A fresh look at compound growth
“Don’t tell me about compound growth! Tell me how to implement it in my life!” When I raise the topic of compound growth while speaking, sometimes I feel this concept has become as exciting as the national budget deficit.
Breakthrough Financial Planning | Brian Hufford, CPA, CFP®
“Don’t tell me about compound growth! Tell me how to implement it in my life!” When I raise the topic of compound growth while speaking, sometimes I feel this concept has become as exciting as the national budget deficit. This is too bad because I have learned that an understanding of compound growth would radically change how financial decisions are made every year. For instance, the simple decision of how to buy a car (lease/loan/pay cash) is critical to the implementation of compound growth. Let me explain how.
You have probably heard all of the Wow! stories of compound growth. One of the original stories relates to folding a piece of paper in half 40 times. While I have not done the math, the story goes that - by the 40th fold - the paper would reach to the moon and back. Wow! So what? What does this have to do with buying a car?
The problem with most compound growth examples is that they really don’t guide day-to-day decision making. Because of this, I wanted to create a fresh way to understand and implement compound growth.
I think this has been accomplished with a teaching tool I call Doubling by Fives™. You probably have heard of the Rule of 72. It describes a mathematical model of how long it takes to double a fixed savings amount. Doubling by Fives is different. Instead of looking at a fixed amount in savings, it looks at what happens to savings accumulation when you save the same amount every year.
For instance, if one of your staff members saves $10,000 in your 401(k) plan each year, how much will it be worth in five, 10, 15, 20, 25 or 30 years? The progression with a 10 percent return is close to the progression: 7.5 times, 15 times, 30 times, 60 times, etc. So the progression in savings goes $75,000, $150,000, $300,000, etc., and increases to $2.4 million in 30 years.
The principle of Doubling by Fives has taught me how important it is to make wise decisions in how to pay for large capital expenditures in the dental office and at home. In addition, the decision of how to repay debt becomes a major - if not the major - financial decision a dentist might face.
If a 35-year-old doctor decides, for instance, to wait 10 years to start saving $40,000 per year in a retirement plan, how much does that cost the individual at age 65? Most doctors don’t think about saving for retirement until age 45. Perhaps a dentist wants to first pay down student loans or pay off a practice purchase loan, then wait until age 45 to begin saving.
Perhaps a dentist wants to pay cash for cars and equipment in the practice in order to “stay out of debt.” In the above example, this seemingly harmless decision to focus on repaying debt first or paying cash - and then begin saving 10 years later at age 45 - costs the dentist $7.2 million at age 65. Yes, the amount lost is $7.2 million!
After only 20 years of five-year doubling, the $40,000 per year grows to $2.4 million. After 30 years, the amount increases to $9.6 million! The last two doubles are $4.8 million and $9.6 million.
At Hufford Financial, we talk about how important it is to make financial decisions with intent instead of instinct. Instinctively, it seems that paying debt first and then saving is the best financial decision. After all, look at how much interest can be saved. The earth looks flat, instinctively, but it isn’t. While debt management is important, annual savings is the critical issue. Compound growth illustrates this fact. Make sure that you protect your annual savings by planning for large expenditures.
So, in 2007, be sure you have a savings goal and that equipment purchases and large capital expenditures do not sabotage savings. Implement compound growth in your life. Stop saving what is left over.
Brian Hufford, CPA, CFP®, is president of Hufford Financial Advisors, LLC, an independent, fee-only planning firm that helps dentists achieve financial peace of mind. Upcoming Hufford Financial Advisors’ Financial Breakthrough Workshop dates and locations are listed at www.huffordfinancial.com. 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@example.com.