Poor little rich doctor …

A couple of weeks ago, I responded to a reader request from a young doctor who is on what can only be described as an OMG level of income:

I am a young physician (early 30s) making approximately 800k per year. After expenses and taxes, I am left with ~300k to save/invest.

Never mind the fact that he is losing approximately $500k a year in “expenses and taxes”, a $300k take home is still pretty good in anybody’s language!

There was plenty of well-considered reader debate and advice for the young doctor, including this highly-reasoned argument from traineeinvestor:

I’d suggest he continue to focus most of his energy on maintaining or growing his professional income. Time spent on side ventures and investments should be limited so that it does not interfere with the $800K professional income.

In terms of investments, given his time constraints, I’d go with a Boglehead approach, possibly supplemented with some geared cash flow positive real estate (especially if he lives in the US and can take advantage of depressed prices and long term fixed borrowing costs).

I agree on both counts:

a) When you are earning a super-high level of salary, your primary goal should be to protect that source of income. It’s a river of money: you should do everything in your power to keep it flowing!

b) However, you shouldn’t just let the money flow into the taxman’s pocket, then into yours, and then out again by increasing your spending. Instead (and in keeping with our ‘river’ analogy) you should also build a downstream dam.

And, you should only open the sluice-gates to let off a much smaller amount than is going into the dam …

Why?

Because that’s the only way that the dam gets to fill up!

This way, when the river stops flowing (ideally, at a time of your choosing i.e. early retirement, but it could be forced upon you even earlier for a variety of reasons), you can keep the sluice gates open, knowing that there’s still enough water in the dam to keep the flow running for the rest of your life.

In other words: you don’t want the dam to run dry before you do

But, this is much harder to achieve than you may think, so here’s where I differ – but, only slightly – starting by reversing the order of traineeinvestor’s otherwise excellent investment strategy:

I’d go with a geared cash flow positive real estate approach (especially if he lives in the US and can take advantage of depressed prices and long term fixed borrowing costs), possibly supplemented with some Boglehead-type investments.

The reasons are two-fold:

Firstly, I’m not accepting that 62.5% (i.e. $500k) of our doctor’s $800k earning capacity can simply be wiped off in ”expenses and taxes” …

… professionals are just sitting ducks when it comes to taxes.

But, by implementing a nicely geared (and, maybe even cashflow negative after depreciation allowances) real-estate strategy, there may be deductions that can legitimately increase his super-high professional’s take-home income, without falling afoul of the tax man.

This is a clear-cut case of where a professional’s advice can add huge value [AJC: not in asking "is real-estate a good investment for me" but in asking "is real-estate a good tax-advantaged but highly legitimate investment vehicle for me?"], and our doctor should not take another step without seeking such professional advice.

Secondly, he should go through every single expense with his accountant and see what he can reduce or better manage. Nobody can afford to burn $500k worth of dollar bills …

… not even a super-high-income doctor.

Secondly, real-estate (especially when prices are depressed) is just a great long-term investment.

With his $300k (and, hopefully much more once he implements some of his accountant’s tax and cost-management advice) cashflow plus any income that he receives from his tenants, the doctor can afford to leverage quite a large portfolio of such high-quality, long-term, income-producing investments.

And, it is this large portfolio that becomes his growing ‘dam’ of cash, trickling out at perhaps a $100k – $150k sustainable annual spending rate … one that he should be able to index with inflation and maintain for his whole life, whether he (one day, perhaps quite soon) chooses to work full-time, part-time, or not at all.

And, isn’t that the whole (financial) point of it all?

Why are professional athletes so horrible with money?

In 2009, Sports Illustrated observed:

78% of NFL players and 60% of NBA players are bankrupt within two years of leaving the game.

From this Get Rich Slowly concluded:

Many professional athletes are horrible with money.

Why does this occur?

Investopedia in a recent article stated the obvious:

Athletes have a unique problem that many other professions don’t: the earnings window is small. While the more traditional careers may allow a person to work 30 to 50 years, a professional athlete will work only a fraction of that time. This leaves the retired athlete with the job of managing what they have to last for the rest of their life with only a fraction of their old salary being earned.

