Doctor, Indulge Thyself
When you get a raise, it is so tempting to reward yourself--whether it’s a car or some smaller luxury. People just can’t resist spending a bit more. But Lawrence Sowka can.
It’s been roughly 15 years since he graduated from medical school, but Sowka manages to live on a budget more suited to the student he once was than the $250,000-a-year cardiac surgeon he has become.
The unmarried Sowka, 42, is living on $30,000 annually, not much more than he spent during his low-paying medical residency six years ago.
Sowka’s largest expense? The $640 a month he spends on rent for his two-bedroom apartment in Bakersfield.
The rest of his money is going into an aggressive savings plan. Sowka is saving between $8,000 and $9,000 a month, with $6,000 allocated monthly to a variable annuity and the remainder divided among cash savings, individual stock picks, a 401(k) and his individual retirement account.
“I’m very frugal because I have a very simple lifestyle,” Sowka said. “I have very simple tastes. So I know I have the capability of saving a lot of what I make because I just don’t spend a lot.”
Sowka is convinced he needs to keep saving at his current rate. Not only is he worried about his prospects when he reaches retirement age, he’s also concerned about possible cuts in Medicare reimbursements, which could reduce his earnings.
“I was just now able in the last few years to start investing money,” Sowka explained. “That’s a lot later than most. I’ve missed a whole decade.”
However, Tim Kochis, a fee-only certified financial planner based in San Francisco, disagreed strongly with Sowka’s harsh assessment of his finances.
“You have financial resources through your earning capacity as a surgeon that are far greater than your current objectives,” Kochis told Sowka. “You are either in a position to dramatically expand on your lifestyle or retire early--by your mid-50s.”
“The relationship between what you make and what you spend, Larry, is so out of the ordinary,” Kochis added.
In addition, the planner pointed out that Sowka can expect to earn even more than he does now over the next few years as he becomes more established in his profession--perhaps grossing $350,000 annually in the near future.
Even if Sowka purchases a house for $500,000 and otherwise doubles his spending to $60,000 a year, he could retire in a little more than 10 years and enjoy an annual income in constant dollars of $75,000 for the rest of his life, the planner said.
Sowka was stunned. “I guess I didn’t really see myself as having all that much money,” he said. “The numbers are going up faster than I sort of realized. But it’s really hard to change your life and attitudes in a short period of time.”
That’s not to say that Kochis approved of many of Sowka’s investment decisions. In fact, the planner argued that the doctor needs to make a significant overhaul of his investment portfolio.
For starters, Kochis suggested that Sowka immediately stop placing any more money in his variable annuity, saying that the benefits of tax-deferred investment growth--even for someone like Sowka, who is taxed at a 48% marginal rate overall--are not enough to offset the investment’s disadvantages.
“The problem with a variable annuity is that you have to be pretty inflexible about it for a long period of time,” Kochis said.
“As you know, there is a 10% penalty on any distribution you take from it before the age of 59 1/2. Since the variable annuity is basically two-thirds of your total wealth right now, you’ve got two-thirds of your money tied up in a vehicle that is not going to be easy to get at.”
Moreover, if Congress reduces the capital gains tax, it’s unlikely Sowka will be saving much money at all by utilizing a variable annuity, Kochis said. The reason: The capital gains tax he pays on ordinary investments may be less than the regular, albeit deferred, income tax he will eventually pay on his annuity gains. And capital gains taxes can often be deferred for a long time too, by holding on to stocks or tax-efficient mutual funds.
Nonetheless, because Sowka would pay a penalty if he withdrew his assets now, the planner urged him to leave the $240,000 he has in the annuity in place, where it is invested in the Fidelity family of funds.
But Kochis wants Sowka to make a new financial start utilizing mutual funds. In his ideal portfolio, the planner said, the doctor should have a third of his funds in U.S. large-cap stocks and mutual funds, a third in U.S. small-cap stocks and mutual funds, and a third in international investments.
The planner suggested that at least 50% of Sowka’s large-cap investments be placed in a stock fund that attempts to replicate the blue-chip Standard & Poor’s 500 index, such as Vanguard Index Trust 500 Portfolio (five-year average annual return: 20%), with the remainder divided between a growth-stock fund such as Brandywine Fund (24%) and a value-stock fund such as Neuberger & Berman Guardian Fund (19%).
Another suggestion: Sowka might want to consider investing in Warren Buffett’s Berkshire Hathaway company, a firm that owns a mix of operating businesses and also has large stock stakes in such companies as Coca-Cola, Walt Disney, American Express and McDonald’s.
Some of these suggestions are possible because of Sowka’s relatively high income. Brandywine Fund requires a minimum $25,000 investment, and Berkshire Hathaway Class A shares are currently trading at $47,200 a piece.
“You can afford to buy the big ones,” Kochis said.
The planner also suggests that Sowka buy into a few small-cap stock funds, weighting them toward value funds such as Longleaf Partners Small-Cap (five-year average annual return: 20.5%) and Mutual Discovery (a newer fund, two-year average annual return: 26%). For growth, Kochis suggested Navellier Aggressive Growth Portfolio (also a relatively new fund).
