9 Rules for Financial Independence
#1 Realize You Have A Second Job
Most airline pilots won't have a pension, so if you want to retire on more than the money Social Security will provide, you'll need to learn how to implement and maintain a retirement plan and fund it appropriately. Putting this off leads to failure. Trusting it all to your “money person” will likely lead to disappointment. Just like mastering different aircraft systems or emergency procedures, this has to be done no matter how tedious you find it. Pretending you don't have to do this is simply denial. Not realizing you have to do this is simply ignorance.
#2 Continue Your Financial Education
Everybody, even if they choose to rely heavily on a financial advisor, needs to do some initial financial education. Reading three or four good books on personal finance and investing is a good start. We then recommend reading at least one good financial book a year. Start with Who Not How or Rich Dad Poor Dad. We're also big fans of Pilot Math Treasure Bath - an episode with the author is coming up!
Just like continuing education for pilots, we need a few hours of continuing financial education (CFE) for our second job each year. Following this podcast, blog, and asking questions in the Facebook Group are great ways to get free CFE.
#3 Save 20% of Your Income for Retirement, Beginning the Day You Leave School
Many companies have underfunded their retirement plans. The reason why is that they have an unrealistic expectation of ridiculously high future investment returns (and they like to spend their money on other stuff). Individuals are no different. The “personal pension plans” of most Americans are almost all underfunded with a median 401(k) balance of just $27,000. Granted, many people have an IRA or a taxable investing account on the side, but even if it were half as big as the 401(k), you're still a long way from a comfortable retirement.
Pilots—by virtue of their late start, high loan burden, and future changes in aviation—need to save 20% of their income each year just for retirement. If you assume a 30-year career, 5% after-inflation returns, and a 4% safe withdrawal rate in retirement, this savings rate will provide a portfolio that will replace approximately 56% of your pre-retirement income. When combined with Social Security, this should provide a nice, comfortable retirement with the ability to travel, leave money to your children, and donate to charity. You could even retire a little bit early. But if you wait 10 years to start and only save 10% of your income, your retirement nest egg will only replace 14% of your income.
#4 Insure Against Catastrophe
There are lots of bad financial things that can happen to you in life. Most of these are minor, like your washing machine breaking. You don't need to insure against these; you simply need an emergency fund of 3-6 months' worth of expenses so you don't have to go into debt when bad things happen. Some bad financial things are major, but you can't insure against them. These include losing your income due to false claims, multiple lawsuits, or the loss of an important contract. However, there are five major financial risks that you can and should insure against: death, disability, illness, liability, and property loss.
Life insurance protects your family against the financial consequences of your death. A large 20- or 30-year level premium term insurance policy will likely do the trick until your portfolio becomes large enough that you can self-insure against this risk. Disability insurance protects you and your family from the financial consequences of your disability. A good individual disability policy is expensive but worth it. As a pilot, it doesn't take long to understand the value of comprehensive life insurance. You should also carry high limits on your auto and homeowner's insurance policies. In addition, you need to have an “umbrella” policy above and beyond these policies. These policies protect you against natural and man-made disasters and also against something that can cost you far more than a car wreck or a fire—a lawsuit. Just as a liability policy protects you from work-related issues, an umbrella policy protects you from liability in everything else in life.
#5 Favor a Passive Investing Approach
The academic literature is quite clear—active management is a loser’s game. Stock-pickers and market-timers simply cannot outperform by more than it costs to do so. Proponents of active management like to point to Warren Buffett’s record and say, “Look, it can be done.” But Warren Buffett himself says, “A low-cost index fund is the most sensible equity investment for the great majority of investors."
We need to humble ourselves and realize that yes, we are part of that “great majority of investors.” That’s OK. We don't invest competitively; we invest to meet our financial goals while taking the lowest possible amount of risk.
