Financial Makeover

Pay debts and save for retirement—on a fellow's stipend?

This young doctor's goals may seem unreachable,but they're not. Here's how a financial expert advised her toproceed

By Doreen Mangan, Senior Editor

Thrift and prudence are second nature for pediatrician IrisMabry (above).

"Would you feel comfortable revealing your finances?"we asked Iris R. Mabry when she volunteered to participate ina Medical Economics financial makeover. "Sure,"she said, laughing. "There's not much to reveal."

This 29-year-old Baltimore pediatrician's earnings, which comefrom a fellowship, are slim. So are her assets. Figure in $31,000of medical school debt, and her net worth turns neon red. Butjudging from the way she's thinking ahead, that's bound to changesoon. "I don't want to wait until I'm 40 to start savingfor retirement," Mabry says.

Last summer, when she began her three-year fellowship at JohnsHopkins Children's Center, Mabry was beginning to repay loansand wondering how best to handle her finances. She was grapplingwith several questions: Would it be smarter to pay down her debtquickly, or make minimum payments and save the rest? Should sheput extra money into an Individual Retirement Account or intoan emergency fund? Would a Roth IRA be a better bet than a traditionalIRA?

To help her get answers to these and other questions, we introducedMabry to Christopher P. Parr, a Columbia, MD, financial planner.We asked him to review her situation and create a plan to launchher on the road to financial security.

Unusual thrift in a young doctor

Even when her earnings reach six figures, Mabry probably won'tbe buying a new BMW every year. Her thrifty nature wouldn't permitit. Although she lived on a resident's salary—about $32,000 annually—forthree years, she still managed to save $4,000 in a money-marketfund. "I sometimes made withdrawals from it, but I alwaysput the money back," she says.

Mabry's parents instilled that economic prudence in her. Theyencouraged her and her two brothers to save for special treats.They also practiced, preached—and enforced—careful use of creditcards. Mabry had a credit card in college, for emergency use only.One evening, she used it in a Popeye's. "When my parentsgot the bill, Mom really got on my case about it," she recalls,laughing.

While at the University of Tennessee Memphis College of Medicine,she lived in a dorm and did without a car. A scholarship paidher tuition, but to cover books and living expenses, Mabry tookout loans totaling about $10,000 per year. When her residencyended last June, she consolidated the debt—which had been deferreduntil then—into a US government 10-year loan with an 8.25 percentinterest cap. Her monthly payment is $192.

Besides chipping away at her loans, this young doctor has setsavings goals. She hopes to replace her 1991 Chevy Corsica ina year or so. And she'd like to buy a house someday. Also, becauseMabry's fellowship income is from a grant, she's not eligibleto participate in Johns Hopkins' 403(b). So she wants to put awaya few bucks toward retirement.

Given that her annual salary is $34,000, accomplishing allthat will take some planning. Her biggest expenses, excludingtaxes, are rent and utilities for her one-bedroom apartment ($9,828per year); life, automobile, disability, and additional liabilityinsurance ($2,888); and loan repayment ($2,309).

She spends a mere $1,700 on clothing annually and doesn't blowthe budget on entertaining. "I probably eat out more oftenthan I should, but otherwise my interests aren't costly,"Mabry says. A green belt in tae kwan do, she also enjoys quieterpursuits, like meeting with her book club and listening to livejazz. Books on personal finance and investing top her nonmedicalreading list. As of now, though, her only investment is AdvantusMoney Market Fund.

"My biggest asset is my earnings potential," shesays.

What Christopher Parr told Iris Mabry

"Although your income is limited and your net worth isminus $12,751, you're living within your means, managing cashflow well, and practicing safe credit management. You have nocredit card debt, which is commendable; most people have at leastsome.

"You've also made other wise financial moves. You've startedto save, and you've gotten a head start on life and disabilityinsurance. The Minnesota Life disability insurance policy youbought when you were a resident is excellent. You have a rightto increase the benefit amount—an option that's tough for medicalprofessionals to get. You also have an inflation adjustment inthe policy, which is very good, considering your youth. The premium—$967annually—is fixed, and the policy is guaranteed renewable, aswell as noncancelable, to age 65. Another policy plus is thatif you become disabled you may elect to receive half the benefitsuntil your death, rather than full benefits until age 65.

"Even though your employer also provides some disabilitycoverage, I recommend that you hang on to your own policy untilyou no longer need earned income. This kind of state-of-the-artcontract isn't widely available anymore.

"After paying all your expenses and taxes, you have $3,000per year left. Let's see how you can best put that money to work,and what else you can do to help achieve your goals."

Build your emergency stash. "Rather than try to pay offyour debt faster, you need to concentrate on building emergencyreserves. That way, if your car breaks down, for example, youcan pay cash for the repairs, rather than use a credit card. Ifyou were to stretch out payments on credit, you'd be paying amuch higher interest rate than you're paying for your school loans.

"You have $6,000 in liquid assets for emergencies. Thatwould cover about three months' living expenses. If you can add$1,000 in each of the next two years, you'll have $8,000 plusinterest. Keep saving until you have funds equal to six months'expenses. That's important, since you're single and don't haveanother income to fall back on."

Fund your retirement kitty. "Although you can't save muchfor retirement right now, the important thing is to start. Bedisciplined and systematic. Ideally, you should aim to save 10to 20 percent of your gross income annually for retirement.

"Because you're only 29, time is on your side. The magicof compounding will help, even with small savings. So I suggestyou start by contributing $2,000 annually to an Individual RetirementAccount. Do that for the next 30 years, and you'll accumulatemore than $225,000, assuming an 8 percent annual growth rate.

