4 Building Blocks to a Successful Financial Future (Part 2)

In part 1 of “4 Building Blocks to a Successful Financial Future”, I discussed the importance of having an emergency fund in place and how to set a budget. Part 2 will cover the last two building blocks: debt repayment and having the appropriate insurance coverage in place.

Remember, the idea of putting the building blocks in place is to have a solid foundation to build the rest of your financial plan upon. Putting this foundation in place takes time and patience but is critically important. Shortcuts won’t work. Trust me. I’ve been there. You just end up working backwards.

Building Block #3 – Developing a debt repayment plan

If you have been following this blog over the past few months, you know I strongly believe that debt (specifically high interest debt) is the number one factor getting in the way of making progress on other financial goals. Many pharmacists are strapped with lots of student loans ($150,000 median debt load for the class of 2015) that have high interest rates (upwards of 6-8%). This kind of debt can blow up a financial plan if it is not taken care of with intention.

Prior to Jess and I getting serious about paying off our $200,000 of non-mortgage debt, we did not have a specific plan in place for how we wanted to pay off our debt. While we were paying extra here and there, other priorities (buying a home, car purchases, kitchen remodel, etc.) took priority over getting rid of those loans all together. I’m convinced that would not have been the case if we would have had a specific goal in place.

I think there are two keys to making sure your debt doesn’t get in the way of being successful with the rest of your financial plan.

First, determine a pay off date. Look at the total amount of debt you have, your household income and set a pay-off date that is reasonable yet challenging. What do I mean by ‘reasonable yet challenging?’ I mean having a pay off date that pushes you to make cuts in other areas to pay off the debt faster without being so unrealistic that you get frustrated early and bail on your progress all together. Put this date on paper and make it a priority to have the debt erased on, or before, this date. Figure out how you will celebrate when it is gone and track your progress along the way.

Second, after determine a pay off date, figure out how much money per month you need to pay towards that debt and make that a line item in your monthly budget. What do I mean by that? Treat your debt payment as you would any other budget item (groceries, clothing, etc.) Maximize this amount and budget around it rather than hoping you have some extra left over at the end of the month.

I want to challenge you that you probably can pay off your student loans faster than you think with a little sacrifice.

Let’s look at an example of a single pharmacist that graduated in 2016 with $150,000 in loans. Let’s assume this individual makes the median pharmacist salary of $121,500 (Bureau of Labor Statistics, 2015). Assuming approximately 35% of his/her salary would go to state and income taxes, this pharmacist would have a take home pay of approximately $78,975 ($6,581 per month). If he/she could live off of $30,000 per year (which is reasonable with a scaled back lifestyle!), there would be $48,975 available to throw at the debts. Depending on the interest rates, this $150,000 of student loans could be paid off in just over 3 years.

What would happen at the end of these 3 years where there would be no student loans and a lifestyle that is manageable because expenses haven’t risen (since you have been focusing on paying off your loans)? A clean slate to focus on home buying, retirement, giving, and other financial goals that are a whole lot more fun that paying off student loan debt.

If you need some extra motivation here, run a student loan calculator to see how much you will save by paying off a loan in 3 years versus 10 years. For example, if someone has $150,000 in debt at 6.8% interest and decides to pay this off over 3 years, he/she will pay out a total of $166,243 ($150,000 original balance + $16,243 in interest). In comparison, if they were to decide to pay this off over 10 years, he/se would pay out a total of $207,145 ($150,000 original balance + $57,145 in interest). That is over a $40,000 difference!

A while back when graduate student loans were well below 6-8%, there was a case to be made for working towards other financial goals such as saving for retirement in lieu of paying extra on student loan debt. With the exception of an employer match, which is free money, it is hard to make a case that you should be saving for retirement in lieu of paying down student loans (or any debt for that matter) that have an interest rate greater than 6%. After you account for inflation an investment fees (e.g., individual mutual fund fees, advisor fees, etc.), it is hard to argue that choosing investing over paying off debt with this type of interest rate is a good idea.

While I have focused on student loan debt for most of my articles written on this topic, it goes without saying that credit card debt can be even more crippling with interest rates in the 20% range. If you have credit card debt, this should be your number one priority outside of making sure you have money available to pay for basic monthly expenses. .

Building Block #4 – Getting appropriate insurance protection

Here we are, the final building block. Assuming you have a budget in place, an emergency fund built up and a plan to get rid of your debt, we are ready to finish building the foundation with ensuring the appropriate insurance coverage is in place.

Let’s take a look at two basic types of insurance that can help protect the rest of your financial plan.

Life Insurance

Is life insurance really that important? After all, 30% of US households have no life insurance at all (LIMRA Facts about Life 2013).

