Financial Planning for the Future: The Young Dentist
by Douglas Carlsen, DDS
Congratulations on your entry into the wonderful world of dentistry. It’s time for your first BMW and mortgage, right? Not so fast. You may be able to cut a prep with a 400,000 rpm handpiece in a couple minutes, yet the full restoration takes time and patience to build longevity.
The same is true of your financial strategy. Decisions made early in one’s career have huge effects on stability years later.
In this article, I’ll paint a landscape using the strokes dentists use to build real wealth.
first, let’s have some comments from a 2012 Dentaltown.com thread called “Financial Mistakes I Wish I Had Never Done.”
- Wish I never bought the home before setting up the office.
- Wish I bought a small home instead of buying the “dream home.”
- Wish I bought life insurance and disability when I was younger and healthier.
- Wish I didn’t buy that swanky car and had my little fun for three years on it.
- Wish I knew who had the Time Machine...
Ntextdent 1/18/2012
- At the top of the list for financial mistakes (and general life mistakes) is marrying the wrong
woman. Nothing else, other than losing your dental license, will be more expensive.
- I totally agree with getting your practice established before buying your house.
- Never spend more than 16 percent of your income on your mortgage.
- Pay cash for your toys. If you can’t pay cash, save until you can.
- If you are over 35 pay cash for everything that isn’t a home. Everything. Boat, CEREC, kitchen
remodel... everything.
bkoenitzer 2/07/2012
…The number-one mistake I made: Arguing with my wife way too many times about changes
that should have been made. If I had listened and made the changes she thought right, we'd
have gotten out of that deep hole I dug much sooner.
ChipPayet 2/6/2012
The Psychology of Debt
Psychotherapist Phil Tyson lists two factors pertaining to the psychology of debt:
First is a principle he labels future discounting. We often take on debt giving little thought
to how we need to change our lives to accommodate it. Madison Avenue has used this approach
effectively for years. Dr. Tyson’s second principle is the relationship between consumption and personal identity.
“Advertising has brainwashed us all to consume brands that provide us an identity. Our self esteem
becomes captive to products.” 1
Student Loans
Dentists attending public institutions often graduate with more than $200,000 in student
loan debt, while those attending private schools often end up owing $400,000.
Should the loan be paid off before taking on other loans or should it be paid off over a long
period of time? Low interest rates often entice doctors to pay as slowly as possible.
For insight, I provide my favorite comment from Dave Ramsey, author and TV personality.
An abridged version:
Dear Dave,
I’m 33 and a resident with $250,000 in student loan debt. Next year I’ll finish my residency and
increase my income dramatically. The interest rate on my student loan is just 3.5 percent, so I’d like
to postpone paying it off and make house payments and begin saving for retirement instead. I’d put
off paying the student loans as long as possible. Is this a good idea?
-Derrick
Dear Derrick,
That loan hanging over your head is unbelievable. I’ve worked with many doctors over the years
where 20 years later they are still playing math games with the student loans like they’re a stupid
pet!….. if you’re not careful, you might catch a nasty disease called “doc-itis.”…Some of the symptoms
include two or three leased BMWs and a fully furnished house with a pool on the golf course. That
student loan can just wait a while to be paid. It’s a financially debilitating disease.
You’ve been used to living on nothing (less than $40,000) for a while now. Just keep on doing
that for a little bit longer… you can have that student loan debt knocked out in a few years.
I’d postpone any retirement savings and buying a home until you’ve completely knocked out the
loan and have an emergency fund ($50,000+) in place…
– Dave
The full interview can be accessed at:
http://a1611.g.akamai.net/f/1611/23575/9h/dramsey.download.akamai.com/
23575/audio/mp3/MyDRS%20Blog/04022008__dont_get_docitis.mp3.
One who stretches out that first loan as long as possible has two strikes against him.
First is the fact that debt structure will be more complex and saving more difficult in the future.
Second, the young dentist will set up an insidious mental framework of debt being a natural
part of life. It isn’t. If you tie your identity to debt, you’ll end up needing to work 10 to 15 more
years than the dentist that doesn’t. This is the most important message in the article: Debt is never
your friend. Many will tell you to use debt for leverage, tax advantage and other ploys. Nonsense!
