THE DALIN EXCHANGE
This month, I am going to do something special for Dental Economics® readers by interviewing two of the best experts when it comes to finances - Dr.
This month, I am going to do something special for Dental Economics® readers by interviewing two of the best experts when it comes to finances - Dr. Hugh Doherty and Brian Hufford. While we might be expertly trained as dentists (as well as other dental personnel who read this publication), many of us are minimally trained when it comes to finances. Most of what we learn about the business aspect of our practices happens after we leave school. Yet, this is one subject that we need to understand and keep under control.
Dr. Dalin: Dr. Doherty, I have listened to your lectures many times through the years, and never miss your columns. I love the way you simplify things. Let’s start by discussing how we can run a practice like a business that is productive and profitable.
Dr. Doherty: Here is a three-sentence course to help understand how a practice runs like a business. First, you read a book from the beginning to end. Second, you run a business the opposite way. Third, you start with the end (net profit), and then you do everything you must do to reach that goal. When all is said and done, a business (a practice) is judged by one criterion alone - performance. To measure performance, you institute a business plan. Generally, this is developed in December. The numbers that must be obtained to measure performance can be accomplished with a computer in the practice and a software product called Quickbooks Pro. The initial step is to project your practice’s expectations for the coming year. Whatever the practice collected in the previous year, you try to surpass with a “stretch target” number. Generally, this is 8 to 10 percent more than the previous year’s collections. This process is called forecasting. Second, institute a budget for your overhead expenses divided by percentages. Every good business needs and uses percentage budgeting. With this approach, all expenses are pooled and dealt with on a definitive percentage basis. When you create a business plan for the coming year, develop a series of expectations expressed in numbers and percentages. When all expenses - including overhead, doctor’s salary, and doctor’s discretionary expenses - have been totaled, you have your “breakeven number.” Every dollar the practice collects that is more than the breakeven number is your net profit. Unfortunately, a large percentage of doctors do not know how to calculate this key number.
Dr. Dalin: What assistance should we receive from an accountant? How frequently should we meet with an accountant?
Dr. Doherty: Accountants come in different flavors. A good accountant can do wonders for you. Conversely, a poor one can cost you many dollars. Dentistry is a unique profession. Look for an accountant who does business with other dentists. It is not necessary for an accountant to meet with you monthly. Meeting on a quarterly basis, similar to corporate America strategies, works fine. Your number reporting system, production per hour, collection ratio, overhead, and net profit should be based upon the early warning system. You want no “surprises.” With the help of an accountant, you might discover something amiss in your practice. If so, the two of you can take the means and effort necessary to solve your problems.
Dr. Dalin: Let’s talk about overhead in our practices. Are there certain goals for which we should be aiming? How can we get our numbers under control?
Dr. Doherty: Overhead is a word, with three syllables, that can cause serious stress. High overhead can affect a practice at every turn. The benchmark for overhead is 55 percent of revenues. If you are currently at 59 to 60 percent, then congratulations. You are in the comfortable range for a general practice. While there are several factors that influence overhead, look first at high expenses, inconsistent production, a failure to raise fees, and low collections. There is, however, a light at the end of the tunnel. Let’s start with overhead expenses. A practice is constantly spending money in five major areas: facilities (equipment/rent/utilities) make up 6 to 10 percent; staff salaries (employee taxes and benefits) comprise 15 to 30 percent; dental supplies account for 8 to 10 percent; and laboratory fees represent 6 to 11 percent. Everything else - such as dues, subscriptions, legal bills, accountant fees, business taxes, telephone, and marketing - is placed into administration and stands for 2 to 6 percent of the total.
As the year proceeds, a parallel set of numbers flows into the practice. These numbers represent day-to-day operations, and are gathered, collated, and reported on a weekly, monthly, and quarterly basis. So, actual costs, sales, profit margins, and earnings can be compared with budget forecasts. These numbers are just a financial picture of the business. Nonetheless, a practice cannot run without them. The numbers serve like a barometer, measuring the practice’s health and well-being.
Dr. Dalin: As I see it, the big issue is being productive and profitable. To achieve this, we must be successful in our recommendations to patients. What are the most important factors in accomplishing patient acceptance of our treatment plans?