Whilst I agree with GRS that many sports players are horrible with money, this is simply an undistributed middle fallacy of the type:

1. All students carry backpacks.
2. My grandfather carries a backpack.
3. Therefore, my grandfather is a student.

In other words, this problem is not isolated to athletes … they are just one class of people who have highly skewed earnings.

Others include anybody with what I call “Found Money”, which is my term for any one-off (or otherwise time-limited) sudden influx of cash. For example:

- Anybody who signs a major contract (athletes, musicians, actors, celebrities, even sales people or small business owners who “land that once in a lifetime deal”)

- Anybody who wins a substantial sum

- Anybody who inherits a substantial sum

… and, so on.

The Horrible Money Management Syndrome, that Get Rich Slowly incorrectly attributes to athletes, actually comes with the sudden influx of money i.e. it’s a problem with the source, not the recipient.

For example, there are lottery winners from all walks of life, yet the operators of the UK Lottery found that, on average, lottery winners had spent 44% of their winnings after just 2.5 years, which supports the anecdotal evidence that 80% will be entirely broke in just 5 years after winning a major lottery!

Whilst some sharp wits may observe that this is “because the qualifications for playing the lottery are being ignorant of the principles of mathematics” [AJC: for example, as one blogger recently observed, you are more likely to die from melting underwear than winning the lottery], my theory is that …

… you need to learn the lessons slowly on the way up, in order to stop yourself learning them the hard way on the way down.

In case any of you are planning to make a lot of money quite suddenly [AJC: even faster than $7 million in 7 years 'suddenly'], you would be wise to heed the lessons that I taught my children when they were still very young (and, follow to this day):

When they get money [AJC: Any money: an allowance, a gift, find it on the street, etc.] half goes into Spending and the other half into Savings.

So, too, does it go for you: anytime that you get any additional money [insert 'found money' methods of choice: you're a professional athlete; you win the lottery; you get a pay increase; a second job; loose change that you save out of your pockets; a gift; a manufacturer's cash rebate; tax refund check; etc.; etc.] you Spend half and you Save half.

At least, this is advice that will tide you over until I share my Found Money System with you …

… next time

How to start with next to nothing in cash and build up from there?

Ken H asks:

I am just starting my journey to the concept of making money when you buy. Can I get more examples of what can be bought to use this concept? Where do I learn a strategy that I can start with next to nothing in cash and build up?

Great question, Ken!

The short answer is that you need a source of cashflow.

The long answer:

A high-paying job is ideal (but, only if you invest 30% to 50% of it after tax) …

… if not a high-paying job, then a second source of income.

I like the idea of starting an online business ‘on the side’ and reinvesting 100% of the profits (a) back into the business to help it grow and, whatever’s left over, (b) in income-producing investments.

The ideal investments, of course, are ones where you can get a silent partner to put up 75% – 90% of the money required. That way you can get more investments quicker.

Also, when the bank puts in 80% of the funds required to fund a real-estate acquisition, and it goes up in price by 20%, you have just doubled your money (less the bank’s interest).

And, the best ‘silent partner’ that I know is The Bank. But, the investments that The Bank likes the most – hence, they will lend by far the most on these – is good old-fashioned real-estate.

So, I would reinvest as much of my savings as possible into real-estate, and then wait 10 to 20 years (unless my business grows really fast, in which case I might wait 5 to 10 years.

Sure beats ‘working for The Man‘ for 40+ years, doesn’t it?

How to become a wealthy doctor?

We all have this image of doctors. We believe that that they are all-knowing and well … rich.

But, is that really the case? Let’s check out what this young doctor (a new reader), David, has to say:

I am a young physician (early 30s) making approximately 800k per year. After expenses and taxes, I am left with ~300k to save/invest. However, I have been making ~40k for the majority of my working life and am completely overwhelmed as to how to handle this chunk of change (unfortunately I received no financial education in medical school…). Do you have any advice as to how and where I should allocate this money? I am worried about investing too much money in one source and would like to be fairly diversified.

