Will You Have The Money When You Need It?

Will you have the money when you need it?  Maybe you have some money now, but don’t need it.  Later you may need money, but will you have money then?  Having the money is important, but so is the timing.

Let’s assume you bucked the trend of many physicians.  You paid off debt and live below your means.  That extra cash can now fuel your future goals and dreams.  You are getting your financial house in order. Congratulations!

Money Now & Money Later

If your dream is now, go for it.  But what if your dream or need for cash is in the future?  Doctors tend to be conservative.  We fear a market crash that could destroy our savings.

But the money won’t go as far in the future.  The concept of “Time Value of Money” tells us that a dollar now is worth more than a dollar later. This is due to both lost investment growth opportunities and inflation.

Are Stocks Worth It?

In the past, stocks have outperformed cash, bonds, and inflation.  The stock market rewards us for taking a risk.  That amount of extra return is the “equity risk premium.”

But anyone who remembers the crashes of 1987, 2000, or 2008 will be aware of the stock market’s risk.  Prior crashes were even worse.

So what are we to do?  How can we be sure to have the money we need at the time we need it?

ROI Isn’t Everything

Most of us spend too much time focusing on market performance rather than our own cash flow planning.  A focus on the market leads to futile attempts to outperform the market.  This misguided focus causes misbehaviors.  

Those misbehaviors can devastate your portfolio.  It is better to work within a framework, such as these seven steps.  Ashvin B. Chhabra inspired me to write this post.  His book, “The Aspirational Investor” is excellent.

Step 1: Why Do You Need Money?

Outline your goals. Do you know what your financial goals are?  What is the likelihood you will reach targets that aren’t clear to you?  The best financial goals relate to one of the three areas of importance.  

  • One, you need protection and adequate safety.  
  • Two, you will need to maintain your purchasing power.  
  • Three, you need to create opportunity through aspirational goals for wealth.  You can cluster these in three categories: Essential, Important, and Aspirational.

Step 2: When Will You Need Money?

Convert your goals into cash.  Now that you know what sums you will need for each category, you can convert that to a cash flow value.  How do you do that?

Chhabra recommends the “zero-discount method.”  It sounds complicated, but it is the easiest way imaginable.  

Savings Required This Year = Cost of Goal / Years in the Future  

For example, let’s say you will need $120,000 to pay for your daughter’s college.  She is now 7. The annual “cash flow” to save this would be $12K ($120K / 10 years).

The beauty of this is it assumes the investment growth rate and the inflation rate cancel each other out. They are often similar.  They are also both unpredictable. Because of these factors, the calculation becomes simple.

Future Dollars = Today’s Dollars

This seems wrong.  Especially since I just explained the “time value of money.”  But it is a deceptively simple estimate.  This result may not be 100% perfect, but it isn’t bad.  This financial prediction will put you in the right ballpark.

You can reassess the goal each year. Rising expenses, low investment returns, or better information may change the picture. Make a course correction if needed.

Three Types of Goals

  • Essential goals will be goals that are a must-do for you.  Things like building a cash cushion and saving for retirement. Maintaining your lifestyle while paying off college loans may be here.
  • Important goals may be college funding for a newborn child, or a vacation.
  • Aspirational goals may be saving for a condo or creating a charitable foundation.

Use the zero-discount method to determine “your number.” Your number is the amount needed for your retirement nest egg.  

Take how much you spend in a year (e.g. $100K).  Multiply by the years of retirement (e.g. 25).  The nest egg needed to retire is $2.5M ($100K x 25). Easy peasy.

Step 3: What To Invest In

Divide up your assets.  We need a framework for financial risk.  Dividing your money into the different risk buckets is also called “asset allocation.”

Organize your assets and liabilities across the buckets.  The three buckets are your personal risk, market risk, and aspirational risks.

Three Investment Buckets

Don’t put assets needed for safety at risk in the market. They should be in the safety portfolio.  

Assets that need to grow in a risk-adjusted way belong in the market portfolio.  

Assets that perform better than the market carry extra risk.  Those should be in the aspirational portfolio.

As proxies for the categories, consider three buckets based on risk: low, medium, and high.  

Options include: cash/short-term bonds, S&P 500, and private investments.  If you aren’t clear where to start, consider how I invest as a starting point: 40:40:20.

40% safe. 40% market. 20% high-risk. 40% short-term bonds.  40% total stock index fund.  20% other investments.  My “other” is mostly small private companies and individual real estate investments.

