Investment and wealth creation
for doctors and dentists
How much wealth do doctors and dentists need to accumulate?
How much capital do you need to be financially independent?
This is the million dollar question.
It is clear that doctors enjoy higher incomes and better lifestyles than most people, and based on our experience, the retirement income needs for medical professionals (as a couple) would range from $120,000 to $300,000 p.a. – depending on the amount of travel you want to engage in. Once you have determined the level of income you require, how do you work out the capital you require?
Safe withdrawal rate
One of the ways this can be calculated is by applying a ‘safe withdrawal rate’. This is basically the amount of money that you can withdraw from your investments each year while ensuring that the capital won’t run out during your life expectancy (assuming 20-25 years from age 60).
A withdrawal rate, or drawdown factor, is expressed as a percentage. For example, if you spend $4,000 for every $100,000 you have invested, you would have a withdrawal rate of 4%.
There are different schools of thought, with drawdown factors typically ranging around 4-7%. We prefer to err on the side of caution and work on the lower end of this range, as this typically involves having to take less investment risk. However, you should seek your own personal financial advice.
By way of example, if you wanted a retirement income of $150,000 p.a. and your withdrawal rate was 5%, then you would require about $3m in investment assets (5% of $3m is $150,000 p.a.).
It needs to be noted that this withdrawal rate of 5% is based on a diversified portfolio that holds assets such as shares, property, fixed interest and cash.
Wealth creation strategies for doctors and dentists
Because medical professionals have good income and a long career, you generally don’t need to take a lot of investment risk. Instead, the strategies you put in place and the benefits of compounding will generally do the ‘heavy lifting’ for you. There are several tax-effective wealth creation strategies for medical professionals, and when used in combination which each other they can deliver powerful results.
Superannuation is a still an extremely tax-effective investment vehicle, ant it makes sense to aim for the maximum amount of tax-effective retirement benefits that can be accumulated for each spouse ($1.6m).
This can be a powerful strategy early on in your career, as you can leverage your strong income in a tax-effective way. However, rather than focusing on the tax benefit, you need to ensure you buy quality assets that will increase in value, and you also need an exit strategy to retire your debts.
Family trust – savings and investment plans
Family trusts offer tax planning and asset protection benefits, and offer a unique environment to establish savings and investment plans.
Investment bonds can be a simplified alternative to a family trust, but typically have more limited investment options. They are low maintenance though and offer exceptional tax benefits after 10 years.
Investing versus speculating
To accumulate wealth and achieve financial freedom, you need to invest. However, many doctors and dentists, like so many other people, make costly investment mistakes because they have never learnt the fundamentals.
For example, many people believe they are investing when in reality they are speculating. So what is the difference between a speculator and an investor? In simple terms: investors have a long-term timeframe, whereas speculators mainly try to make short-term profits by actively trading and timing the market. Speculating is generally considered to be higher risk.
Investors believe that as long as they buy quality investment assets and hold them for the long term (‘time in the market’), they will reap the rewards in terms of achieving good capital growth. This is also our philosophy.
According to Albert Einstein, the power of compounding is the eighth wonder of the world. Compounding refers to the ability of an asset to generate earnings (e.g. interest), which are then reinvested in order to generate their own earnings. In other words, compounding refers to generating earnings from previous earnings.
Time plays a critical role in building wealth, and generally speaking, the sooner you start investing the better the long-term results will be. This is because of the power of compounding.
Let’s consider the example where someone starts investing $2,000 per annum from age 20 for 10 years, versus someone who starts investing $5,000 per annum from age 45 for 20 years. Who do you think will have the highest balance at age 65, assuming the average return was 7% p.a.?
Surprisingly, it is the person who invested less ($20,000 in total versus $100,000), but started earlier, who ends up with approximately $337,800 as opposed to $240,000 – a difference of approximately $97,800.
Risk vs return
Different types of investments carry different levels of investment risk and will also produce different expected returns. As a general rule, the higher the potential investment return, the higher the investment risk. So-called defensive assets such as cash produce lower long-term returns and carry a lower risk of capital loss, while growth investments such as shares may provide higher returns but are also higher risk.
Higher risk does not always equate to a higher return; there are risks worth taking and risks that are not. There are many examples of high-risk investment products that have resulted in significant or total capital losses for investors.
It is important that you consider both your appetite for risk and your timeframe before you invest. Over the long term, time can smooth out a lot of the volatility of growth investments, and the longer your timeframe for investment, the more exposure to growth assets you could therefore potentially sustain.
Diversification is a genuine way of reducing investment risk without compromising expected future returns. Diversification involves spreading your investments in order to reduce risk and the impact that any single asset can have on your portfolio.
The ultimate aim of diversification is to reduce the incidence of negative returns, or completely avoid them where possible.
While most people understand the basic concept of diversification, many still do not fully diversify their portfolio. For example, the mere fact of holding several shares does not provide adequate diversification, especially if they have similar risk factors by being in the same geographical market (e.g. Australia) or belonging to similar industry groups (e.g. banks or resources).
If you would like to learn more, you can download our free eBook in the Free Resources section of this website.
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~ Dr Green
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