Over the last 32 years I have been following the literature concerning money, investing and debt. In the last few years I started writing about the topic as well as sharing my knowledge with other physicians through one-on-one financial coaching. Through the years I have seen many people make the same mistakes when projecting financial goals, and they make them year after year.

When all of the answers are at our fingertips on the internet, one would think people would figure out how to make financial projections correctly. But I think the real answer is that short cuts are being taken to make these calculations, which lead to the wrong results. I remember the first time I saw this, it was in a popular money magazine that I trusted when I was younger. The author showed us their client’s numbers and gave a projected retirement date. But as I looked over the numbers, the projection was way off. The person could have retired long before the date the “expert” had calculated. That was the day I realized not everything I was reading in those magazines was correct.

The following are the four errors almost everyone is making:

**#1 Neglecting the difference between monthly and annual payments.**

Annual reports often use annualized figures instead of the monthly figures for simplicity, but if monthly payments are being made, instead of annual payments, the outcome will be significant different over time.

Let’s take paying off a motorhome as an example. If you have a $100,000 loan at 5% interest and you want to calculate how much it will take to pay it off in 7 years, how would you make this calculation? One way is to plug the numbers into a spreadsheet or financial calculator. Entering the parameters to give the annual payments, your results would be $17,281.98 per year. But if you did the same calculation using monthly payments, which is what you will actually be paying, you come up with $1,413.39 a month or $16,960.68 a year.

The difference is $321.30 a year or 1.89%, which doesn’t seem like much. But if the dealership told you they would raise your interest rate by 1.89% you would protest the increase as being outrageous. At nearly $30 a month, if you and your financial company calculate your payments differently and there is nearly a $30 a month discrepancy, you would think a mistake had been made somewhere. That is the effect of paying a little principal each month verses making an annual lump sum payment.

When you perpetuate this error over many years, and several different debts, your outcome will become significantly different.

**#2 Not taking compound interest into account.**

I see this error often when people are estimating how much it will take to pay something off early. The issue is compound interest moves in a logarithmic pattern, but we think in a linear pattern.

Let’s say you want to know what your monthly payment will be in order to pay off a $400,000 home loan in 30 years. Many people will just divide the $400,000 by 30 years to come up with a rough answer that they think will be a close estimate. In this case, the results are $13,333.33 a year or $1,111.11 a month.

But when you take interest into account, and let’s use 4% in our example. The monthly principal and interest payments will be $1,909.66, which is just short of $800 more than the monthly estimate.

Another place people make this error is in estimating how much it will take to pay off a debt early. Let’s take the $400,000 mortgage again and now you have paid it down to the last $100,000. You want to know how much your monthly payments will need to be in order to eliminate that debt in two years. Many people would just divide the $100,000 by 24 months. That comes out to $4,166.66 a month. But the actual number is $4,342.49 when compound interest is applied. The difference is $175.83 per month. After making their $4,166.66 monthly payments for two years they are then surprised that they still owe $4,219.92.

**#3 Neglecting the snowball effect.**

This is the most common error I see that causes real differences, since using the snowball effect encompasses multiple different loans each with different payments, interest rates and maturity dates. Calculating the amount of time it will take to pay off all your debts is not something one can do in their head. Although, we all try.

The first time I made this erroneous calculation was when I sought to pay off the $500,000 debt that I had accumulated as a young new surgeon. I read that nearly everyone can pay off all their debt in less than 7 years. I thought there was no way that could be possible. I had a 30 year mortgage on my house, as well as, multiple smaller debts. But when I actually sat down and made the calculations, I could pay everything off in only 3.5 years. What a surprise, I thought there was no way my debt could be paid off that quickly. But it was true.

The snowball method is done by ordering your debts from the smallest outstanding balance to the largest outstanding balance. Then adding whatever additional money you can afford to throw at it, like say an extra $3,000 a month, by increasing your smallest debt payment by that amount each month. Once that debt is paid off, you use the total amount that you had been paying on that loan, $3,000 plus the $400 minimum amount on your, say car payment, and add $3,400 to the monthly payment on your next smallest debt. Keep doing this until all your debts have been paid off and you are now debt free. By the time you get to the last debt, which is usually your house, you are making some big payments.

