Financial Planning

Financial Rules of Thumb for Doctors


By Bill Martin, CFA 

Published July 09, 2024

Financial rules of thumb are popular and generally act as a quick framework or general guideline. They can be a helpful shorthand and some have been derived from historical and collective wisdom that have stood the test of time. Earned has compiled popular and relevant ones below; we also break down how they are particularly relevant for doctors.

1. 50/30/20 Rule:

What does the rule say: Allocate 50% of your after-tax income to needs, 30% to wants, and 20% to savings.  Needs are defined as expenses that are essential to daily living, such as housing, food, insurance, transportation, while wants encompass discretionary spending and “nice-to-haves” like vacation, hobbies, entertainment.  Savings include investing, retirement savings,  emergency savings, and debt repayments beyond minimum payments.  

This rule was popularized by Elizabeth Warren and Amelia Warren Tyagi in their book "All Your Worth: The Ultimate Lifetime Money Plan."

How does this rule apply to doctors: To cut to the chase, save as much as you can.  The more you save, the more interest income and capital appreciation you can compound.  

On a tactical level, doctors should take full advantage of employee sponsored retirement accounts and check for additional retirement benefits offered at your hospital.  Doing so leads not only to more retirement savings but also substantial tax savings that compound over time as well.  Furthermore, consider building your wealth across  three distinct “tax buckets”: tax deferred, tax-free, and after-tax accounts. By actively optimizing these buckets, you may end up paying less taxes and have more control of your tax situation in retirement, leaving more dollars to grow your wealth over time.

At a higher, “life level,” given the high levels of burnout and financial stress reported by many doctors, keeping your spending under reasonable limits will also give you more financial and psychological freedom.  Doctors, if not careful, may fall prey to lifestyle creep. Each dollar saved is a dollar invested and compounding more wealth for you.  There is a reason the saying “spend like a resident” is commonly referenced! Build in fiscal discipline early in your career and stick to it. This will be the most reliable way to build long-term wealth.

2. 30% Housing Rule:

What does the rule say: Do not spend more than 30% of your gross income on housing expenses (rent, mortgage, property taxes, maintenance expenses, etc). 

This rule originated from federal housing policies aimed at ensuring affordability for low-income households. It has since been broadly adopted as a financial planning guideline to help people manage their housing expenses more sustainably. 

How does this rule apply to doctors: Housing expenses are one of the largest expenses for Americans in general, but also for doctors, who seem to prefer living in large houses.  Medscape’s report indicated that while the average house for sale was ~2,500 square feet in 2021 in the United States, at least 40% and 53% of PCPs and specialists, respectively, choose to live in bigger houses than that.  Almost 20% of doctors have a mortgage larger than $500,000, and 18%-26% of doctors said their families have mortgages larger than the national average of $431,000.  

At Earned, we recommend that our physician clients spend no more than 30% of their gross income on housing, and a lower rate would be much preferred such that you start creating more margin to build wealth with financial assets.  A larger house invariably means more expenses as well, from property taxes to maintenance, and being “house poor” is a major contributing factor to why many doctors feel financial pressure.   

3. 4% Rule for Retirement Savings:

What does the rule say: Very broadly, the gist of the rule estimates that you can withdraw 4% of your retirement savings annually without running out of money for at least 30 years. The formula is as follows:

Retirement savings = Annual Withdrawal / 0.04

For example: If you need to spend $10,000 a month ($120,000 a year), you will need retirement savings of ~$3 million. 

This rule was developed by professors at Trinity University, and is based on the “Trinity Study.” More specifically, William Bengen summarized it as: “Assuming a minimum requirement of 30 years of portfolio longevity, a first-year withdrawal rate of 4 percent, followed by inflation-adjusted withdrawals in subsequent years, should be safe.” The rule assumes a balanced portfolio of stocks and bonds and considers historical return rates.

How does this rule apply to doctors: While many doctors are mid-career and in the accumulation phase, we think this is an interesting way to quickly “back-of-the envelope” calculate how your current spending rate would match up to the retirement savings you would need later.  Furthermore, as many doctors report feeling burned out, and some are seeking to reduce their time practicing core medicine, this rule could also help calculate how working fractionally or diversifying your incomes would impact your financial situation.

The 4% rule has flaws and doesn't fit every doctor's situation. For example, the rule ignores other income streams such as social security and part-time work in retirement and assumes that spending won’t fluctuate from year to year. Rather than rely solely on this rule, Earned encourages doctors to build a dynamic retirement strategy that adjusts withdrawals based on financial circumstances and market changes. This approach can increase the probability of success of your retirement plan.

4. Rule of 72:

What does the rule say: Divide 72 by the annual rate of return, for a quick way to estimate how long it will take for an investment to double at a fixed annual rate of return.  

For example: If you expect an 8% return, it will take approximately 9 years (72 / 8 = 9) for the investment to double.

While the exact origin of the Rule of 72 is unclear and attributed to various historical figures, it has been a useful heuristic in finance for centuries.

How does this rule apply to doctors: Similar to other rules stated in this article, it’s a helpful back-of-the-envelope formula to calculate different situations, and it illustrates the benefits of compound interest. 

Because doctors start earning later, the Rule of 72 can help you understand how quickly your investments can grow, which is critical for catching up on retirement savings. For example, if you invest in a retirement account with an average annual return of 8%, you can use this rule to estimate that it will take ~9 years to double (without factoring in ongoing contributions).  Similarly, when faced with the decision to pay down debt aggressively or invest in retirement accounts, you can also apply this rule to make more informed decisions.  

As with other rules of thumb, the rule of 72 has certain limitations. The rule doesn't account for real-world factors like inflation, taxes, or market volatility, which can affect actual doubling times. Nor does it factor the impact of ongoing contributions and investment savings. Earned, through our financial planning process, accounts for these factors to develop more reliable estimates of future wealth.

The above information is for educational purposes only. Individuals should seek the counsel of a properly licensed professional prior to taking any action. Earned Wealth is an investment adviser and does not provide accounting advice or services.

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