As our company perseveres at getting better at HELPING CLIENTS CREATE WEALTH two questions drive me. First, what is the No. 1 financial danger faced by dentists? Second, can any dentist – regardless of income – manage annual financial results and have a significant impact on wealth creation over a lifetime? To put both questions simply: What is the largest barrier to wealth creation in dentistry, and how do you remove that barrier? The solution to this problem might be appropriately called the wealth accelerator system.
The largest financial danger is that there never seems to be enough money – regardless of income – to meet a dentist’s financial priorities: needs, wants, and savings. Something is always out of balance. Either taxes are too high, debt is too large, college for kids is too expensive, or the need to purchase new technology in the office is too strong. Traditional tax planning, financial planning, pension planning, and investment planning never seem to overcome these challenges in a significant way to allow for maximum wealth creation.
What if you thought about the problem differently? I think of the problem of maximizing wealth creation as a simple money-balance equation. This equation says that to accelerate wealth creation each year – regardless of income – needs, wants, and savings must be properly aligned. Needs should comprise 50 percent of income, wants 30 percent of income, and savings 20 percent of income. Still, you might say that your needs seem to consume all of your money, and that you really don’t know where your money goes. So, let’s make this simple.
Needs
Needs should be no more than 50 percent of income. What are needs? I find the easiest way to classify what a “need” is in dentistry is to be a little counterintuitive. To me, needs comprise two items: loan payments and taxes. Taxes include federal income, social security, and state income. Loan payments should be no more than 25 percent of income, and taxes should be no more than 25 percent of income. This gives you a combined total of 50 percent.
By income, I refer to production minus overhead, or the net income from the practice prior to pension, relatives on payroll, owner’s fringe benefits, etc. Try this exercise. Add up your monthly loan payments, practice and personal, with the exception of an office building mortgage if you own your building. By multiplying monthly payments by 12, an annualized amount can be determined. Add the annual loan payments to your annual total taxes and determine what percentage loans and taxes are to income. If this amount is more than 50 percent, it is relatively easy to fix the problem by properly structuring existing debt and reducing taxes with the right kind of pension plan.
Wants
Wants should be no more than 30 percent of income. What are wants? The best way to think about “wants” is to simply look again at two broad classes: large purchases and lifestyle. Large purchases in the practice are cash expenditures for equipment or technology in excess of $3,000. Large purchases also include cash expenditures for home-related items such as automobiles, furniture, or college tuition for children. You might think that college tuition is a need. It is not. Spending $50,000 for tuition at Notre Dame is not a need. It is a want.
People who pay debt rapidly and attempt to pay cash for large purchases after debt has been eliminated are guilty of two sins that sabotage wealth creation. First, they sabotage wealth creation by spending too much on “needs,” loans and taxes. Then, later in life, they overspend on wants by paying cash for large purchases. Remember that loan payments, mortgage, auto, and equipment are in the needs category. So, large purchases are simply cash payments in the current year. Lifestyle is everything spent at home except loans and taxes.
Savings
Savings should be 20 percent of income. Savings includes your share of pension payments annually, as well as personal savings. If you are not able to save 20 percent, it is because needs or wants – or both – are out of line.
It is difficult to fully develop these wealth-creating concepts in one column. The first step – as you balance needs, wants, and savings – is for your accountant to change your financial reporting to a cash flow format. Every quarter try to classify where your cash goes in the needs and wants formats I have outlined. I believe there is no better way to accelerate your wealth creation.
Brian Hufford, CPA, CFP®, is CEO of Hufford Financial Advisors, LLC, an independent, fee-only planning firm that helps dentists achieve financial peace of mind. The company is recognized as the only strategic alliance partner for financial planning services for the Academy of General Dentistry. Contact Hufford at (888) 470-3064, or at [email protected].