The only reasonable use for debt is a home mortgage and a practice loan.
What can a young dentist do with onerous student debt? Unfortunately, suck it up and live
like a student for a few years after becoming a doctor. One who pays off student debt quickly
will have real savings by age 50.
How Much Debt is Appropriate?
Auto
An example involves two dentists, Dr. I.B. Smart and Dr. Wanda Beemer, who became financially prudent at slightly different ages. The first dentist, Dr. Smart, from
age 30 until age 65, always paid cash for a two-year-old moderately priced, yet nice
vehicle, such as a Toyota Highlander, and replaced every four years. The second dentist, Dr. Beemer, did the same, except for one slight difference. She splurged at age 30 and took out a four-year loan for a new BMW 7 series. Four years later, she became enlightened to the high depreciation inherent in a luxury auto and prudently bought
two-year-old Highlander-type vehicles for the remaining 31 years of her career.
That one-time purchase created a difference in savings of $35,480 for those four years
between our two dentists that compounded to $309,000 (in age 30 dollars) by age 65, or the
equivalent of $14,000/year for life! After all fees and taxes, the average sale amount of a dental
practice is near $300,000. In other words, an expensive capital purchase early in one’s career can
have an effect as powerful as the sale of a dental practice.
A dentist will spend vast amounts of potential retirement savings taking out loans or leasing
new autos frequently. Start a good habit. Always pay cash.
Consumer Reports repeatedly states that the worst way to buy a car is via lease with its hidden
fees. Second worst is dealer financing. The best way to buy is cash.
Practice Loan
Brian Hufford, CPA, CFP of Hufford Financial, provides guidance with his Financial
Balance Guide. From a dentist’s net income, Hufford indicates that one should designate 25
percent to personal living expenses; 25 percent to all loans, personal and business; 20 percent to
savings; 25 percent to taxes; and five percent to large personal or practice purchases. 2
For a young dentist, age 35, with a $180,000 income, total annual loan payments should be
no more than $45,000. Two auto loans at $1,250 per month eats up $15,000. A student loan
of $2,500 per month ends the process. No practice or home loan is possible. Kill that student
loan early, docs!
For a young dentist with no student loan or auto debt and an expected net income of
$180,000, a 10-year $300,000 practice loan at a rate of seven percent would have $3,500
monthly payments with a total yearly loan burden of $42,000. That’s within Hufford’s guidelines.
Yet, there isn’t enough left for a home loan yet.
Please be careful to take out a reasonable practice loan, with plenty of wiggle-room in your
personal and practice budget in case your practice production falls short of projections.
Mortgage
Charles Farrell, JD, LLM, in Your Money Ratios: 8 Simple Tools for Financial Security, points
out that the maximum amount of mortgage debt should never be more than twice your net
family income. By age 50 it should be down to 1.5 times income to retire by age 65. By age 65
it should be completely paid off.3 Full table is found at citation listed below.
Therefore, our 35-year-old dentist making $180,000 per year should not have a mortgage
of more than $360,000. And that’s contingent on Hufford’s total loan amount, including any
practice loan or auto loans, of 25 percent of $180,000, or $45,000. Not easy, is it?!
Take out a 15-year mortgage. The monthly interest isn’t that much more than a 30-year loan
and will provide additional savings in your 50s.
Farrell also makes it clear that your primary residence value increases only at the rate of inflation
over many years.4 You will not be able to fund your retirement via your personal residence. And the more
mortgage you have, the less you’ll have for retirement. Never buy more home than you need.
It’s great to look successful, yet real wealth is measured by your Vanguard account, not the
size of your kitchen, master bath accessories, or the money you owe to Bank of America.
Carlsen Debt Recommendations
- Read The Total Money Makeover by Dave Ramsey.
- Pay off student loans as quickly as possible and before taking out any other loan. This means always paying cash for autos. That BMW X6 M is a wonder, yet pay cash.
- Set up an emergency fund.
- Take out a practice loan, if applicable.
- Take out a home mortgage. The home mortgage always comes last and should be for 15 years.
Why have I spent over half the article beating you guys up on debt? Debt is the main block to
savings and real wealth. If you have nothing to save, investing is not important. And there are many
dentists, age 50, with little savings.
