Building a Personal Firewall

Physicians face a multitude of financial risks. Some of these risks are unique to the profession while others are more general. What most potential risks have in common is that they usually don’t get the attention they deserve. For example, when is the last time you had a complete review of your risk management strategy? Or perhaps more telling– Do you have a risk management strategy?

A prudent financial plan should give equal consideration to both risk and return. If you don’t have a solid foundation, you won’t have the ability to remain true to a long-term investment strategy. This is crucial because adhering to a sound strategy provides you with the highest probability of building financial security over time. Anything less devolves into speculation.

What are some of the financial risks that should be considered when creating a long-term plan?

Emergency Fund
One of the surest ways to jeopardize your future is not having a “margin of safety” to protect yourself from unanticipated events. An interruption in expected monthly income or a large expense can quickly put you in the hole (and add significant stress), if you are not prepared for it. High-income earners should aim to keep one year’s worth of basic living expenses in an FDIC-insured savings account. The return on this money will be next to nothing, but that’s ok. In this case, what is most important is the return of your money—safety and liquidity.

Life Insurance
If you are working and have dependents, your most significant asset is probably the present value of your future earnings. Therefore, it is essential that you have adequate life insurance coverage. At a minimum, life insurance should cover all of debts (including the mortgage) as well as future education costs for your children. It may also be appropriate to think about the cost of paying for childcare. Term insurance is the most cost-effective way to protect against loss of income. For example, a 40-year-old male in good health can obtain a 20-year, level-term policy with a $1,000,000 benefit for about $700 per year. However, there may be instances when permanent life insurance is an appropriate alternative. To help you decide how much and what type of policy is best for you, consult an independent, fee-only financial advisor.

Disability Insurance
According to the Social Security Administration, there is a twenty-five percent chance that you will become disabled prior to retirement. If you are working and not yet financially independent, you need disability insurance to protect against a loss of future earnings. Since the odds of disability are relatively high, this type of insurance is expensive, so buy only what you need. A policy that will replace 60% of income until age 65 (after 90-days of disability) is fairly common.

Malpractice Insurance
Understand the different types of coverage and make sure your policy limits are appropriate for your particular situation. Differentiating factors include specialty, practice location, type of practice, and procedures performed.

Property & Casualty Insurance
When making insurance decisions, the best advice is to only insure yourself against risks that you can’t afford to cover out-of-pocket. For example, insuring low-cost depreciating assets (like personal computers) is not smart. Save your premium dollars for more costly risks like homes and automobiles. Usually, it makes sense to bundle cars, home, and personal liability (aka umbrella insurance) together with one carrier. An umbrella policy provides coverage in the event you are sued for an amount greater than what is provided in your auto and homeowner policies. Your umbrella policy should be equal to the value of your total assets.

Health Insurance
Health insurance is often a personal choice that is dependent on more than just financial merit. That being said, if you and your family are relatively healthy, it makes sense to consider a high-deductible plan combined with a health savings account. Those enrolled in a high-deductible plan with family coverage are able to save up to $6,250 per year (tax-free). These monies are allowed to earn interest until you need to access the funds for qualified medical care.

Long-Term Care Insurance
Not everyone needs long-term care insurance. If you have significant assets, you have the ability to self-insure against the risk of needing long-term care. If your net worth is small, you can choose to rely on Medicaid. However, if you are between the ages of 50 and 65, you should at least investigate the pros and cons of long-term care insurance by speaking to a long-term care specialist.

Identity Theft
As online transactions increase each year, identity theft impacts a greater percentage of the population. Always assume that someone is watching you online and only do business at trusted sites. Shred financial statements and credit card solicitations. Educate yourself and stay current on the best advice to protect your identity.

Asset Allocation
The primary determinant of long-term investment returns is the asset allocation decision. In other words, how your investments are divided between stocks, bonds, real estate, and cash. If your portfolio is too heavily weighted toward stocks, you may not be able to stomach the price volatility in your portfolio during poor economic times (risk being that you cash out near the bottom and lose the potential for upside during the recovery). Conversely, if your portfolio is too heavily weighted toward bonds and cash, you may not be able to preserve the purchasing power of your portfolio over time (risk being that inflation cancels out your investment return).

Assuming your asset allocation is appropriate, there remains the risk that your portfolio is not properly diversified. In its simplest form, diversification is “not putting all of your eggs in one basket.” The risk of non-diversified portfolios was especially evident during the technology crash of 2000-01, and the more recent financial crisis when banks and real estate suffered the most significant declines in value. It is easy to get sucked into the idea that we are smarter than the next guy and that we will know when it is time to get out. History, however, proves that even the most experienced investment professionals fail when it comes to trying to time the market on a consistent basis.

Outliving Your Assets
As life expectancy continues to rise, a growing percentage of the population will face this problem. The good news is that this risk can virtually be eliminated with proper planning and willingness to trade current gratification for future security. It all starts with setting goals and creating a plan for achieving them. After that, it mostly comes down to discipline and making good decisions—keeping your eye on the prize.