You see, right here is where doctors go wrong!

Firstly, $120k – $250k net spending money p.a. [AJC: my estimate, depending on how the taxes and other expenses work out] is, indeed, quite a large “chunk of change” …

… especially when jumping from $40k starting salary.

So, the first mistake that most people in this situation make is to immediately increase their standard of living. Now, a conservative person won’t increase their living standard to $120k less 10% (because that’s what the books tell you that you should ‘pay yourself first’), but the chances are that they will raise their living standard quite dramatically.

The $40k quickly becomes $60k as they equip themselves with a new car and some extra furniture and a larger TV or two … then $85k as they move into a bigger apartment (with a view) … then $120k as they step into a more committed relationship and buy the house, school the kids, and so on.

In other words, the treadmill has a way of increasing its speed until you forget that you are supposed to be ‘rich’.

You see, David’s sudden increase in income comes under the heading of ‘found money’; I’ll post on it soon …

Life’s tough at $250k a year …

I was chatting to a friend last night and was amazed at his reaction to what I had to say.

The conversation went something like this:

Me: Did you see that article about the guy who can’t live on $350k a year?

Him: What guy?

Me: Oh, some guy written up in the Wall Street Journal the other day.

Him: I didn’t see the article. What about him?

Me: He’s a lawyer or law professor or something who earns $350k a year and can’t make ends meet.

Him: Yeah, I know people like that. Remember Elton John nearly went broke?

Me: Yeah [laughs]. But, that’s not what I’m talking about. He says he can’t even afford to own a house because he lives in New York … in Queens or Brooklyn or somewhere like that … and between his taxes … I think he pays nearly half in taxes … and his rent, he is really struggling.

Him: Poor him [laughs]

Me: [laughs]. Yeah I guess it seems funny. But, I actually know where he’s coming from. I own my house and my cars outright. OK, I have two kids in private school, so that’s expensive. But, we struggle to stick to our $250k a year spending budget.

Now, here’s the weird part: my friend didn’t seem surprised at all …

… like NOT being able to live on $250k a year (before taxes) when you have NO mortgage, NO car payments – in fact, NO debt at all – is nothing unusual.

I made $7 million in 7 years so, for me, spending ‘only’ $250k a year is probably being frugal.

What’s his excuse?

And, how much annual expenditure are you banking on your Number being able to produce?

Installing an ATM in your business …

I met a small business owner a few weeks ago …

He was a smart young guy [AJC: aren't they all?] who was setting up his own Internet design studio, building Internet-based software projects for other business owners.

His business is essentially a professional service business, and my advice to him was pretty much the same as I give to all professional service business owners (consultants, accountants, attorneys, doctors, etc.):

Except in rare circumstances, you don’t have a business, you have a high-paying job … with perks!

[AJC: the perks are around the tax benefits that attribute to business owners but not to paid employees; ask an accountant for examples.]

Most of these kinds of businesses don’t scale very well i.e. they can’t grow very large; they rely on the owners’ personal exertion (sometimes called ‘partners’); and, either can’t be sold, or can only be sold for small multiples of annual profit or turnover.

In short: you can’t rely on selling these businesses to fund your retirement.

But, what they do generally provide is income …

Because they are professional services, the owners are able to sell their own labor – and, those of their employees – at high multiples, usually generating excellent recurring revenue.

And, because they often take years of hard work and relationship building over many, many clients they can be quite “bullet-proof” (if well managed) in terms of providing that income reliably.

This was certainly the case for the young guy that I met.

Even though his agency was still quite young/small, it was already generating a nice income and showing signs of growing well.

My advice for him was to grow his personal income very slowly (this is advice that I would give to any business owner), and to pull as much money out of the business as possible (this is not advice that I would give to other business owners) …

… my advice was to treat the business as his personal ATM

[AJC: but not to the detriment of the business, or his partners, employees, clients, backers, etc.]