One such family I met had 13 different loans with interest rates ranging from 0% to 16.24%. They were on a 30-year plan to get them paid off. Their total debt was $793,258 with a monthly payment of $8,258.42. When we ran it through the snowball calculator I use, with a $2,000 a month extra payment, they would become debt free in only 7 years, 8 months. But if you multiply the extra $2,000 by the 92 months they needed to pay to get rid of their debts, they paid an extra $184,000 in the 7 years, 8 months. Using the snowball method they eliminated the remaining 23 years, 4 months of debt payments and become completely debt free.

The power of rolling the payment of each paid off loan onto the next gives astonishing results.

**#4 Forgetting to account for taxes when estimating retirement withdrawal needs.**

I discussed this one extensively in a previous blog titled Everyone is Using the 4% Rule Wrong. The main point is if you are like me, and all my retirement money will be taxed when I use it, then I cannot just multiply my annual budget by 25 to see how much retirement money I need. If I take out 4% and pay 25% tax, that will leave me with 3% to spend. So to calculate my retirement need I would have to multiply my annual expenses by 33. Once I have saved that much, then I can safely take out 4% each year to meet my needs in retirement.

Alternatively, you can add your tax bill to your living expenses and then multiply that total by 25 to get the number of dollars needed to cover your retirement expenses.

Forgetting to compute taxes can make your retirement estimates way off.

**Trouble**

The trouble I see is that several of the above mistakes are made in the same assessment. I recently saw such an assessment published. In that case the author laid out all the financial goals the person had and concluded their goals were unrealistic.

Because of some missed assumptions, the calculations used to reach these goals required $135,000 a year put toward their goals to accomplish everything. Since the client was not able to contribute that much to debt repayment and investing, it was concluded the client’s goals would have to change. They would have to work longer or shoot for smaller financial goals.

But when I used the exact same numbers to make the calculation, eliminating the errors in judgement listed above, it turned out the client could meet their goals with just $100,000 a year going toward debts and investments, which they could afford to do. Their printed recommendation was off by 35% due to the compounding effect of several mistakes. It is a big deal to mistakenly tell someone they will not be able to meet their goals.

I remember when I was in medical school, I showed my financial plan to another doctor who I looked up to for his opinion. I was planning to save enough money every year to be financially independent by age 50 and have the option to retire. He told me there was no way I could save that much money. I was devastated to know my plan wouldn’t work. But I ran the calculations again and I knew it would work. So I ignored his advice. I did hit my goal at age 50 and retired at age 54. This notion of setting retirement dates is very important to a lot of people. So we must get it right.

I have seen several articles that recommend keeping a home mortgage into retirement. In these cases, more money must be saved that the actual amount needed to pay off the mortgage! The impact of that debt in retirement is often grossly underestimated.

One person I counseled planned to work another five years to reach his retirement number. It turned out if he just took some of his retirement money and paid off his house, he could retire immediately. He was only working five more years to amass enough additional money to make his house payment. Not a smart plan.

**Bottom line**

Never use rough estimates, guesses or conditions that are not real (such as annual payment numbers when you make monthly payments) when calculating your financial goals. If you **really** want to know when you can retire, or how soon you can become debt free, you have to use the actual numbers**.** It is true that you will still have to make some assumptions, such as what will be your actual rate of return on your investments, but the fewer assumptions you make, the closer you will be to your actual numbers.

Don’t waste time making an unrealistic or incorrect estimate.

just wondering about how to handle healthcare in retirement

Right now thats a benefit I enjoy though my university

If there are pre-existing conditions if retiring before 65 would need private insurance and would need to factor that expense for a couple that might make retirement age pushed back

please advise, enjoyed your article, and the comments, its a good discussion physicians don’t often have

CJ,

Health insurance is simply another expense line in your budget. You need to find out how much it will cost you and put it in the budget. If you want to save money on the cost you can consider a health sharing option like we did. This is not different than the question of having a house payment in retirement, or whether you will buy cars with borrowed money and have a car payment. If your office paid for it before, then when you retire you will be paying for it. Add in all the new expenses you will have and remove all the ones that will go away and come up with your retirement budget. Then work on having enough money to cover it.

Why would you want to be a physician and retire from an incredible job at 54? That’s when it gets great. If all you want to do is retire then why seek such an incredible profession in the first place?

Life is not exact. People get sick, pandemics happen, kids get born, spouses get expensive sicknesses, college scholarships are lost, stock markets go down all this exactitude neglects the inexactnesses of real life. Do you really think that you can control the future with a spreadsheet?!? And retire from a rewarding career at 54 to weather another 40 years based on a spreadsheet from when you were 30?

