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Practice Management: A Simplified Evaluation
of the Dentist's Personal Financial State Douglas Carlsen, DDS

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A Simplified Evaluation of the Dentist's Personal Financial State




"The main concerns of
any financial advisor are
income, savings and debt.
Far too often, the main
concerns of the dentist
are to own the largest
home possible, drive the
latest and greatest auto
and disregard debt."		 by Douglas Carlsen, DDS

A burgeoning mass of online retirement programs and advisors are standing by, ready and willing to calculate – for a price – your financial future, and, in so doing, will paralyze the parietal lobes of the unwitting dentist. Yes, we've entered the golden age for both the dentist and the financial advisor. Dentists now earn more than primary care physicians, and the financial community smells the pecuniary plasma. Where does one turn in this jungle of computational connivers and infrequent sagacity? One safe bet is to work with a competent CPA or advisor with the Certified Financial Planner (CFP) designation. Nevertheless, you should always be well informed as a consumer of this service. To assist you, I've been asked to provide a condensation of simple formulae and calculations one might use to evaluate one's current financial situation. Note that the following provides a generalized guide to one's financial health. Please consult with a professional advisor to ensure that your specific financial condition has been adequately evaluated.

The main concerns of any financial advisor are income, savings and debt. Far too often, the main concerns of the dentist are to own the largest home possible, drive the latest and greatest auto and disregard debt. Are these matters at odds? You bet they are!

The first section provides six basic questions to evaluate your current financial status. The second section provides a method to evaluate your path to retirement. The third section gives selected average monthly expenditures for families in an average dental income range. I've left out estate planning, tax and risk management, college savings, and investment objectives to keep the discussion to a simple format.

I. Six Questions
Let's evaluate your financial status keeping the following legend in mind:
    S = total savings.
    SY = yearly total savings.
    SE = emergency savings.
    M = your total mortgage balance.
    MY = your yearly mortgage payment.
    i = your yearly net income.
    D = your non-mortgage total personal debt.
    IL = total term life insurance.

1. Is your personal checkbook stable?
If you always have a $5,000-$10,000 balance – great. If your checkbook resembles Jackson Pollack artwork or you don't even know where it is, go to Quicken now. You must be current with all payments before anything else.

SY = MY
Does your yearly savings match your yearly mortgage payment? If you cannot save at the same level as the mortgage you covet, reassess. This is my #1 key to financial freedom and an early retirement.

M = 2i
Consequently, your total mortgage needs to be no more than twice your yearly net income. Sure, financial institutions will lend you much more. Yet with the burden of taxes, savings, and other debt, many dental financial advisors advocate that dentists spend 20 percent or less of net income on mortgage payments.

D = (0.1)i
What is your non-mortgage debt? This does not include practice debt. The total should be zero, yet realistically it should not total more than 10 percent of your net income. For the average dentist, this total should be less than $25,000, including cars. If you have more than this, and many do, please attack this beast first, as it aggressively retards your financial independence.

SE = (0.25)i
Do you have an emergency fund? You need six months personal expenditure savings in a liquid account. This is approximately one-fourth of your net income – $50,000+. Dentists do have strokes and fall off mountain bikes – I've personally assisted two dentists who were off work for several months. Their practices survived, yet income fell to near zero for those months.

SY = (0.12)i
What percentage do you save for retirement each year? A common guide is to save at a rate of 12 percent of net income per year. This is the amount if you start at age 30 and are consistent. Add one percent for each year starting to save after age 30 or for any missed years.

IL = 12i-S
Do you have adequate insurance? Have term life insurance in the amount of 12 times your net income minus your total savings. Split it proportionally between you and your spouse related to income. Do you have disability and office overhead insurance? Buy the maximum amount. How about liability? At least $2,000,000 for each claim and occurrence. Don't be stingy here. Have an umbrella policy for at least $2,000,000. Long-term insurance? Investigate at age 50. AARP has wonderful information and plans.
Table 1
Age Savings to
Income Ratio
30 0.1
35 0.9
40 1.7
45 3.0
50 4.5
55 6.5
60 8.8
65 12.0
II. Personal Financial Ratios
In 2006, Charles Farrell, JD, LL.M. provided an elegant analysis of Personal Financial Ratios in the Journal of Financial Planning.i The following table from Mr. Farrell's article illustrates the ratios of savings to income necessary to be able to retire at age 65 (see Table 1 on page 48). It assumes a conservative five percent real rate of return (beyond inflation) on investments with an equally conservative five percent withdrawal rate at retirement. This will easily allow a couple not to run out of funds before age 90 in almost any scenario. The ratios are calculated to allow an advised savings of 12 percent per year.

