By the Numbers: 3 Common Financial Mistakes With Major Consequences
By Tomas McFie, DC, PhD
Warren Buffett is on record for sharing the hidden art of becoming wealthy and making it simple enough for anyone to grasp. He has done this by boiling down his financial wizardry to just two simple rules: "Rule # 1: Never lose money.Rule # 2: Never forget rule # 1. But just because something is simple doesn't make it easy, and in attempting to make something simpler than it really is, you run the risk of destroying the value of whatever it was in the first place.
So, how can you, as a chiropractor, apply Buffett's two simple rules of building wealth into your life without destroying it? The answer to that question is easy (no pun intended.) It comes down to understanding three common mistakes most doctors make and knowing how to avoid them; and just as important, using that knowledge to your benefit. After all, many of your peers will likely ignore this advice because, according to CNNMoney, "Doctors are reluctant to trust the opinion of anyone other than their own."1
Mistake #1: Not Understanding the Value of Your Own Money
What is the value of your own money and how does that relate to building wealth according to the two rules Buffett has delivered? Suppose you are planning to acquire a new computer-based patient records system for $12,500. You can lease the system, purchase the system for cash or finance the system.
If you finance the system, your payments will be $253.45 a month for five years. If you lease the system, your payments will be $275 a month with a $500 buyout after year five. And if you pay cash for the system, you will have no payments.
You may not realize it, but if you choose to finance, you will pay a total of 21.66 percent over the cost of the system in payments, even though the loan rate is only 8 percent APR. If you choose to lease with the buyout option, then you will pay 36 percent more than the original cost of the system.
Even if you pay cash for the system, you might be losing 10 percent or more because your own money could have been compounding for you during that five-year period. Earning only 2 percent, that $12,500 could have grown to $13,813.49 (10.51 percent more) in that five years.
Thus, it becomes imperative that you use the tool bankers and the Fortune 1000 CEOs use to park their money in. They do this so they can continue to benefit from the compounding effects of money while being able to leverage it without penalty or service charge. Going back to the scenarios above, you would be able to keep the 21 percent, 36 percent or even just the 10 percent you would be throwing away instead. And in doing, so you'd be right in line with the two wealth-building rules proposed by Warren Buffett.
Mistake #2: Not Tapping Into the Power of Debt to Build Wealth
Money is a funny thing. Today, money is a derivative of debt, just as surely as orange juice is a derivative of oranges. If there were no oranges in the world, there would be no orange juice; likewise, if there were no debt, there would be no money. But how does this make any difference to you, a chiropractor trying to build wealth?
Again, the answer is easy, but if you don't understand where you are, how are you going to get to where you want to go?
Most chiropractors earn less than $100,000 a year, with the median income being $65,300 according to the U.S. Bureau of Labor Statistics (2013). There are several reasons for this brutally low level of income, but one reason is connected to the Income Based Repayment and Forgiveness plans on student loans that are being bantered about today.
Debt that is forgiven is considered income by the Internal Revenue System on the date that debt is forgiven. What you were planning on being a windfall may become a hard reality. That reality could be impossible to make up at that later date.
But putting the tax consequences aside, consider the math. If you have a $150,000 student loan with an interest rate of say, 5.46 percent, you can pay it off in 10 years by paying $1,625 a month. If you qualify for a Qualified Income Based Repayment and Forgiveness plan, you might be able to reduce your monthly payment to half of that and only have to pay $812.50 a month for the next 25 years. But doing so will require you to pay $48,750 more on your student loan.
Why would anybody want to throw that kind of money away? For the average chiropractor, that's more than a year's worth of net income down the commode.
Carefully consider your options. If you can afford to pay the $1,625 monthly payment, do it. Then, when your student loan is paid off, continue to pay that amount to yourself – you're worth it! Prove it to yourself. Earning a low interest rate of only 2 percent, that $1,625 will accumulate $340,784 toward a better retirement, which according to CNNMoney is several hundred thousand dollars more than the average net worth of Americans 55 and older today.2
Using debt in this manner can build wealth. Yet too many chiropractors still believe debt elimination, not the continuation of preferred debt, is the key to building wealth.
Not understanding the value of your own money and not tapping into the power of using debt to build wealth are two of the most common mistakes that are costing doctors hundreds of thousands of dollars today. The third mistake is similar, but different because it has to do with the government's qualified retirement plans.
