The Doctor's Bill: Jersey Shore Decision

Johanna’s Take:

Dr. and Mrs. “Mike T. Situation” are tired of renting and want to buy a sweet little crib in New Jersey for $1.1M to house their family of six.

They have a 20% down payment saved and are 25 years from retirement. Dr. MTS wants to know, “Can we afford it?”

In preparing this analysis, I had a few questions for Dr. Mike, but my timing may have been off because I was unable to reach him.

So, for the purposes of this evaluation, I have read between the lines to lay out some assumptions, listed below.

The positives:

· Relatively high income

· Planned long career

The negatives:

· Savings rate of only 12%

· 4 children to put through college – I question whether $250k will be enough

· HCOL state

Basic assumptions (I will use conservative estimates wherever there is an uncertainty.)

· 6% average long-term returns on savings (Assuming no emotional mistakes in upcoming bear markets and corrections)

o By my calculations, they will have ~$3.5M at retirement

· Average inflation

· Plenty of appropriate life and LTDI in place.

· No divorce

· Savings of $43,800/yr for 25 yrs

· No significant financial assistance for other family members

· Reasonably good health

Additional facts I assumed:

· $250k down-payment

· 5%, 30-yr loan

· Currently paying rent of $3k/mo

· Already contributing to 529s; I bumped up savings needed to $300k in future dollars

Typically, when I first review a submission, I make a snap judgment – “thumbs up or thumbs down?”, then try to prove myself wrong.

I wouldn’t be surprised to find most of our readers do the same.

Then I begin my analysis, plugging in the numbers, emailing the applicant, putting it all together in a logical report, and cross-testing figures.

It’s fun to see if my final opinion matches what I initially intuited.

When I first read Dr. Situation’s information, I was not feeling very optimistic about him purchasing a home at triple his salary, so I guessed “thumbs down”.

According to the “buy no more than 2 – 2½ times your income, it wasn’t.

According to the 28% rule (mortgage payments should be no more than 28% of your monthly gross), however, it was affordable.

Interesting.

Then I began my calculations.

My first step, if applicable, is to calculate NPV of the future nest egg needed for college.

I take that right off the top of current savings.

This is a very conservative measurement because I assume front-loading rather than spreading deposits throughout the life of the 529 (the term for saving for a known future need is a “sinking fund”).

Given the ages of the 4 children, I calculated an NPV of $144,926.

Next, I project savings at retirement given the current savings rate.

I have created “tranches” for the various stages of a physician’s career in my spreadsheet.

For example, full-time for 10 years, then part-time until retirement, consulting for a few years, etc.

This one was simple – only one tranche.

Calculations showed ~$3.5M by retirement at age 64.

I think that’s on the low side.

The PV of that amount today is $1.7M, not an amount I would advise a client to retire with.

Third step is to look at cash flow – do the numbers provided make sense?

This is where things can get interesting – and our “Jersey Boy” did not disappoint:

Gross income $ 365,000

Savings @12% ( 43,800)

Living expenses (110,000)

Est. taxes (federal, state, FICA, local) (98,550)

Unaccounted for (EXCESS) $ 112,650

We are missing even more dollars than the Situations have calculated for living expenses.

What could this possibly mean?

I came up with several possibilities:

This amount has been going into their down-payment account, excluded from the savings %.
They have been contributing this to 529s, excluded from the savings %.
They are spending a heck of a lot more than Dr. S estimated.
A combination of the above.

Given their location, monthly PITI [Principal, Interest, Taxes, Insurance] payment is ~$7k.

This is an extra $4k above the rent they will be replacing, or $48k/yr.

The Situations easily have enough excess to cover this – if they truly do have excess of > $100k/yr.

So, yes, they can afford the mortgage.

But let’s be honest: most all of the folks who submit their information for analysis can afford a given luxury if they reduce their savings rate enough.

What I am trying to determine is if they can afford their dream and accomplish the Big Kahuna: their retirement goal.