But, my advice was not to spend that ATM-cash on personal lifestyle building (homes, cars, vacations, etc.), but on passive investments.

I recommended that he use that cashflow to fund an aggressive investment portfolio, outside of his business: one that would one day grow to replace his personal income as generated by the business.

When the day comes that his passive income surpasses his personal business income, he becomes free.

What would you advise?

Are wealthy people more unethical?

It’s nice to see science magazines writing about money

This time , it’s trying to find a link between wealth and (a lack of) ethics.

This is not a new notion, just check out Charles Dickens’ “A Christmas Carol” and it’s offshoot – and my favorite cartoon character – Scrooge McDuck and you need look no further.

But, I think that these scientists – and authors and cartoonists – miss the point:

You do not have to be unethical to make money …

… and, I think that it actually harms your chances as people often can spot unethical tendencies and will take that (correctly) as a sign that they cannot trust you.

However, if the study is correct, I think one explanation may simply be that wealthy people have been exposed to more opportunities to make the “should I be ethical or unethical in this situation?” decision.

More exposure simply means more unethical behavior evidenced.

For example, working on a production line may not produce wealth …

… but, it also may not produce many opportunities to take unethical action during the 8 hours a day that you are at work.

[AJC: although, you may have plenty of opportunity to indulge in unethical behavior after hours if that is your bent]

However, being in business or running around making real-estate investments may give you plenty of extra opportunities to (a) become wealthy and (b) exhibit unethical behavior both during and after hours, thereby giving you twice the exposure to both potential outcomes.

So, I think it is a case of increased exposure rather than cause and effect …

What do you think? Do you need to be unethical to make money? If so, is that a ‘cost’ you are willing to carry?

Did I fail the Ultimate Money Test?

Financial ‘personality tests’ are fun. I like doing them; you should try this one.

Unfortunately, the results don’t always speak for themselves:

[AJC: the star is my score; very average, as I am in (almost) all things in life. The $7m7y logo to the top-right is how my financial performance probably compares to 99%+ of the population]

Whilst this is a pretty good test – much better than many others that I have seen – it will only identify average performance and sub-/super-performance perhaps to one standard deviation (for those statisticians amongst you) …

… however, these tests can’t identify the factors that produce the outliers i.e. the ones (like me) who can make $7 million in 7 years.

If you want to produce (slightly) better than average financial performance over your lifetime, use this test – and others like it – to identify areas of weakness, typically:

- Not saving enough,

- Overspending,

- Credit Card Debt,

… and so on.

All valid reasons why you may be in financial trouble today, but certainly not highly relevant to your chances of retiring rich and retiring soon.

If you do want extraordinary financial performance, keep reading read this blog

Before you can find the answer …

Yes. Before you can find the right answer, you need to know the right question.

So it is with personal finance: most pf bloggers will answer a whole variety of questions:

- How can I become debt free?

- How can I pay off my credit cards?

- How can I save for retirement?

- How can I be more frugal?

BUT, these are not the questions that you need to be asking … at least, not at first.

No, there are only TWO questions that you need to ask. The first is in two parts, and it simply asks:

a) How much money do I need to support the life that I truly want to live? And, b) when do I want to begin?

I have a hypothesis about the typical answer to these questions, but the truth is that for every human being on this planet there is a different answer:

For some, it may be that they are happy doing what they are doing today, and are happy to keep doing it until they drop. For, them personal finance begins with maintaining their current lifestyle (which probably revolves around maintaining their employment) and staying healthy.

It probably also means learning all the lessons about personal finance that the blogosphere has to share: living below your means, eliminating debt, cutting up your credit cards, paying off your home, setting aside an emergency fund …

My second question – which I’ll come to in a moment – is moot for these lucky, satisfied, job-secure, working-class few.

But, my hypothesis is that most people are not satisfied with their current lifestyle … that you are not satisfied with your current lifestyle … that you:

- Want more time with your family,

- Want to indulge your hobbies and interests,

- Want to travel more,

- Want to be more relaxed and healthier,

… and, the list goes on.

And, I’ll wager that the limiting factor for you, right now, is money.