Mistake #3: Overlooking the Cost of Qualified Retirement Plans
Forbes.com is now on record as saying, "It's time to rethink savings. You might be better off skipping the 401(k)."3 Even the U.S. Department of Labor reported in August 2013 that "by far, the largest component of 401(k) plan fees and expenses is associated with managing plan investments ... you should pay attention to these fees (as) these fees ... may not be immediately apparent."4
CNNMoney has reported multiple times on the cost of these fees. You would do yourself a favor by spending some time online using their website-based 401(k) calculator to learn just how much a mistake down this long dark alley will cost.5 Many will lose over $100,000 to these occult fees and service charges, believing that the money printed on their quarterly statements is all for them in their golden years of retirement.
For now, however, forget about the service fees and charges associated with these qualified plans, and focus on the restricted use of your own money and taxes, which you are going to be required to pay in the future.
Marion Snow, in her book Stop Sitting on Your Assets, documents that if you defer $1,200 of taxes in a 401(k) or other qualified plan, you will pay that $1,200 back to the IRS over 18 times by the time your are 84 years old. Who would have ever thought that could be possible? Well, you need to know who thought it was possible and why they call these plans qualified.
Qualified plans are structured such that you pay a penalty if you use your own money before you are 59½ years old. Then you have a penalty-free zone of 11 years during which you can use your own money without paying any penalty. (You still have to pay the taxes on any of the money you use; but no penalty is assessed.) Then, once that 11-year period has passed and you've reached the magical age of 70½, you enter into another penalty zone that will last until the end of your life – or until all your money is gone.
In this later stage, if you don't take out the required distribution from your qualified plan, the IRS will. And it will keep 50 percent of what you were required to take out!
Now imagine needing to borrow from your qualified plan before age 59½. What then? Well, if you qualify for the loan, you will be charged interest for using your own money, and that interest will be paid with after-tax dollars. When you take your money out in retirement, you will get to pay taxes again on that same money. Double taxation!
If for some reason you can't pay the loan back in the qualified time period allowed, then you will be taxed on that loan as if were income earned that year – a tax burden that has left many a doctor financially wiped out.
Contribute $5,500, the maximum annual allowed, and you will lose the opportunity of that money ever working for you again without paying a penalty, more taxes or both.
The solution: Don't play the qualified plan game because when you do, you are giving others permission to use your money unrestrained, many times over again; and you are willfully exposing yourself to the risk that comes with it: a chance of losing it all.
Besides, there is no tax advantage when it comes to deferring your taxes in a qualified plan. If you defer the tax on $5,500 today and it can produce an 8 percent growth while deferring taxation on the gains, then in 20 years you will have $27,097.42 in your qualified plan account. Now begin taking that money out. If your lifestyle is similar to your current lifestyle, then plan on paying the same percentage of taxes on your income then as you do today – a highly unlikely event because taxes paid have gone up every single year since 1913 when the tax code was first introduced, even though tax rates have been as high as 93 percent in 1945 and as low as 1 percent in 1913, according to the Internal Revenue Service.
Assuming you are paying 30 percent of your income today to the IRS, you can safely assume you will be paying 30 percent or more of that $27,097.42 to Uncle Sam in the future. That means $8,129.23 of that $27,097.42 isn't your money, but the IRS allows you to keep it in your account so it continues to grow – and the taxes the IRS can collect will be even greater as the money in your account continues to compound at 8 percent.
By the way, that $8,129.23 is $6,479.23 more than what you deferred 20 years ago. And pathetically, your original $5,500 was more valuable because inflation will have eroded away the value of your dollar by then.6
You might say, "But I don't intend to take all my qualified plan money out as soon as I retire. I only want to take out 8 percent ... just live off the interest and let the principle continue to work for me."
Well, 8 percent of $27,097.42 is $2,167.79. What kind of taxes will you pay on that? Try $650.34. And how much tax did you originally offset by that contribution of $5,500? $1,650. So, in three years of "living off the interest," you will have paid $301.02 more in taxes than you deferred 20 years earlier. And the craziness of it all is that you still won't have the use and control of your own money. You will still be assuming the risk of losing everything while someone else puts your money to work for them.
And for those of you who are self-employed and think you gain more because your corporation gets to deduct the matching contribution to your own self-employment qualified plan account, think again. You have opted to pay Social Security tax in the future on money you could have used today, only paying income tax today. But that's the price for this common mistake most doctors make.
The good news is it doesn't have to be this way. You can take control of your own money and overcome the commonly known fact that doctors lag financially 10 years behind those who do not pursue a higher education and specialized training. You can heed the advice about common mistakes that prevent you from using and controlling your own money. You can build an enormous legacy while enjoying a lifestyle that will outpace and outperform your peers.
Dr. Tomas McFie, a 1985 graduate of Palmer Chiropractic College West, has owned four wellness clinics in three states in his 25 years of practice. He is the founder of Life Benefits, Inc., and writes and lectures extensively on how to understand the banking equation and reap the financial rewards.