Savings
Emergency Fund
This is funded after paying off student loans and before taking out a mortgage. It may be
funded along with a practice loan. Remember the mortgage always comes last.
Have the emergency fund in liquid form (money market account) of at least six months of
your expenses. For the young doctor, this is normally $25,000-plus. Why? I personally know
three doctors, who suffered a ski injury, a stroke and cancer, which caused three to six months
of disability. Disability policies paid little and they lost a huge chunk of income to medical copays
and loss of work.
This is not an “emergency-trip-to-the-Caribbean fund” or “I-really-need-a-new-golf-membership”
fund. It’s strictly for medical and family emergencies.
Retirement Savings
How much is appropriate?
Those who I’ve worked with that have saved 20 percent consistently, have no trouble retiring
between age 55 and 58. But 20 percent is very difficult for many of us!
For an article titled, “Only Four Percent of Dentists Able to Retire at 65? Nonsense,”5 I used
Monte Carlo software to analyze savings scenarios for a hypothetical doctor. Savings would be
held in index funds with a 50/50 mix of stocks to bonds at a discount brokerage such as
Vanguard with passive, buy-and-hold investing.
A typical dental couple needs around $140,000 per year in retirement to keep his or her
lifestyle intact. This is less than the working incomes listed, yet lack of mortgage, lack of savings
and decreased taxes lower the income necessary substantially in retirement years.
From the article:
Let’s next look at a young dentist, Dr. Anita Know, age 30, with an income that starts at
$125,000, increasing to $170,000 at age 40, $230,000 at age 50, and $310,000 at age 60.
These are fairly normal averages for dentists (four percent real increase per year).
If she saves 10 percent per year starting at age 30, she will be able to retire with $140,000
income at age 63 using a 50/50 stock-bond portfolio throughout her career.
Saving 15 percent per year will provide retirement at age 60. Saving 20 percent will provide retirement at age 57.
If Dr. Know waits to start saving until age 35 at 10 percent per year, she will be able to
retire as above at age 65.
If Dr. Know doesn’t start saving until age 45 with at 10 percent per year, she will be able to
retire at age 69. If she wishes to retire at age 63, though, she will have to save 21 percent per year.
If using active management investment strategy, add one to two years to retirement ages
above (see Swedroe comments); if using a traditional broker or insurance agent, add another two
years due to high fees/commissions.
The bottom line is to make a commitment, as soon as student loans are paid off, to save at
a rate of 15 percent per year and you’ll never look back.
As far as savings for children’s education, it takes second place to saving for retirement and
there isn’t space for coverage of the topic in this article.
Where Does One Invest?
I need to be blunt. You need to read two books before funding retirement savings.
The Elements of Investing by Burton Malkiel and Charles Ellis
The Only Guide to A Winning Investment Strategy You’ll Ever Need by Larry Swedroe.This is paramount before choosing where to invest.
Excerpts from Swedroe’s book on active management (timing the market by buying and selling
individual stocks and/or mutual funds):
Fortunately, there is a sure way to win the loser’s game of active management. Don’t play!
Rather than attempt to time the market or pick individual stocks, it is more productive to
invest and stay invested. Warren Buffet said: “We continue to make more money when snoring
than when active.” Mr. Buffet also said: “Most investors, both institutional and individual,
will find that the best way to own common stocks is through an index fund that charges
minimal fees. Those following this path are sure to beat the net results delivered by the great
majority of investment professionals”.6
We have seen that the average actively managed fund underperforms its benchmark by
close to two percent per annum… With the availability of tax-managed funds, which improve
on the tax efficiency of index and passive asset-class funds, we can now raise our underperformance
estimate to perhaps as much a three percent per annum.7
My comments: A three percent annual loss of capital over a working career of 30 years
means a loss of about 60 percent of one’s total portfolio. $2.5 million in savings invested with
a buy-and-hold strategy would be reduced to $1.4 million if managed actively.
Please don’t fall for the hype. Of all investment firms I talk to, 98 percent of them use only
active management, as if it’s better. It’s worse docs; normally much worse.
- Owning individual stocks and sector funds is speculating, not investing.