Savings include the current values of all tax-deferred and taxable investments, including all IRAs, profit sharing, brokerage accounts, the fair market value of any investment real estate and the value of your practice. This does not include the value of your home, cars or personal possessions. If you are sure you will downsize in retirement, you can include the difference in price as part of your savings. Income includes both spouses' incomes. Passive income not from capital gains, interest or dividends may be included.
Table 2
Age Debt to
Income Ratio
30 1.70
35 1.50
40 1.25
45 1.00
50 0.75
55 0.50
60 0.20
65 0.00
Table 2 evaluates debt to income in a similar way. Debt includes all mortgage, auto loans and leases, student loans, and consumer debt. According to Mr. Farrell, practice debt need not be included, assuming that you eventually will profit from sale of the practice.ii

Note that the above debt ratios may look small in today's hectic real estate environment. Be assured, they accurately reflect the ratios appropriate in today's financial environment. With new graduates encumbered with $150,000+ school loans, debt is a major menace to wealth building.

Let us look at an example: Dr. Willy E. Road a dentist, age 45, and his wife, Rodea, age 44, have a combined income of $250,000. Their total savings, including a projected practice value of $300,000, is $500,000. This provides a savings to income ratio of 2.0 – not quite on track for retirement at age 65. Their total debt, including a $400,000 mortgage, auto leases, credit cards, and a lingering student loan is $590,000. This gives a debt to income ratio of 2.36 – far above the recommended 1.0. Obviously, the Roads' debt load has not allowed them to save at Farrell's 12 percent per year for the last 15 years, and seriously hurts their chances to retire at age 65 with a lifestyle comparable to pre-retirement. Luxury vacations and that office remodel will have to wait.
Table 3
Expenditure Amount spent
per month
Food at home $530
Food away from home $630
Apparel $502
Vehicles:
  Loan, lease,
  purchase costs		 $801
  Fuel and
  maintenance		 $845
Health care $416
Entertainment $683
Education $404
Cash contributions $620
Personal care $121
Housing:
  Personal dwelling $1,831
  Household supplies $112
  Utilities $765
  Household
  maintenance
  and upgrades		 $557
III. Selected Expenditures for Higher Income Earners
Table 3 is adapted from U.S. Bureau of Labor Statistics' (BLS) data for the year 2005, updated by the CPI index for July 2008 for an average family of 3.2 people earning $272,000 per year:iii

This is but a partial list, yet gives clarity to two issues: First, we all spend more than we think on cars. $1,600 per month sounds crazy, yet in interviews of retired dentists, I'm told that two cars normally cost this amount. I'm afraid we're stuck. Second, an $1,800 mortgage payment may seem low for this earning group, yet the additional costs are significant. The BLS report provided no line for property taxes and homeowner association fees. These fees can easily add an additional $500 to $1,000 per month to housing costs.

In this instance, an $1,800 mortgage can easily balloon to $4,000 per month in total housing costs. The bottom line? Don't fall for the debt schemes littering the financial landscape, pay cash for your autos and don't buy too much house. Is it that simple? Yes

References

i Charles Farrell, JD, LL.M, "Personal Financial Ratios: An Elegant Road Map to Financial Health and Retirement", Journal of Financial Planning, January 2006, Article 6

ii Phone conversation with Mr. Farrell on January 9, 2008.

iii "Table 3: Higher Income before taxes: Average Annual Expenditurs and characteristics, Consumer Expenditure Survey, 2005," Consumer Expenditures in 2005, U.S. Bureau of Labor Statistics, Report 998, 2005.
Author's Bio
Douglas Carlsen, DDS, owner of Golich Carlsen, retired at age 53 from a 25-year private dental practice and clinical lecturing at the UCLA School of Dentistry. He writes and lectures nationally on retirement and financial topics from the point of view of one who was able to retire early on his own terms. Dr. Carlsen consults with dentists, CPAs, and planners on business systems, personal cash flow, and retirement scenarios. Visit his Web site: www.golichcarlsen.com; call 760-798-0886 or e-mail drcarlsen@gmail.com.
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