINATE - START INVESTING NOW
Doctors get used to a lifestyle they see as commensurate with their income.
To maintain their lifestyle into their retirement, doctors need to start investing in superannuation early in their careers. Don’t delay. Since some doctors are self-employed, putting income into superannuation is not mandatory. With changes to rules around maximum contributions, it is more important than ever to start young. If you put it off until the last moment, it is likely you will not be able to put in enough to retire comfortably. Furthermore, because superannuation is tax-effective, the same considerations should be given to it as to paying off non-deductible debts, such as your home mortgage or credit card.
EXAMPLE: Assume you are 25 years old, would like to retire at the age of 65 and want to have additional accumulated superannuation of $1 million. The return from your superannuation investment is 6% p.a. over and above inflation but before tax.
How much money do you need to invest every year?
- Your regular annual investment is approximately $6,500 p.a.
However, if you start investing at the age of 50 instead of 25:
- Your regular annual investment is approximately $43,000 p.a. You need to start investing as soon as you can!
SEVEN: BE REALISTIC AND AVOID RISKY SCHEMES
High taxpayers are often attracted to the large tax deductions spouted by different schemes offering high returns. The issue here is not to prioritise a tax deduction above preservation of capital.
You also need to understand some of the investment basics when you are planning your non-superannuation / superannuation needs and retirement income. You can visit one of the Government websites, ‘MoneySmart’
(www.moneysmart.gov.au) for more financial guidance or find a Trusted Financial Adviser to help you.
EIGHT: DO NOT UNDER-PRIORITISE INSURANCE
The previous principles help stem the outflow of cash, but what if the source of income dries up due to some unexpected misfortune?
This tip is more of a safeguard should things go wrong and is particularly important for doctors. Doctors, like many others, tend to be underinsured. However, compared to everyone else, they are more likely to have a greater amount of debt and are also the primary income earner in their family.
Income Protection (i.e. Disability Insurance) is one of the most important types of insurance for doctors. The greatest asset of doctors is their ability to earn income, so it is important to insure it. Life, Total and Permanent Disablement and Trauma Protection, Health Insurance and Business Insurance are also very important and should not be overlooked. Unfortunately, even if doctors do have Income Protection Insurance, they tend to be underinsured.
NINE: MAINTAIN A CASH SAFETY NET
This is another safeguard. Maintain a cash reserve to cover emergencies such as unexpected medical expenses and things outside your control which you must have cash in order to cover (80% off sale does not constitute an emergency). Common wisdom dictates that you should have at least three months expenses in a separate savings account.
TEN: FIND YOUR PURPOSE OF MONEY
The tips so far have focused on the growth and safeguard of your nest egg. They are very much focused on money as an end in itself.
This tip asks you to go deeper and understand what, for you, is the “purpose” of money. Too often we conflate purpose with goals. In much the same way, we conflate wealth with money. Consequently, when asked their reason for investing, doctors will often give their goals.
Purpose is the broader context which puts goals in relief. For example, the reasons often given for investing are to buy a new car, a well-equipped yacht, world travel, pay for the children’s education, have a specific amount of money at retirement and so on. These are goals, not purposes which bring a broader meaning to your financial considerations. A Financial Adviser can best assist a client if they have a mutual understanding of “why” the client is investing.
Above we listed some goals. They were ways of spending money and not purposes in themselves. A purpose is, by contrast, the direction you want to take over the long term with goals serving as the mileposts along the way. To illustrate, my purpose may be to go east. I can, as a resident of Perth, go to Adelaide, but once there I can go even further east, for example to Sydney and further beyond in that direction. It is important to have both goals and a purpose. Once goals are attained, you can set higher goals.
EXAMPLE: • If you say you want $5 million in your retirement fund by age 60, that’s a goal. If you say you want to be free of money worries by retirement age, that’s a purpose. • If you say you want to send your children to college, that’s a goal. If you say you want to have well-educated children, that’s a purpose. • If you say you want to purchase your first ‘Namatjira’, that’s a goal. If you say you want to have a collection of Australian art, that’s a purpose.
The goal is a step in the direction of achieving your purpose.
However, you also need to bear in mind that research into wellbeing has been unanimous in concluding that, above a certain level of poverty, extra money makes very little difference to our overall fulfilment. Instead, fulfilment is better measured by the relationships we have formed and an overriding sense of purpose in life.
Therefore, it is important to work out what TRUE wealth means to you. It is vital that you, yourself or with your Trusted Financial Adviser, identify what is truly important to you and set goals in the proper order.
Understanding why you want to have money comes first. Once that’s clear, it becomes the context in which to create a MEANINGFUL financial plan with set goals and priorities.
Putting purpose first makes decision making much easier.
Written and produced by Venus Wong, of AMA Financial Services.