#6 Hire Only Competent Advisors
It’s OK to do your own financial planning, manage your own investments, and do your own taxes. With minimal input and assistance from appropriate attorneys, you can even design and implement an adequate estate plan and asset protection plan. You do need to put in some effort up front to educate yourself, but these subjects are far easier to understand than a nephron or an action potential. Developing an interest in financial subjects is far easier when you realize just how much of a difference it can make in your finances.
High-level credentials—such as one or more of the following: CFP, CFA, ChFC, or a CPA/PFSIt—mean it's also OK to rely on an advisor. This doesn’t excuse you from your need to learn about finance and investing and to do your CFE each year, but many doctors simply don’t have the interest, time, or disposition to manage their own money. However, there are legions of financial professionals whose business is transferring money from your pocket to theirs, not necessarily helping you to reach your financial goals. In many ways, by the time you know enough to select a good financial advisor, you know enough to do it yourself.
When choosing a financial advisor, you should look for the following:
Reasonable Fees
Avoid commissioned salespeople by sticking with a fee-only advisor. Annual fees should be less than $10,000 per year. These might be payable as an hourly rate, as a percentage of assets under management, or as an annual retainer. Some advisors will work for a few hundred dollars per hour, for 0.15%-0.5% of assets under management, or for an annual fee of as low as $1,000 per year. If you’re paying more than this, realize that every dollar you pay in fees is a dollar you don’t have working for your retirement. If you need some help finding good advice at a fair price, contact us.
A Fiduciary
Many financial advisors select investments for you based on a lower “suitability standard.” If the investment is suitable for you, they can sell it to you. You want someone willing to sign a pledge to act as a fiduciary, meaning they are obligated to do what’s best for you, no matter what it costs the advisor.
A Cloudy Crystal Ball
You want an advisor who knows that neither you nor they can predict the future and who will design and maintain a plan that has a high likelihood of success no matter what happens in the financial markets over the next month, year, or decade.
A Bias Toward Low-Cost, Passive Investments
As mentioned above, active management is a loser’s game. If your advisor isn’t aware of this, it reflects a serious ignorance of the academic investment literature, and you should look elsewhere.
#7 Minimize Expenses and Taxes
Every dollar you spend on investment expenses, fees, and commissions (or that you send to Uncle Sam) is a dollar that isn’t working toward your retirement. Studies show that the best predictor of future mutual fund returns is the cost of the mutual fund management. The lower, the better. Despite frequent claims to the contrary, a buy-and-hold strategy is still the best way to invest because it helps you avoid buying high and selling low and because it minimizes expenses AND taxes. A wise aviator also maximizes tax-protected investing accounts such as 401(k)s, cash balance plans, and Backdoor Roth IRAs. When investing in taxable accounts, use only tax-efficient investments and take advantage of opportunities to tax-loss harvest.
#8 Minimize Debt and Manage Necessary Debt Well
Credit cards are not for credit. Buy your automobiles, recreational vehicles, furniture, and vacations with cash. Don’t ever have a mortgage more than twice as big as your salary. Minimize your mortgage interest by putting 20% down, refinancing when rates drop, and using a 15-year mortgage instead of a 30-year one. Prioritize paying off high-interest student loans. If you have sizable student loans, become an expert on the various programs, including SAVE and PSLF. Refinance your loans as soon as you know you won't be going for forgiveness. Live modestly until saving 20% of your income toward retirement is easy, and your only remaining mortgage or student loans are at ridiculously low rates.
#9 Protect Your Assets, Plan Your Estate, and Stay the Course
Most importantly, don’t sell out at market bottoms. You will pass through 3-6 serious bear markets during your investing career. Don’t invest so aggressively that you cannot sleep at night when things turn south, as we know they will. Buying high and selling low can add 5-10 years to your career that you might have preferred to spend doing something else. Your investment plan should be like an oil tanker, not a speedboat. Any changes in direction should occur over a long time period. Be aware of the simple strategies to protect your exposed assets from malpractice and personal lawsuits. Consider implementing some of the more complex strategies. Get a will and a trust. If your assets begin to approach the estate tax exemption limits ($13.61 million per person in 2024), see an attorney to draw up a more complex estate plan.