- Never work with a commission-based advisor (stock broker or insurance agent) – there is a
misalignment of interests.
- Before acting on seemingly valuable information, ask yourself why you believe that information
is not already incorporated into prices.
Where does one go for financial advice besides the above-mentioned books?
Podcasts
“Sound Investing” provides clear, concise advice on money and retirement, and includes
interviews with the most influential people in the money business including Vanguard’s Jack
Bogle,Kiplinger’s Knight Kiplinger and Money
Magazine’s Jason Zweig.
“Man vs. Debt” provides wonderful commentary on the perils of debt and how to escape its
ugly clutches.
The Web
Fund Advice (www.fundadvice.com) provides free model portfolios for Vanguard, Schwab,
T. Rowe Price and Fidelity investors.
Lazy Portfolios (www.marketwatch.com/lazyportfolio) provides even simpler portfolios that
beat the street easily in the last decade.
Financial Advisor?
It often makes sense for one who doesn’t want to take the time to invest on one’s own to hire
an adviser, yet be aware that the airwaves are full of sharks. Your best bet is to work with a
Certified Financial Planner or a CPA with a Personal Financial Specialist certificate.
For dentists specifically, Thomas Wiring Doll at 877-939-2500 has a bevy of planners who
offer ethical advice with reasonable fees.
Discount brokerages offer the lowest cost financial advice. Examples are Vanguard, Schwab
and Fidelity
Can one invest effectively on one’s own? It’s fairly simple. The easiest way is to use a target
retirement fund from a discount broker. There is virtually no work, your portfolio is diversified,
it’s automatically rebalanced periodically and the fees are low.
An even lower cost is to devise your own portfolio from Fund Advice or Lazy Portfolios
listed above and rebalance on your own once a year.
Please, don’t fall for anyone who promises to beat the market. Academically, almost all trail
their benchmark indices by a wide margin.
Dark Pits of Financial Depravity
Insurance Companies: Please steer clear of any insurance product touted as an investment.
Annuity is normally a moniker for “sucker.” There are valid reasons for annuities, but only in
retirement. The fees are hidden and atrocious.
HELOCs (Home Equity Line of Credit): These were really fun for many during the housing
boom. It was like free money for new kitchens, cruises, Cerecs, and paying off credit cards.
Yet many lost their homes because of HELOCs they couldn’t afford in later years.
Free Seminars with Meals Attached: Content, beef-fed dentists are favorite prey for annuity,
commodity partnership and time-share salesmen. Be sure to get a second opinion from a neutral
third party before “investing” in something presented with any freebee.
Day Trading: Jim Cramer and his gang may be fun to watch on CNBC, yet any type of market
timing is anathema to your savings. And it looks so easy! Yet there are countless illustrations
of PhD mathematicians and engineers diving headfirst into trading, followed quickly by an
unremitting plunge due to the competition of institutions’ algorithmic
computer programs. It’s a no-win game, docs.
Vacation Timeshares: The maintenance, special assessments
and taxes are normally higher than the rental rate at the same
resort. And dare I mention depreciation? It’s higher in the first
year than purchase of a luxury auto. Yes, I know that you can
trade for other resorts whenever you like. Yet, I’ll normally find
a better price through AAA or Kayak for the Grand Hyatt next
to your condo without the trading hassle.
You are entering a very honored profession. There is little
taught in school of practice management or personal finance.
Please keep this article in a special place to refer to in the years
ahead. I’m always available at the listed e-mail in my bio.
References
- 1. Phil Tyson, Ph.D., “Do You Understand the Psychology of Debt?” downloaded at www.mens-wellbeing.com/2010/02/do-you-understand-the-psychology-of-debt.html on April 28, 2011.
- Brian C. Hufford, CPA, CFP, “Maximize Your Wealth: Improving Upon the Reality of Your Finances,” AGD Impact, February 2010.
- Charles Farrell, J.D., LL.M., Your Money Ratios: 8 Simple Tools for Financial Security. New York, NY: Avery, 2010, page 79.
- Ibid, page 85.
- Douglas Carlsen, DDS, “Only 4% of Dentists Able to Retire at 65? Nonsense!” Dentaltown, March 2012.
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