"Should you opt for a Roth IRA, which isn't tax-deductible,or a traditional deductible IRA? If you contribute the 1999 maximumof $2,000 to a deductible IRA, you'll save $300 in federal taxesfor 1999. But I suggest you consider a Roth. Because earningswill be tax-free, this could provide 10 to 30 percent more after-taxincome during your retirement years than a traditional IRA. Theactual amount will depend on your marginal income-tax bracket.As your income grows, the Roth's relative advantage will increase.

"The Roth has two drawbacks, though. Unlike a traditionalIRA, which is mostly protected from creditors, the Roth may notbe. It hasn't been around long enough for us to see whether thecourts will protect it. And, once you're earning about $110,000annually, you won't be eligible to contribute to it, as a singletaxpayer. But at that point, you could start making nondeductiblecontributions to a traditional IRA.

"When you've finished the fellowship, you intend to seekwork in an academic practice setting. Your starting salary willbe less than you'd make in private practice; probably $65,000to $75,000. But you'll be able to contribute to a 403(b) or asimilar plan. Assuming that once you start taking home a largersalary, you save at least $10,000 annually and your retirementkitty earns 8 percent a year, I estimate you can pile up at least$950,000 by the time you turn 60, in 2030. With your IRA savings,you'll have about $1.2 million in all. That, plus Social Securitybenefits, should generate an annual income equivalent to $138,000in today's dollars.

"Of course, there's no telling exactly how much your savingswill return, or what salary you'll earn. Also, you've mentionedthat you'd like to marry someday and have children. Your husband'ssalary will have to be figured in, as well as expenses of raisingand educating children. So you'll need to re-evaluate this savingsplan periodically as your situation changes."

Find additional savings. "Once you've funded the emergencystash and IRA, you'll have practically nothing left to save foryour other goals, or even to add a little flexibility to yourspending. So I suggest that you scrutinize your monthly discretionaryspending closely to see whether you can free up any more dollars.

"You could cut your insurance costs. Consider increasingthe deductibles on your auto and apartment coverage, currently$250 and $500, respectively. By going further and replacing yourauto, renters', and umbrella liability policies with more economicalones, you can reduce the amount you're paying by about 30 percent.I realize that you had to get this insurance quickly last summer,when you moved to Baltimore, but if you shop around you can dobetter.

"Since you have no dependents, you could drop your $100,000term life policy. Your employer provides that amount of coverage,which is more than enough for you now. Even though your premiumis only $130 a year, you'd benefit more by adding that to youremergency fund or your nest egg for a new car. If you want tokeep the coverage, consider switching from your adjustable-premium,five-year-renewable term policy to a 20-year level premium termpolicy. You'll probably get twice as much coverage for the sameamount, and your premiums won't increase.

"You have few opportunities to reduce income taxes. Butsince you're in the 15 percent marginal federal tax bracket, thisisn't a big concern now. You mentioned that you're thinking aboutdoing part-time ER work. If you do, you'll generate self-employmentincome, some of which you could shelter in a SEP-IRA or Keoghplan."

Invest wisely. "Your emergency money should remain ina money-market fund, to preserve principal and provide liquidity.Right now, you're in Advantus Money Market Fund. Although it recentlyreduced its operating fees from 1.36 to 0.85 percent, that cutcould be temporary. The greatest drag on investment performancefor money-market funds is operating expenses, so it pays to findone with minimal fees. T. Rowe Price Prime Reserve charges just0.66 percent, and Vanguard Prime charges 0.33 percent. Both returnmore than Advantus.

"Savings needed to meet goals in two to four years, suchas buying a new car, should be in high-quality, short-term bondfunds, which offer the potential for higher returns—typically,6 to 6.5 percent. Two that I like are Vanguard Short-Term BondIndex Fund and Vanguard Short-Term Corporate Fund.

"Invest your long-term savings, such as those for retirement,primarily in stock mutual funds. I recommend that you start witha core US fund, such as Vanguard Total Stock Market Index. Ittracks the Wilshire 5000 Total Market Index and currently holdsmostly stocks of large US companies. The fund is relatively safeand has a five-year annualized return of 25.3 percent. As yourportfolio grows, you can add specific niche funds, such as thosethat invest in small or medium-size companies, international securities,stocks with rapid earnings growth, bargain-priced stocks, andso on. Diversifying reduces your overall risk of losing money,because various types of stocks generally react differently tosimilar market conditions.

"You've expressed interest in so-called socially responsibleinvesting. Along those lines, I'd recommend Domini Social Equity,a large-stock fund that has returned an average of 28.2 percentannually over the last five years, and Ariel Appreciation, a mid-capfund with a 19 percent average annual five-year return. Both avoidinvesting in alcohol and tobacco stocks and environmentally unfriendlycompanies.

"As far as estate planning goes, all you need now is awill, a financial power of attorney, and a living will that spellsout your wishes in case you become incapacitated."

Mabry has already begun to act on some of Parr's suggestions,and she's evaluating others. In addition to looking at her budgetto see what fat she can trim, she has decided to move her emergencysavings to a money-market fund with lower expenses. Currently,she's considering several alternatives to T. Rowe Price.

With both time and determination on her side, it seems likelythat this doctor will soon be on her way to achieving her financialgoals.

Christopher P. Parr, CFP, heads his own financial planningand investment management firm in Columbia, MD. He works on afee-only basis; 15 percent of his clients are doctors.

This article is one of an occasional series. If you think yourpersonal finances need an overhaul and would like to participatein a story like this, contact the author by phone (201-358-7347)or e-mail (doreen.mangan@medec.com ).

. Pay debts and save for retirement--on a fellow's stipend?. Medical Economics 2000;2:69.