Having too much cash seems like a good thing, right? Well, yes, up to a point. A cardinal rule of financial planning is to have three to six months of living expenses in the bank as your emergency fund.
But if you have cash — in addition to the emergency fund balance — sitting in some low-interest savings or checking account, it’s wasting away — when it could be doing so much more for you. We most often see this with docs early in practice. They often follow the sage advice to keep their spending level steady as they go from a resident or fellow’s salary to the income of a practicing physician.
So what’s the problem with that advice? Young docs are happy to watch their bank account balance grow as their $60,000 “ramen noodle” income rises to a $300,000 per year “lobster” income. But they often don’t realize the mistake they are making by letting cash sit — without a sound financial plan for investing.
How to Start Allocating Cash for Long-Term Financial Health
If you’re wading in a pile of cash, you’re not alone. As far as problems go, newfound cash is a nice one to have. However, letting it stagnate is no way to build a financial future. Fortunately, the solution is simple. Starting from the beginning of their careers, doctors need to develop a sensible saving and investment plan they can easily follow.
Here are 10 ways to make the most of your extra cash, ranked in the approximate order of importance.
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Keep your emergency account steady. Having an adequate emergency fund — from three to six months of living expenses — helps you sleep better at night. This amount will vary from person to person based on their personal situation and their comfort level about how much cash they might need for emergencies.
But there’s a catch — actually two. First, don’t dump any extra cash into this account beyond the amount you’ve set. Why? Most likely, it will be in a savings or money market account, earning less than 1% interest. You’re better off investing additional cash in higher-earning vehicles. Second, don’t take money out except in true emergencies.
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Save for anticipated expenses. Beyond emergencies, you will need another liquid cash account for large expenses you can anticipate, such as private school tuition, roof repairs, a car replacement, or a long-overdue vacation. You can plan for such expected costs with what we call a “save-to-spend” account. Importantly, this savings or money market account should be kept entirely separate from your emergency fund.
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Pay off high-interest-rate debt. If the interest rate of your credit card debt is at double-digits, pay it down rapidly. Also, see if you can refinance other loans, such as 6.8% student debt. If you can’t refinance at a significantly lower rate, and you’re not planning on using PSLF (Public Service Loan Forgiveness), add this to your pay-down-quickly pile.
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Maximize your retirement plan. Fully fund retirement plans at work with $19,500 per year ($26,000 if you are 50 or older in 2021.). If you’re under 40 and your employer offers Roth deferral, you may wish to fund some or all of the amount with this after-tax Roth money. Why? If your tax rate increases over time, by paying tax on the deferrals now at the lower rate, you avoid paying a higher tax rate on the distribution later on.
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Fully fund your HSA account. Have a high deductible health plan? Decrease your taxes by funding your pre-tax HSA account to the maximum allowed — $3,600 for individuals and $7,200 for families. Further, if you pay for your medical expenses out of pocket, you can invest in the vehicles your HSA vendor likely provides — allowing the account to grow tax-free.
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Take advantage of the backdoor Roth IRA method. Are you and your spouse under 50? If so, you can each fund a backdoor tax-free Roth IRA account with $6,000 per year. Even better, if you’re over 50, you can each contribute $7,000 per year.
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Pay off lower interest debt. I rarely recommend paying off lower interest debt. However, if you’re highly debt-averse, rapidly paying off your mortgage or car loan may relieve stress — and it’s hard to put a price on your wellbeing. No financial advisor is qualified to gauge the emotional impact of paying off these loans quickly, so speak up if you think this option works for you.
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Fund your retirement. Are you funding your retirement investment vehicles to the maximum amounts permitted and still not saving at least 20% of gross income? Open a taxable investment account, and each month deposit the amount needed to reach at least 20% of gross income saved towards retirement. Even better, have the bank automatically transfer the amount from your checking account to your investment account each month. That’s one less decision, and more money saved and invested.
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Save for college. If you have children and are already adequately funding your retirement, consider building 529 college account balances as a tax-free vehicle to help pay for their college education.
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Think about whole life insurance. In most situations, I’m not a fan of whole life insurance, which some insurance salespeople say is a great way to pay for anything from retirement, to college funding, to restoring lost hair. However, if you’re in a high-paying specialty or live well below your means, certain tax-favored features of whole life insurance may make this an attractive option.
Here’s a bonus tip: Now that you’re no longer sitting on that pile of cash, what’s next? It’s important to set up automatic investing each month so you avoid sitting on extra cash again and trying to decide what to do with it. Arrange monthly deposits to an investment account, 529 accounts, the whole life policy, or whatever options you have chosen.
Don’t Get Too Comfortable with Cash.
Don’t let all your extra cash just sit in low or no-growth accounts — especially since the low rate of interest you earn will not even keep pace with inflation. Yes, first you’ll set the right amount of liquid cash in your emergency fund and “save to spend” accounts. But then, don’t waste time. Get busy funding all the other important savings vehicles that will help you achieve financial independence.
The above article is intended for informational purposes only. Please consult a legal or tax professional regarding your situation.
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About Dr Joel Greenwald
Joel S. Greenwald, MD, is a graduate of the Albert Einstein College of Medicine in Bronx, New York, Joel completed his internal medicine residency at the University of Minnesota.
He practiced internal medicine in the Twin Cities for 11 years before making the transition to financial planning for physicians, beginning in 1998.
Joel’s wife is a radiation oncologist, making him all too familiar with the stress of medical practice.
Knowing firsthand the challenges of practicing medicine, Joel’s passion is making the lives of physicians easier by helping relieve them of financial worries.