by Brian Hufford, CPA, CFP
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During challenging economic times, it is important to move toward your fears and to increase savings. When investment markets are difficult, the temptation is to discontinue saving altogether. But I recommend you fight this temptation and defeat the assault on your confidence that difficult markets bring.
I have tried to read every best-selling book about how to be financially successful, and then measure the impact of the advice for creating wealth for dental readers and clients. The strategies offered in nearly all of the books that I have read can be classified in one of three categories:
- Have a frugal lifestyle and get out of debt
- Incorporate and deduct everything for tax purposes, your children, dog, and electric car
- Start a business, preferably real estate (at least until recently). Better yet, start an Internet-based business and become wealthy following the author's foolproof step-by-step process. Day-trading is still popular, and as a breakfast waitress shared with me recently, offers investment returns of 10% per week.
Hopefully, if you participate in any of these strategies, they will bring you the desired results. In case they don't, I would recommend the traditional “fall-back” strategy of creating wealth from increased annual savings in a well-managed dental practice.
The tool my company has created to determine if a dentist has financial habits that will result in wealth creation is the Financial Balance Guide™. It aims to identify barriers that block a dentist's ability to save 20% of annual income from practicing dentistry. Whether a dentist makes $80,000 or $800,000 per year from dentistry, saving 20% of income is the ultimate measure of future financial success.
I do not view a high income, debt elimination, tax reduction, or frugality individually as guarantors of financial success. If implemented properly, these strategies can contribute to success but only if accompanied by increased savings.
The ability to save 20% of income is a function of the proper financial balance of four critical categories of cash outflows. These categories are loan payments, taxes, lifestyle spending, and large purchases such as equipment, automobiles, or college tuition.
If spending in any of these four categories is too high, the ability to save 20% of income is eliminated. The Financial Balance Guide™ examines needs, wants, and savings to determine which categories are out of alignment, thus creating a barrier to saving.
We define cash flow needs as loan payments and tax payments. These two items should not be more than 50% of income. Loan payments should be no more than 25% of income, and tax payments should be no more than 25% of income. For many younger dentists, generally up to age 45, these two items — loan payments and taxes — can be as much as 70% of income. This is well beyond the recommended 50%.
Try this exercise: Add your annual loan payments for practice and personal debt, including home mortgage, but excluding your office mortgage. Then determine if these loan payments exceed 25% of your income. Likewise, add income and Social Security taxes that you paid this year. Will they exceed 25% of your income? Typically, the implementation of the correct debt structure and a qualified retirement plan can eliminate the barrier to saving 20% of income. Needs should be 50% of income.
Wants, defined as lifestyle spending and large purchases, should be 30% of income. Lifestyle spending is generally not the culprit in exceeding the 30% limit. Typically, the barrier is large purchases paid for with cash. College tuition and large equipment purchases paid for with cash can inhibit the ability to save. While I am not an advocate of borrowing to fund college or pay for equipment, the reality is that the most important goal is saving 20% of income.
I advocate the intelligent use of debt to facilitate savings. Here is a typical progression in a dental career. In your 30s, debt payments will keep you from being able to save. In your 40s, taxes will prevent you from being able to save. In your 50s, large purchases, such as college tuition, will prevent you from saving.
Throughout it all, lifestyle spending needs to be managed. Are your financial priorities properly aligned to offer the ability to save 20% of income? Do you have savings, needs, and wants properly aligned with the Financial Balance Guide™?
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 at [email protected].