Let no debt remain outstanding

by Brian Hufford, CPA, CFP®

There is no financial topic that is more telling about a dentist's wealth philosophy than the topic of debt.

Two questions display the full range of beliefs about the use of debt in dentistry. These are, "How much debt can one safely incur?" and "How quickly should debt be repaid?" The admonition from the book of Romans in the Bible is "Let no debt remain outstanding."

One of my friends interpreted the Bible passage literally as prohibiting the use of any debt whatsoever. He refused to purchase a home because he could not afford to pay cash. His family always rented. Apparently a lease is not a debt. Our government seems to have taken the opposite tack -- "Let all debt remain unending." Somewhere between these extremes there is the right answer for you.

Some dentists try to classify debt in terms of the purpose for incurring it -- either good debt or bad debt. Good debt is debt incurred for education, business, investing, or buying a home. Bad debt is any debt used for consumption (except for purchasing a boat).

This good debt/bad debt comparison never seemed to work for me, perhaps because I was suspicious that either the banking or real estate industry was behind this method of classification. Other dentists treat the reason and risks for incurring debt as a light issue, but then become religious about debt repayment. In this case, perhaps good debt is any debt that can be amortized in five years, including a mortgage. All excess cash should be used to more rapidly repay debt.

The breakthrough for me regarding how to think about debt came only as I explored the impact of debt on other important financial goals. In other words, debt is neither good nor bad unless it negatively impacts other more important financial goals. Examples of these relationships are:

1. Debt is a liquidity risk; it's best to have a six-month cash reserve. The question of how much debt one can safely incur is unanswerable. Will you be able to make mortgage payments for 30 years? Who can answer this? No one knows the future. Rapid repayment of debt does not mitigate liquidity risk until the debt is finally eliminated. Between the times of debt and no debt, liquidity risk must be addressed. Rather than rapidly repaying debt, one should first set aside a six-month cash reserve equal to six months of total debt payments.
2. Debt is a wealth accumulation risk; best to save 20% of income. While rapid repayment of debt is the surest way to get out of debt, it is also the surest way to sabotage wealth creation, especially in dentistry. My first thought when asked how quickly debt should be repaid is how quick repayment will affect the ability to save 20% of income. If the ability to save for future goals is impaired by rapid debt repayment, then debt payments should be restructured. Having no debt is not a complete goal. Replacing working income is a complete goal. We were born without debt, but we cannot independently support our needs. Saving is a primary goal; debt elimination is a secondary goal.
3. Debt is a bet on the future; best to live in the present. One of the most difficult questions for me has been how much debt may be wisely used to pursue future goals. Chief among these is student loan debt. I was recently introduced to a graduating dentist with more than $700,000 of student loan debt. How does one approach that? Is $250,000 okay, but $700,000 is not? Higher education and home costs have grown beyond reasonable norms at times due to the availability of easy credit. There is always a reckoning when the availability of easy debt fuels prices. Incomes and valuations tend to cycle within norms and extremes. There are cyclic trends within larger secular themes. Neither is easy to discern, except in hindsight. Future debt bets should be evaluated with traditional investment valuation tools such as diversification, internal rate of return, etc. A new office building, for instance, should be evaluated based upon traditional practice overhead statistics. Present-day traits, such as frugality and simplicity, should underlie future bets.

In the end, debt is simply debt. Like alcohol or food, debt can enhance life or end it. In dentistry, debt is a necessary evil which, with proper management, can be used to create tremendous opportunities. When paired with wisdom, the proper use of debt leads to wealth creation throughout a career.

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 bhufford@huffordfinancial.com.