This content is provided for informational purposes only and does not constitute financial, tax, legal or other advice. Any strategies discussed should not be undertaken by any individual without prior consultation with an appropriate professional for the purpose of assessing whether such strategies are suitable for their particular situation.
How should physicians manage investments after a significant jump in salary?
There will be multiple times during your career as a doctor when you receive a significant jump in pay. This may be due to a large promotion or from a quarterly or annual bonus. The most common time, however, is when you make the transition from training to becoming an attending physician.
So when you receive a pay bump, how should you manage this money?
Beware of the Physician’s Diderot Effect
The Diderot effect, which was named after a French philosopher from the 1700s who fell into financial ruin after a sudden influx of wealth, describes the psychological phenomenon that happens when people receive a major bump in pay. When this sudden accumulation of wealth happens, you can make a big money mistake if you aren’t aware of it.
This is the same phenomenon that happens to major athletes, entertainers, and artists. It also happens to be the same phenomenon that happens to doctors, too, when you finish training.
Like Denis Diderot, you might experience the “sudden contamination of wealth” and feel the need to increase your lifestyle in lock-step with your influx of money. The Diderot effect is what leads to the many common purchases among new attending physicians, including the new doctor house, car, and private schooling for the kids.
None of these are bad financial decisions, in and of themselves. However, coupled with a heavy student loan burden and low net worth, it can make financial progress toward your goals extremely challenging.
However, falling prey to the consequences of the Diderot effect can be prevented. You can have your cake and eat it, too, as you build wealth while you enjoy some of your hard-earned wealth. This is accomplished through the 10% Rule.
The 10% Rule
One of the best ways to defeat the Diderot effect is to recognize that you are human and you will want some things that seem “frivolous,” and that’s OK.
This is where you need to apply the 10% Rule.
For every bump in pay, bonus, or unexpected money you receive: 10% of the money goes toward lifestyle creep, and the other 90% goes toward building wealth.
The 10% Rule allows us to give 10% to what the heart wants while we apply the other 90% toward wise financial decisions such as destroying our student loan debt, investing in low-cost index funds, starting a backdoor Roth, or saving for your kid’s 529.
Investing the Other 90%
If you aren’t sure how to use the other 90%, I’d encourage you to consider the cash flow waterfall that we teach our students in Medical Degree Financial University. Accomplish each step in turn with any cash flow that you create through your monthly income and the 90% you use from influxes of wealth:
Step 1. Create Momentum with a Deductible Emergency Fund (~$1000)
Step 2. Take the Employer Match (100% return)
Step 3. Pay Off High-Interest Debt (>8%)
Step 4. Create a Real Deal Emergency Fund (three to six times monthly living expenses)
Step 5. Meet Charitable Giving Goals
Step 6. Max Out Your 401K
Step 7. Pay Off Student Loan Debt
Step 8. Pay Off Medium Interest Debt (5%-8%)
Step 9. Meet Your Annual Savings Goal
Step 10. Pay Off Low-Interest Debt (<5%)
The Take Home
The purpose of the 10% Rule is to allow your desires to be fulfilled while we work toward financial independence. The more you allow yourself an occasional break while remaining financially disciplined, the more wealth and wellness you’ll obtain simultaneously.
The Medical Business column features questions from the Doximity community answered by physicians versed in finance. Post your question in the comment section below.
Dr. Jimmy Turner is a practicing anesthesiologist, physician entrepreneur, and coach for doctors. You can find him on Instagram or Twitter @tpp_md. You can also learn more by visiting thephysicianphilosopher.com.
Animation by Jennifer Bogartz