Here is how to answer that question. If you were to die tomorrow, would your family be in a tough spot since they depend upon your income today? If the answer is yes, then you should ensure you have the appropriate life insurance coverage in place.

How much coverage do you need?

The answer lies in how much income your family would need replaced upon your death. For example, if someone was in their sixties and had $4 million dollars in retirement funds that could be accessed by his/her family in the event of their death, a life insurance policy may not be needed or if so, it may be small. In contrast, if someone were married in their thirties with three children, very little savings and his her income made up 70% of the household income, a life insurance policy (with a significant amount) would make sense. There are several online life insurance calculators (i.e. https://www.mint.com/life-insurance/) to help you determine how much life insurance is appropriate for your individual situation.

While there are various types of life insurance available, some policies pair the insurance policy with an investment option (e.g., whole life, universal life, variable life) whereas others do not (e.g., term life insurance). In my opinion, it is wise to start with a policy that is associated with a predictable monthly payment with the appropriate amount of coverage so you can focus on your other financial goals (e.g., debt repayment). Term-life insurance accomplishes this goal, which provides a certain coverage amount (e.g., $1 million) over a pre-defined period of time (e.g., 20 years) with a fixed premium owed per month. Therefore, if one has a $1,000,000 20-year term life insurance policy, he/she will pay a premium each month for that coverage and if he/she were to die within that 20-year period when premium payments are being paid, his/her beneficiary would receive $1,000,000. While term life insurance does not provide a vehicle for earning any growth on your investment, it achieves the goal of minimizing financial hardships on your family upon death at a fairly inexpensive cost to you while you are alive. For someone that is in their 20s or 30s without any significant health risks, a 20-year term life insurance policy for $1,000,000 can be as inexpensive as $30-$40 per month.

I have a 20-year term life insurance policy worth $950,000 that costs $38/month. My wife has a similar policy for $400,000 that costs $14/month. In sum, we are paying $52/month for the next 20 years ($12,480 total) for $1,350,000. The worst-case scenario is that we are out $12,480 over 20 years. Considering that ‘investment’ gives us peace of mind knowing we, and our boys, are taken care of in the event of one of us dying during that time period is well worth $12,480.

Delaying the purchase of term life insurance was #2 on my top 10 list of financial mistakes I have made. Considering my wife stays at home with our boys and I didn’t pull the trigger on buying term life insurance until after our 2nd son was born, I kick myself for making that decision.

Disability Insurance

Another important insurance consideration for the new practitioner is disability insurance. The purpose of disability insurance is to help replace a portion of your income in the event of a disability or illness that is not work related that impacts your ability to collect a paycheck. While you may think you are unlikely to incur a disability, statistics would say otherwise. The Social Security Administration predicts that more than 25% of today’s 20 year-olds will become disabled before the age of 67. However, almost 70% of those working in the private sector don’t have long-term disability insurance.

There are 2 different types of disability insurance: short-term and long-term. Short-term disability insurance provides a payout of a percentage of your monthly salary for a pre-defined period of time (e.g., six months). For most employers, this insurance kicks in after any accrued sick time is used. In contrast, long-term disability insurance covers a period of time after the use of accrued sick time and the short-term disability insurance policy, all the way to the end of the disability or to the beginning of retirement. Similar to life insurance, the goal here with disability insurance is to protect you and your family from hardships that may occur and to protect the rest of your financial plan.

Many employers offer life and disability insurance as a part of your benefit package but the amount of coverage varies and it wise to determine whether or not the amount provided by your employer is appropriate to meet your needs. If coverage offered by an employer is insufficient, most employers often offer additional life and disability insurance coverage through their broker or policies can be purchased independent of an employer through an insurance broker or professional organization.

Your Financial Homework:

How many of the four building blocks to you have in place? If not all four, do you have a plan to complete these before focusing on other priorities? My challenge to you is to put a plan on paper within the next week to have these completed in a time period that is realistic for you. I’m not suggesting that you have all these complete in 7 days but rather you put a goal in place for each one that you don’t have yet completed. Be as specific as possible in your goal. For example, you may say “I will have an emergency fund of 6 months of expenses in place by July 1, 2017.” Or, “I will purchase a term-life insurance policy and incorporate the monthly premium in my budget by September 1, 2016.” Share these goals and find someone that will keep you accountable. If you don’t have someone that will hold your feet to the fire, send me your goals at tulbrich@yourfinancialpharmacist.com and I will follow-up with you to make sure you are taking action. Taking the time to build this foundation will be well worth it. Get started today.

As always, if you found this information helpful, please share with your friends and colleagues. You can also follow me on Twitter (@Financial RPh) and Facebook (www.facebook.com/yourfinancialpharmacist

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