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For maybe the fourth time in my life, I will be out of debt again this year. Of course, this is the case if you don't count the years remaining on my office lease or my leased business automobile.
It's funny, but I don't really view this accomplishment as a cause for celebration. My wife, though, views a paid–for–home as an unassailable castle. My brother–in–law burned his mortgage document at 14,000 feet while atop Long's Peak. Still, I don't have any compelling urge to recline in a chaise lounge on a beach or hit that little white ball (since I hate golf).
In my on–again, off–again relationship with debt through the years, I have found several important principles that have served me well. It's not that I believe you shouldn't have a plan to get out of debt. I am just not part of the crowd who believes debt is a demon that must be exorcised.
Nor for that matter, do I view debt as the principle focus of a financial plan. Rather I view it as an important tool in wealth creation. Debt is a tool which — if used improperly — can sabotage wealth creation, especially for most dentists who have ongoing needs to obtain expensive technology.
Here are some of the principles I have learned:
When does one have too much debt? Entrepreneurial debt is difficult to classify. It includes student loans for dental school, debt to purchase a dental practice or a fourth dental practice, and debt to purchase a Buffalo Wings franchise.
One can forecast outcomes and project cash flows, but this requires that the future unfolds somewhat according to plan. Frequently it doesn't. I remember the giddiness of driving my German sports car at 140 mph on a lightly traveled two–lane country highway until I noticed a deer crossing sign for wooded areas that ran adjacent to the road.
Assuming that you are past the entrepreneurial–debt stage, it is possible to answer the question of whether you have too much debt. My approach to debt is counter–intuitive. In my view of the economy, one is either in the “debt–as–a–religion crowd” (any debt is too much), or one believes simply that debt is a barrier to wealth creation and must be properly managed.
Since most dentists don't have a choice of whether or not to use debt, I take the latter path. In my economy, one has too much debt if either of two factors are present.
The first factor is if a dentist is unable to save 20% of income in retirement plans and personal savings. If this is the case, then it is likely that debt payments are sabotaging wealth creation. Thus, the dentist has too much debt, or debt payments at least.The counterintuitive part of this rule is that too much debt is related to cash flow and not the absolute amount of debt.
A dentist may not have a large amount of practice and personal debt and yet — if the cash flow committed to debt repayment eliminates the ability to save 20% of income — the debt is sabotaging wealth creation.
Here is an example. Let's say that a dentist only has $400,000 of total debt — practice and personal — and that total principal and interest payments are $6,700 per month or $80,400 per year.
By dividing the monthly payment of $6,700 by the total amount of debt ($400,000), we see that this dentist has a debt payment ratio of 1.68%. A good debt payment ratio should only be 0.8%. In this case, 0.8% of $400,000 is $3,200. This is less than half the current payments.
A debt payment ratio of 0.8% is the ideal total debt repayment percentage in dentistry. In our example, the dentist is throwing away $3,500 of monthly savings potential and millions of dollars of wealth creation over a career in dentistry.
The second factor illustrating too much debt is the inability to retire all debt at a financial freedom goal date.
Let's assume that you wish to be financially free at age 62, even though you hope to productively work until you are age 70.
In this case, debt factors into the financial freedom goal in two ways: During a career when a high debt payment ratio sabotages savings, and second, when the ultimate debt remains unretired at financial freedom. If you retire all debt by selling your office building and practice by your financial freedom goal date, you are probably fine. If so, you should focus on savings, not retiring debt. If not, achieve the savings goal first, then work a short time longer to retire debt.
To maximize wealth creation, a dentist must view debt elimination as a hindrance to wealth creation, not as the defining factor of financial freedom. After all, the definition of being broke is having no savings and no debt.
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. Contact Hufford at (888) 470–3064, or [email protected].
