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Obstacles to Savings by Dr. Doug Carlsen

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In the last two months, we have presented a method to calculate how much a dentist needs to save for retirement, then how savings scenarios play out. This month we look at major obstacles dentists come across that foil saving.

Revolving Credit
If you don’t do anything else, please eliminate credit card debt. Paying by card is such an easy, yet insidious trap. Not only does it inhibit your ability to save, it psychologically entraps you. Many dentists carry well over $50,000 in revolving debt, often paying over $10,000 annually in interest.

Psychotherapist Phil Tyson lists two factors pertaining to the psychology of debt. First is a psychological principle called future discounting.We often take on debt with little thought of the details of changes needed to accommodate it. We look to the future and discount the pain of making payments. 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. As adults, we wish to become a part of something bigger, to promise us the narrative of youth, beauty, health and sexiness. Our self-esteem becomes captive to products.”1

For a dentist, it’s so easy to go online to Restoration Hardware, Saks, Golf Galaxy, Patagonia, Brooks Brothers, Patek Phileppe (don’t even think of going there!) and quickly establish a false sense of high self-esteem. Unfortunately, such consumption also sabotages one’s wealth.

Plan:
Put a 24-hour hold on any impulse purchase over $500 and get permission from your spouse. Second, pay the cards off! Start with the smallest total card and work your way up. Psychologically, this works easiest.

After completely paying off one card, an amazing transformation begins to bloom. It’s called satisfaction.

Too Much House
One’s personal residence is often the largest block to savings. Revolving credit is worse emotionally, yet a big home saps your savings the most. Typically, a dentist will buy a “starter” home in his or her early to mid-30s, then purchase a second “trophy” home in one’s 40s, and finally a nice retirement home near or at a resort in one’s 60s.

The second home is the one that destroys the ability to save. Just as the dentist has paid off the first practice loan, there is a time when there is an abundance of cash flow. Many couples opt to use that money for the GPS house. The wise ones stay put and save. How much home can you really afford? Charles Farrell, JD, LLM, provides ratios at a given age to gauge whether one is on course to retire.2

For example, a 50-year-old dentist, who wishes to retire at age 65 and has an income of $250,000, should not have more than 1.5 times, or $375,000 left on his primary home mortgage. If he does, it will inhibit his chances to save enough to retire by age 65.

Note the maximum amount of mortgage debt should never be more than twice your net income.

Farrell also makes it clear that your primary residence value increases only at the rate of inflation over many years.3 No, you won’t be able to fund your retirement via your personal residence.

Don’t forget home ownership costs including maintenance, insurance, taxes and upgrades. For modest homes, these costs average about 2.5 to three percent of the home value per year. Expensive homes often average four percent-plus per year. A $300,000 home might have $9,000 per year in the above costs; a $1,500,000 home might have $60,000 in costs. That difference of $51,000 a year buys a lot of retirement and college!

Why the higher percentage for more expensive homes? Upgrades, pure and simple. Higher cost homes in higher cost neighborhoods upgrade kitchens, baths and landscaping much more than modest abodes. We must keep up with Dr. Jones in the “classier” quarter.

Plan:
Sell and downsize? Sure, yet I realize that’s normally an impossible task emotionally. A better tactic is to stage any upgrades. Have a yearly upgrade budget of two to 2.5 percent of your net family income, no matter what the size of your home. That’s $6,000 to $7,500 for a dentist earning $300,000. That might pay for a garage remodel in some locales, yet to remodel a kitchen might eat up 10 years’ worth; a bath, two to three years.

Private K-12 Schools
A corollary to “too much house” is private K-12 schools. Those living in “nice” homes often feel neighborhood and peer pressure to have their children educated in “appropriate” schools. Top prep schools now average $17,000 per year4 with the Eastern elite schools charging $40,000-plus.

Take $17,000 per year for 12 years for two children starting one child at dentist age 35, the second at age 39. Invest that amount instead in a 50/50 mix of stock and bond index funds with five percent real growth until age 65. A dentist would have $51,000 per year in current retirement dollars by not paying for private school.5

Plan:
I personally know of dental families that have sought out the best public school neighborhoods, often with homes at reasonable prices. Or they have children who attend magnet schools. Their children later graduated with honors from University of California, Stanford, Harvard and University of Michigan.

Bottom line for housing and education costs: you can save $50,000-plus per year living in a smaller home and/or staging upgrades and have $50,000 more per year in retirement by having children attend public primary and secondary schools.

Overconfidence in Investing
One quality I find in almost all doctors: we know we are smarter than the herd. There has to be a way to beat the system. Yet, according to Carl Richards, “The smartest investors are the ones who acknowledge that they’re not smart enough to forecast events or pick the best stock or avoid every scam.”6

He’s right. No one can predict the future and those who try almost always fail. Sure, some guess right some of the time. Richards goes on to state that the ability to build and protect wealth is inversely related to having current market knowledge and acting upon it!

Plan:
Richards goes on to state, “The next time you’re about to make an investment decision because you’re sure you’re right, take the time to have what I call the overconfidence conversation. Find a friend, spouse, partner or anyone you trust, and walk them through your answers to the following questions:

Question 1: If I make this change, and I am right, what impact will it have on my life?

Question 2: What impact will it have if I’m wrong?
Question 3: Have I been wrong before?7

Let’s go through the questions with Dr. Guess, age 57, from last month. He’s had a horrific decade of investing with his “genius” broker, vacillating in and out of the market at just the wrong times, depleting a million dollar portfolio to $300,000. He’s decided to invest 100 percent in gold bullion and is sure it’s the only way to retire at age 66.

Is investing all in gold a prudent investment?

Question 1: According to media moguls and infomercials, he might be able to retire well before age 66, possibly by age 61-62 if gold goes to $3,000 per ounce.

Question 2: From a software analysis (Financial Engines), if Guess stays in gold, he probably won’t be able to retire until age 69 or later with gold’s risk.

Question 3: He’s almost always been wrong in investing; even with an SAT math score in the high 700s.

What did Guess do? He’s still in gold, rolling the dice, yet at least with knowledge that he might work beyond his late 60s.

There are many other obstacles to savings, yet knowledge of these four might increase your personal wealth harvest at any age.

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.
  2. Charles Farrell, J.D., LL.M., Your Money Ratios: 8 Simple Tools for Financial Security. New York, NY: Avery, 2010.
  3. Ibid, page 85.
  4. Downloaded from http://www.greatschools.org/find-a-school/defining-your-ideal/59-private-vs-public-schools.gs on 1/11/2012.
  5. Larry Swedroe, Investment Mistakes, McGraw Hill, NY, NY, 2012, p. 138.
  6. Carl Richards, The Behavior Gap, Penguin Books, London, England, 2012, p.85
  7. Ibid, p.18-19.


Author's Bio
Douglas Carlsen, DDS, owner of Golich Carlsen, retired at age 53 from private practice and clinical lecturing at UCLA School of Dentistry. He writes and lectures nationally on financial topics from the point of view of one that was able to retire early on his own terms. Carlsen consults with dentists, CPAs, and planners on business systems, personal finance and retirement scenarios. Visit his Web site: www.golichcarlsen.com; call 760-535-1621 or e-mail drcarlsen@gmail.com.
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