Michael,

I think you have the wrong impression. All I wanted to do was be a physician, not retire as you suggest. But I was not planning to be a surgeon forever. We all have a retirement date in mind. I made financial plans when I was in medical school. Then I knew how much I needed to save and how much I could spend. I therefore had a very content and financially free lifetime in medicine, which I loved. I never got into trouble financially, because I always had plans. Very few people work until they die. My retirement came at age 54, after 23 years of a great general surgery practice. No one can control the future, but we can make plans. That’s what going to medical school was all about, planning for a future in medicine. I hope you have some plans for your future. Otherwise you will have a tough time financially when you can no longer work someday. Best of luck to you.

Good advice! However, its good to keep in mind that some physicians come from lower income backgrounds, choose primary care, and could never afford a $400 K house, much less put $100,000 a year into paying off debt.

The best advice I would give is to LIVE WITHIN ONE’s MEANS to PREVENT debt. Some of us worked our way through college. Some of us could only afford medical school by serving in the military or PHS, and/ or later serving in remote rural areas to help pay back student loans

The primary goal for most physicians would be caring for patients, and I’m sure you made many sacrifices to do so. Surgeons especially, considering that appendectomies and emergencies require surgery deep into the night.

I recommend that new physicians chose sensible homes/mortgages/cars etc. Avoid extravagant spending; as Ben Franklin is quoted as having said

“a penny saved is a penny earned.” Planning for charitable giving is also something physicians may wish to add to their goals.

KNKlein,

Good points. Everyone has different numbers in their own household. It doesn’t matter, since the concepts are the same for everyone. For some people, the numbers I used were way too low and they would never buy a cheep $400,000 house. Those numbers were only true for one household. This is why I wrote my book series “The Doctors Guide to..” to use bigger numbers for those who didn’t relate to the little numbers. I too had to work my way through college and went to medical school on a Navy scholarship to avoid student debt.

Definitely true. Life is unpredictable. Loss of a spouse can change everything.

Michael, I share your thoughts and I too do not plan to “retire early“. Retirement is more than just leaving a job. It is a dramatic change in direction. I imagine that the good doctor did not dislike the profession but rather felt it was time to go in a different direction. I will let him speak for himself. Retiring early does not necessarily mean that you did not love the profession of medicine. I too will be working longer by choice simply because there is nothing that could be as stimulating and productive as the profession of medicine-for me.

It is less and less about money as we get older. Many people find other rewarding things to do after and or during their time as a physician.

Playing out the string for another 40 years is what we all do as we get older if we are lucky to have that many years. How we fill those additional years is a very personal choice. How we handle our money before our change in direction is also a very personal choice.

The 4% rule tax example is off base. You don’t pay 25% tax on the entire amount, but just the capital gains. If it is a 401K or IRA, you pay at your marginal rate (which for you may well be 25%, since you have a lot of real estate income, but for many people it is much lower as they fill up the lower brackets) but in your taxable accounts it is the long term capital gains rate (likely 15%) and for your Roth accounts it is 0%. So 4% does not become 3% but something much higher, but is different for each situation.

The simple way we did it was to look at our annual expense, not including taxes. Then multiplied that number by our magic number to get our requirements.

Scott the numbers are exactly right for my exact situation. Everyone will be different. The point is to take taxes into consideration. The bulk of my money was in a 401(k) so will be taxed fully at ordinary income rates. If you have Roth products, your taxes will be lower. I have nothing named Roth. What ever you do have, be sure you take taxes into consideration or you will be in for a rude awakening.

Love the article. Thank you for that. My savings are all in taxable accounts. Unfortunately I do not own a home (used to). I have no debts. I am 55 years of age. I hoped to be semiretired by now but as a widow I became the only provider. My kids are grown. I have substantial saving in saving IRA, stocks, 401k. If 25% will be taxed, I cannot retire.

Should I invest in real estate as passive income if I can from my present income or should I purchase a home or both? How much should we save in our total savings in order to be able to semi-retire? Especially living in the northeast which pays less than the mid-west but more costly to live? I have additional in cash saving.

M,

There is not enough information in your comment to answer the question as to whether you should buy a home vs. invest in real estate. Also not enough info to talk about how much to save to semi-retire. There is a lot that goes into making that decision. If you truly need help with these issues, I would be happy to get into helping you make a plan as your coach. Send me an e-mail through the contact tab at the top left of the website so we can explore it.

Love your advice AND your book! We made all the mistakes and have turned our life around as empty nesters, life is so much less stressful!