Imagine a weight crushing down on these layers. How will they hold up?

Step 4: Should You Risk Losing Money?

Assess your risk level.  Is 40:40:20 the right mix for you?  What is the “right” asset allocation?  Unfortunately, there are no exact answers.  

Subjective factors matter.  How well would you sleep at night if your stocks crash?  That indicates your psychological ability to withstand a loss.  

It isn’t all about emotions though.  Other factors matter too.  What is your financial ability to withstand a loss? 

Can You Recover From a Loss?

Do you have enough time and human capital to earn it back?  Could you financially wait it out until returns turn in your favor?

Some should be aggressive with investments. They have a high ability to take on risk and a low desire to avoid risk.

Others are more conservative.  They have a low ability to take on risk and a high desire to avoid risk.

The rest of us are moderate.

Do You Have Enough?

If you stopped working today, how many years could you live on the money you have?  

Let’s say you have $2.5M.  Your burn rate is $100K/year.  That is 25 years of income that you have stored up.  

How does your actuarial life span compare?  Do you fear running out of money in retirement? If you likely have only 10 years of life left, you could take more risk with your money if you want to.  You are building a legacy fund at that point. 

Human Capital is Your Best Asset

Your level of human capital is important. Think of human capital as a store of future earnings.  It is an asset.  Its value depends on your future earnings.

Compare, for example, that amount for a surgeon versus a carpenter.  A 30-year-old orthopedic surgeon may have $8M more human capital.

Keep Getting Paid

Also, consider a semi-retirement phase before complete retirement.

You may not want to fully retireEven in retirement, we need purpose and structure in our lives.  It is worth thinking about making some money then too.

A profitable hobby or part-time job can help a lot.  It can provide social support, meaning, and some income.  Even a small stream of income would lower your savings need and delay your asset spend-down.

Step 5: Where Will You Invest?

Here is where you explore the practical options of implementation.  Where will you put your “safe-money?”  Common choices include a savings account, money market fund, or short-term bond fund.

What about your “market bucket?”  Options include an S&P 500 or total stock market ETF.

And your “aspirational bucket?” Think leveraged real estate, venture capital, or a physician-owned hospital.  Make a plan now.  Who do you know who has such investments?  Could you reach out to them? 

Opportunities are out there, but they won’t just fall into your lap. How will you find these investments?

Step 6: Will You Have Money After a Crash?

Analyze and test.  Crash test your portfolio.  Run some worst-case scenarios. If you have an advisor, get them to help with this. 

If you are a do-it-yourselfer, use an online Monte Carlo simulator. Work through possibilities like these.

  • You can’t work for five years.
  • The “market bucket” crashes 50%
  • Your “aspirational bucket” crashes 70%

How would you feel about all that? If you would be comfortable and not overreact, then that asset allocation is fine. If not, adjust now.

Likely effects of a market decline similar to 2008.

Step 7: Review and Rebalance

Unfortunately, this isn’t a “one and done” process. You will need to reassess. This could be between one and four times a year.  See if your assets have gotten off track.

If your job is less secure, beef up your safety bucket. Add to your bond fund after rising interest rates decreased your balance.  

Stop Speculating.  Start Investing.

Is it time to cash in on your Bitcoin success? It might be too late for that one!  It could be time to cut your losses on that Chinese stock you bought on margin. Switch to a low-cost market-based index fund. 

Beat most active managers by following this path.  Pay for asset protection.  Invest in market returns.  Put some assets in high-return investments.

You now have a road map for achieving your life goals. Follow these seven steps.  You will have the money when you need it.  What do you think?

8 Comments

  1. Xrayvsn said:

    This really is an excellent guide for people to follow. I cannot stress the safety bucket enough. This historic bull market run has created a breed of greedy investors who believe they can do no wrong. It is tough to set money aside in this type of environment when the market is doing so well. Yet it can (and most likely will) come crashing down.

    The worst thing is retiring and running out of money and being forced to enter the work force again. Your skills are likely diminished, you age may make you less desirable an applicant, and sometimes the field you were in has changed and no longer viable.

    January 21, 2019
    Reply
    • Wealthy Doc said:

      Glad you liked it, Xrayvsn.

      I remember the pain from 1987, 2000, and 2008. It has made me more risk-averse.

      Also, the one message I heard loud and clear from the few super-rich I have talked to (worth hundreds of millions) is beware of downside risk. They obsess about losing money.
      I try to apply what I learned from them.