But, I’ll also bet that with a little thinking, you could come up with a salary that if a rich uncle were to pay it to you, would allow you to stop working full-time (or, altogether) and fund your ideal lifestyle.

I’ll also take a stab that ‘salary’ would bear little resemblance to your current salary.

But, if you can take an educated guess at what that ‘salary’ would need to be, I can tell you what your Number is (the answer to the first half of my first question) simply by telling you to multiply that amount by 20.

Let’s now assume that you have no rich uncle and have to amass this amount yourself …

How long will you give yourself to reach your goal so that you can begin to live the life you really want to live before you are too old to enjoy it?

I gave myself just 5 years to reach my Number of $5 million; in the end, I made $7 million in 7 years, starting $30k in debt.

[AJC: keep in mind that the longer you allow to reach your Number, the larger it will need to be because of the effects of inflation. For example, whatever Number you come up with today, you will need to add 50% if you aim to reach it in 10 years, and you will need to double it if you are prepared to wait 20 years ... just to keep up with inflation.]

Which brings us to the second most important question in personal finance:

How am I going to get there?

For example, in order for me to reach a $5 million target in 5 years from a virtual standing start:

- I had to learn how to invest (I had no investments and no idea HOW to invest or WHAT to invest in)

- I had to turn my business around (it was breaking even, at best)

- I (more importantly, my family) had to sacrifice our existing life: we had to move overseas, my wife gave up her career, my children their friends, we all gave up our families for the 5 years we were away from home.

But, we all agreed that it would be worth it, because we had already answered the first question (both parts).

How about you?

Are polar bears left-handed?

Here’s some interesting ’information’ that I picked up:

Apparently, all Polar Bears are left-handed.

Well, it seems that there are two types of people in this world: those who will now run off and propagate this ‘fact’ at trivia and pub nights, and those who will go and check their sources.

I’m in the latter … now, I’m not obsessive about it, so this information ‘seems’ right, but I’ll let a polarbearophile prove me right or wrong with these Polar Bear Myths:

- A hunting bear will cover its black nose while lying in wait for a seal.

Canadian biologist Ian Stirling has spent several thousand hours watching polar bears hunt. He has never seen one hide its nose, nor have other scientists.

- The great white bears are left-pawed.

Scientists observing the animals haven’t noticed a preference. In fact, polar bears seem to use their right and left paws equally.

- Polar bears use tools, including blocks of ice to kill their prey.

Scientist Ian Stirling believes that this assertion can be traced to unsuccessful hunts. After failing to catch a seal, a frustrated and angry polar bear may kick the snow, slap the ground — or hurl chunks of ice.

- A polar bear’s hollow hairs conduct ultraviolet light to its black skin, thus capturing energy.

This theory was tested—and disproved—by physicist Daniel Koon.

- The polar bear has a symbiotic relationship with the arctic fox, sharing its food in exchange for the fox’s warning system.

Not only is the bear-fox relationship not symbiotic, the little foxes often annoy the bears. An arctic fox will sometimes tease a bear by darting in to nip at its heels and will sometimes try to drive a bear off its prey.

- Orca whales prey on polar bears.

This has never been observed.

- Polar bears live at both poles.

Polar bears, of course, live only in the circumpolar North. They never encounter penguins, which do not live in the same regions as polar bears.

[AJC: Polar bears = Arctic and Greenland; Penguins = Antarctic, Australia and New Zealand. Get it??!!]

Source: http://www.polarbearsinternational.org/bear-facts/myths-and-misconceptions/

So?

Well, if this is how many myths polar bears can generate, imagine how many there are about our favorite subject: personal finance?!

Here are just some that I have tried to dispel on this site:

- The myth that entrepreneurs are driven by greed

- The myth that a high income equates to wealth

- The myth that diversification is one of the most important personal finance tools around

- The myth that retirement planning centers around replacing your income

… and, I have written many, many more (just type the word ‘myth’ into the search box at the top of this page).

What myths (personal finance or otherwise) have you recently had cause to question?