Kochis believes that today’s global economy demands that investors also have some overseas holdings. He recommended that Sowka put at least half his overseas investments in one or two large-cap funds such as Warburg Pincus International Equity (five-year average annual return: 15.1%) and T. Rowe Price International Stock (11.9%), with the remainder divided between a small-cap offering such as Acorn International (two-year average annual return: 16.2%), and an emerging-market fund such as Montgomery Emerging Markets (five-year average return: 12.8%) or the newer Warburg Pincus Emerging Markets (two-year average return: 13.2%).
The doctor was a little squeamish, however. “My problem with overseas investing is that I just don’t know a lot about it. And it’s difficult for me to put money into something I really don’t have any idea about,” Sowka said.
Kochis said a broadly diversified mutual fund should calm some of the doctor’s fears, but he added that Sowka should stick to what he knows when it comes to the 10% of his portfolio invested in individual stocks that both he and Sowka consider “play” money. The doctor currently has more than a dozen such purchases in his portfolio, ranging from pharmaceutical giant Merck to Starbucks.
Moreover, Sowka buys and sells stock frequently, running up transaction costs. In some cases, he flips them for nonfinancial reasons.
“I did own Columbia/HCA [a hospital company], but I sold it. It was a principle type of thing. Their earnings are still there, and from a financial aspect I think it’s probably smart to own them, but I don’t like the way they conduct themselves,” Sowka said.
The planner suggested cutting back to four or five individual stocks Sowka knows something about through his work. “What makes sense for you is to invest in areas where you can apply your professional skills in identifying companies or products or services that you have special insight into,” Kochis said.
“For instance, one of your holdings is Medtronic. Medtronic makes pacemakers, and as a cardiac surgeon you know about pacemakers,” the planner said. “But it doesn’t make a lot of sense for you to own Boeing. What do you know about making airplanes that everyone else doesn’t know?”
Other suggestions for Sowka include reducing his $53,000 stake in fixed investments and consolidating all his holdings at one securities firm.
In addition, Kochis recommended that Sowka investigate some insurance issues. While the doctor is well covered for malpractice and disability, he could use renter’s insurance as well as a minimum $2-million umbrella liability policy, which would protect his personal assets from any claims. The planner suggested that Sowka might want to look at policies that give him up to $5 million in coverage.
“Some people will consider you an attractive target because of your financial success,” Kochis warned.
The planner said Sowka need not be concerned with life insurance yet, although the issue hits home for the doctor, who expects that his brother and sister, both mentally disabled and under the care of his parents, will one day live with him.
Kochis suggested evaluating the situation in the future, when and if Sowka assumes responsibility for his siblings.
Finally, and most important, the planner urged Sowka to seriously think about his long-term financial and lifestyle objectives. “You could afford to retire from the practice of medicine early. You could afford to spend more money. You could afford to be very generous to family and friends and charity. . . . There are a lot of things you could do that you haven’t yet begun to identify. That’s your homework assignment from this whole event.”
For now, Sowka said his goal will be an early retirement and perhaps a bit more travel.
“I don’t have any great need right now to change my lifestyle,” he said.
Helaine Olen is a regular contributor to The Times. To participate in a Money Make-Over, send your name, age, phone number, income, assets and financial goals to Money Make-Over, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053.
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This Week’s Makover
* Investor: Lawrence Sowka
* Occupation: Cardiac surgeon
* Age: 42
* Gross annual income: $250,000
* Financial goals: To ensure a comfortable retirement but also be in a position to assume financial responsibility for his two mentally disabled siblings.
Current Portfolio
* Net worth: $370,000
* Stocks: 13 worth $40,000, including Merck, Microsoft and Starbucks
* Annuity account: $240,000 divided among Fidelity’s Equity-Income, Growth & Income, U.S. Equity Index and Contrafund
* 401(k): $18,000
* Individual retirement account: $53,000, invested in bonds
* Cash: Money market and checking account funds worth $15,000
Recommendations
* Stop contributing to variable annuity.
* Consider spending more or retiring earlier.
* Move investments so that holdings are evenly divided among large-cap and small-cap funds and international mutual funds.
* Keep only four or five individual stocks that are in businesses within his area of expertise.
* Obtain renter’s insurance and an umbrella liability policy of $2 million to $5 million.
* Consolidate holdings to simplify paperwork.
* Reduce holdings in bonds and cash.
Options for New Portfolio
Large-Cap Funds
* Brandywine (800) 656-3017
* Neuberger & Berman Guardian (800) 877-9700
* Vanguard Index Trust 500 Portfolio (800) 662-7447
* Berkshire Hathaway, a holding company run by Warren Buffett (ticker symbol: BRK/A or BRK/B)
*
Small-Cap Funds
* Longleaf Partners Small-Cap (800) 445-9469
* Navellier Aggressive Growth Portfolio (800) 887-8671
* Mutual Discovery (800) 342-5236
*
International Funds
* Acorn International (800) 922-6769
* Montgomery Emerging Markets (800) 572-3863
* T. Rowe Price International Stock (800) 638-5660
* Warburg Pincus Emerging Markets (800) 927-2874
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Meet the Planner
Tim Kochis is a certified financial planner based in San Francisco. His firm, Kochis Fitz Tracy & Gorman, specializes in investment planning for corporate executives, professionals and business owners. He is the former national director of personal financial planning for Deloitte & Touche and Bank of America.