      We have had an amazing and historic ride for the last decade. Up up and away. It isn’t just being fearful when I say a crash is coming. It is just a fact. I can tell you how much or when though. We just need to make sure that if the magnitude and timing are especially bad for us that we are still able to meet our financial goals.

      I agree that going back into clinical medicine after being out is particularly difficult. I have heard that from physician leaders who gave up clinical work. After 2-3 years they feel completely incompetent in the clinical realm.

      January 21, 2019
      Reply
  2. Enjoyable read on knowing the appropriate risk tolerance for meeting your financial goals. The hardest part is identifying said goals and mapping out a plan to accomplish them. The rest are all tools and judgment calls to allow you to reach these destinations in an efficient, risk-tolerable manner.

    Financial Samurai had a great post with similar arithmetic about quantifying your risk tolerance in terms of years required to recoup potential losses you’d experience in the market. I found it as a good framework for assessing your own personal risk tolerance and would highly recommend reading his SEER model.

    January 22, 2019
    Reply
    • Wealthy Doc said:

      Young and the Invested,
      Thanks for your interest and for leaving a comment. I was just checking out your site and it looks pretty awesome.

      I agree that identifying the goals and mapping out the timing and cost is tough. For me, it is nearly impossible. I’m terrible at planning ahead or predicting my own future. I know people (engineers it so happens) who map out virtually every aspect of their life in a spreadsheet and make it happen almost on schedule.

      I’m at the other end of that spectrum. I want to improve and grow but I also mostly enjoy the process and am fine with letting life take me where it leads.

      Thanks for the reminder about the Financial Samurai post. My readers may enjoy that too if they liked this one. Personally, I had trouble applying it to my life. Maybe it is because I’m FI? Maybe it is because I just didn’t understand it?

      I agree with the tenant of that post that we overestimate our own actual risk tolerance. I certainly did in 2008. I thought I was broadly diversified and was prepared for financial cycles. When half my wealth evaporated I definitely felt that emotionally. After that experience, I think of myself as more “moderate risk.”

      That would imply a lower # on the SEER scale, right? But mine comes up 51 when I do the math from the first formula and that seems high. I didn’t know how to reconcile my reality with Samurai’s theory.

      January 23, 2019
      Reply
  3. Beware of waiting for next year all the time. My grandfather told me when he was young, he had all the energy to do things but no money. Now that he was old, he had the money but was not healthy enough to do anything. Find a happy medium where you use some of it all along the way and you won’t reach the other end with plenty of money and no health.

    Dr. Cory S. Fawcett
    Prescription for Financial Success
    Dr. Cory S. Fawcett recently posted…What Does it Take to Become Wealthy? Hint, it’s not Money.My Profile

    February 1, 2019
    Reply
    • Wealthy Doc said:

      Dr. Fawcett,
      Thanks for dropping another wisdom gem on us.
      There is some irony in life. When we are young we have optimism, energy, and ideas but not much money to make things happen.
      Then we are older with less free-time, less energy, and maybe less healthy and fitness. We have money but are unable to do many of the things we like.
      You have mastered the balance.
      Part-time at 50. Then “repurpose” before 55. Time and money for travel and new interests. Continuing to serve, create, and earn.
      You work on your fitness even to the point of a Spartan competition. Wow.
      Not all of us can play the game of life that well.
      But we can try to remember that life is shorter than it seems and the journey is more important than the destination.

      February 2, 2019
      Reply
  4. Crispy Doc said:

    Wealthy Doc,

    Thanks for this post. I find that decelerating clinical medicine makes it more sustainable for specialties like ours and allows us a longer runway prior to leaving medicine.

    That runway can serve as a buffer against SORR and provide any needed time to make up market losses or await a recovery.

    So practicing less medicine has extended my human capital at a modest (sub doctor) income rate but for a potentially far longer period of time. That in turn increases my risk tolerance. It’s a virtuous cycle!

    Enjoyed this post and the thinking underlying it,

    CD
    Crispy Doc recently posted…Docs Who Cut Back #11: BTMy Profile

    February 8, 2019
    Reply
    • Wealthy Doc said:

      Yes, CD

      Downshifting has been wonderful for me. I noticed almost no financial impact but a big boost in my QOL and the richness of my relationships.

      I would be very concerned about the SORR if I were retiring right now. Any 30-year-old who truly expects to not make any money and just live off 4% is naive.

      In medicine, career longevity with a high savings rate can make up for a lot of financial screw-ups or bad luck along the way.

      February 9, 2019
      Reply

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