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A few years ago, I wanted to create a tool that would identify barriers to wealth creation. It seemed to me that, regardless of a dentist's income, there should be a way to identify where spending is too high, thus creating an inability to save. I have named this tool the Financial Balance Guide™. It identifies barriers to wealth creation.
The Financial Balance Guide™ defines financial success as keeping savings, wants, and needs perfectly aligned in a 20%:30%:50% ratio. I have a nerdlike need to test financial urban legends. One such urban legend is that dentists should save 10% of income to achieve a successful retirement.
By running numbers, I have found that saving 10% is too little unless the dentist begins saving in his early 30s and continues throughout a career. If saving is delayed, the appropriate amount of savings needed is at least 20% in a dentist's 40s and perhaps 30% or more in the mid–40s to early 50s. You should calculate your retirement savings needed as a starting point to implementing the guide.
Once savings have been determined, needs and wants must be aligned to allow the savings to happen. Determining what are needs or wants can create definitional problems. Are private schools for children a need or a want? How do you determine whether home mortgage payments are affordable? Is a bigger home a need or a want?
I have solved the definitional problem by determining two major needs and two major wants that must be managed to allow significant savings to happen annually. The guide answers questions about what is affordable and what is not.
Needs comprise only two items: loan payments and levies (income and payroll taxes). Together, loan payments and levies should not be more than 50% of income. Loan payments include practice debt — excluding an office building mortgage — as well as personal debt payments.
In general, loan payments should be approximately 25% of income and levies should be approximately 25% of income. Determine how much you have paid on debt that you owe this year.
Does it exceed 25% of your income? If so, you are sabotaging wealth creation and your ability to retire from dentistry. Dentists who rapidly repay debt always break this cardinal rule. Ideally, the total amount of monthly debt payments should not exceed 0.8% of the amount owed.
If you owe $500,000 on debt (practice and personal), monthly debt payments should not exceed $4,000. This is 0.8% of the amount owed. With a proper debt structure and a well–designed pension plan, needs can typically be reduced to 40% of total income.
Wants are only two items: large purchases and lifestyle spending. A large purchase is any item that is nonrecurring, exceeding $3,000. Private schools for children are a large purchase. College tuition is a large purchase. A new automobile is a large purchase. New dental equipment is a large purchase. It makes intuitive sense to lump large purchases with lifestyle and limit them to 30% of income.
These wants are discretionary in nature and must be controlled in total to allow savings to occur. Frequently, large purchases are a culprit in lack of savings. How is it possible to eliminate private schools, college tuition, or dental equipment purchases? It isn't. But, with the proper structure of existing debt and an enlightened use of debt for large purchases, needs and wants can be kept in alignment.
If the guide could be applied to each year of a dentist's career in hindsight at age 60, it would be likely that improper debt structure and the lack of management of large purchases would have eliminated nearly 80% of the total wealth creation potential in a dentist's career.
How do you pay yourself first and avoid saving what's left over so you don't experience the Breakeven Syndrome? There is only one way to do this. You must follow the guide, the Financial Balance Guide™. I think it is the one essential financial tool to create wealth during a dental 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 firstname.lastname@example.org.