That means I’m very uncomfortable with buying a $1.1M house given a paltry 12% savings rate.

I believe this leaves them significantly underfunded for retirement.

And we haven’t even considered the possibility that Dr. Mike may not want or be able to work another 25 years.

This is too great a risk for me.

I’d like to see Dr. Mike do the following:

· Bump up savings rate to 25%, which would give them ~$6.2M at age 64 or ~$4.3M at age 59.5, in 15 yrs.

· Put together a solid budget and figure out where the “leakage” is.

· If the unaccounted-for funds are being saved for the down-payment, continue this for an extra 2 yrs and put the excess (after increasing retirement savings to 25%) down on the house.

I think this is possible and affordable – just not quite yet.

In this instance, I’ll stick with my initial guess…

Xrayvsn’s Take:

I was happy to see that Johanna revealed some of her methodology in breaking down these financial case studies.

I also am prone to making a snap judgement when I first go over the financial details provided and then try to do a deeper analysis to see if my judgement remains the same or if I have a change of heart.

In my first pass through a case submission I like to emphasize red flags, things that make me hesitate to give approval for a large purchase such as this home.

The big red flags in the current financials provided for me were:

Low savings rate of 12%.
- As a physician who is already behind the 8 ball when it comes to retirement savings it is vital to make up for lost time from the delayed start of earnings.
- The 10-15% savings rate that may be adequate for the more traditional workforce really leads to under-funding of a physician’s retirement account because of the delayed time penalty we incur.
  - Financial Samurai has a great discussion of what your net worth should be for a particular age for a traditional worker and you can see how this doctor (and most doctors at this stage) fall behind the curve.
  - Because of this I really am a proponent of saving at least 20%, and prefer 25-30%, of your income if you plan on making up financial ground.
Liquid Assets of $250k.
- Although this seems like a large sum (and it is), the majority of this ($220k) will be required for a 20% down-payment, leaving only $30k.
Four children.
- Don’t get me wrong. Having children is a tremendous source of joy, but from a financial standpoint each mouth to feed can chew up some sizeable resources in a heartbeat.
  - Having just become a parent of a teenage daughter myself, I will tell you that the expenses only exponentially climb as they get older.
Optimistic view on college expenses.
- Depending on where they end up going, $250k may not be adequate enough to cover one, let alone 4 children given how tuition costs are far outpacing inflation.
High Cost of Living Area
- I have previously written how geographic arbitrage can impact your finances.
- On top of more expensive property taxes and housing costs, the state income tax of 6.37% takes another large bite of the income pie.
High mortgage required ($880k).
- White Coat Investor wrote a post which gave a guideline for having your mortgage < 2x your gross salary.
  - In this case this would put the highest recommend mortgage at $730k.

The positives that are going for this doctor are also not a given:

High income specialist as a radiologist.
- There have already been rumblings among the radiology community about what kind of impact artificial intelligence may have on our field.
  - Potential downsizing the number of radiologists needed.
  - Potential drastic reimbursement cuts as computers will provide cheaper alternatives.

Now do I feel that AI is an imminent threat to my livelihood?

No.

But my anticipated remaining career length is far shorter than that of this submitter.

Which brings me to the next point…

Plan of working for another 25 years.
- It was around this age that burnout started to rear its ugly head for me.
  - Ask me when I was a fresh-faced, newly-minted radiology attending about how long I could work for and I would have given you a far different answer than what I would now as a grizzled, “mid/late career” radiologist.

A desired $110k/year spending in retirement would require $2.75M of income producing assets (i.e. home value not included unless plan on downsizing/selling) in today’s dollars.

Johanna calculated above that on the current trajectory the doctor would have $1.7M (today’s dollars) at retirement, which highlights the shortfall that will happen.

The Decision:

Johanna Verdict: Thumbs down

Xrayvsn Verdict: Thumbs down.