Dr. Doherty: Until a patient says, “Let’s do it,” you are an unemployed dentist. The foundation of any successful relationship between a patient and a practice is a good comprehensive exam. It will afford an opportunity to collect the data that is needed to present the proper diagnosis for a patient’s condition. A practice’s mission statement could be “Helping our patients keep their teeth for a lifetime.” Unfortunately, there are roadblocks to treatment acceptance. The issues are pain, fear, time, money, and ignorance. Ignorance is the predominant roadblock. The IQ level among Americans about the benefits of good dental care is low. Patient education is the key to successful treatment acceptance. The second issue is communication. Herein lies the secret. With our sense of sight, we retain 86 percent of what we see, while with our sense of hearing we retain only 11 percent. Americans are visual learners. Therefore, it is imperative that we use the sense of sight to educate. We have heard the colloquialism “A picture is worth a thousand words.” The technology that we have today is invaluable in enhancing and increasing patient acceptance of proposed treatment. This is accomplished via digital cameras, intraoral cameras, and digital X-ray systems. Third-party testimony comes into play when dealing with before-and-after pictures as well as testimony by staff members who are vocal and positive about a doctor’s treatment and clinical skills. The third roadblock is money. We must understand how to make dentistry affordable. There is no better way to accomplish this than by participating with the CareCredit patient finance program. This program should increase a practice’s production and profitability while reducing the accounts receivable. My admonition to doctors is to “Stop playing banker.”
Dr. Dalin: Many dentists are approaching retirement. What are your strategies on how to best tackle this crucial process? I understand it is becoming more difficult to do this properly.
Dr. Doherty: Concern regarding the ability to secure a comfortable retirement has become more acute in recent years since market volatility has eroded the value of retirement plans. In a survey, preretiree doctors told me that “assuring a comfortable standard of living during retirement” is an important financial goal for them. In fact, 80 percent stated that this was their top concern. Even more incredible is that more than 90 percent of doctors are unable to retire and maintain the same standard of living that they currently have. In the survey, these same doctors expressed concern about retirement security by making the following responses:
• “I am very concerned about outliving my money in retirement.”
• “I am unable to create a steady income stream for day-to-day expenses that will last long enough.”
• “I feel I need to make up for lost time in my saving for retirement.”
Also, many indicated their estimated retirement date would be later than what they imagined it would be five years ago. So, it’s easy to paint a gloomy picture regarding the prospects for a preretiree doctor’s ability to lock in secure retirement income.
Dr. Dalin: What suggestions have you made to doctors about how to overcome these statistics?
Dr. Doherty: I examined my “Doctor Achievers” clients. This offered some ideas of how these doctors achieved their success. These wealthy preretirees were characterized by their higher-than-average net worth. They also constantly worked on their goal of assuring a comfortable standard of living during retirement. They were significantly more conscious of increasing their net worth. Upon closer inspection, I saw that the key to their success was with the types of financial instruments they owned. They had amassed stocks, bonds, IRAs, mutual funds, income real estate, and a qualified retirement plan. Naturally, they were disciplined savers and investors. Besides having a qualified retirement plan, they proactively protected their accumulated wealth with long-term care insurance. Additionally, “Doctor Achievers” had a formal, written financial plan. Quite simply, they had a vision of what retirement security was all about early in their preretirement years. This is what I describe as “thinking out of the box.”
Dr. Dalin: Brian, I attended one of your lectures at the ADA meeting in Orlando a few years ago. Part of your presentation dealt with cost segregation. At the time, I was about ready to start with the purchase and reconstruction of a building. With what I learned from your presentation, I demanded a detailed bid from my contractor and hired a cost segregation expert to run an analysis of what we did. I realized a considerable tax savings from my knowledge of the concept. Please explain what cost segregation is and how dentists can take advantage of it.
Hufford: Jeff, I am delighted that you were able to benefit from the tax planning opportunity. Our firm tries to uncover unique and conservative tax strategies that benefit a large number of dentists. In recent years, we have found that many dentists own their office buildings, yet have not heard of cost segregation.
For years, the IRS maintained - through a long line of court decisions - that components of office buildings were part of the buildings and had to be depreciated over 39 years. So, expenses such as plumbing and electrical costs that were associated with dental equipment, but were part of the office building, had to be depreciated over 39 years - even though the costs were related to dental equipment. Then in the “Hospital Corporation of America” tax case, the courts agreed with the taxpayer that building owners should be allowed to segregate costs of building components that were incurred to treat patients. The bottom line is that approximately 25 to 40 percent of a dental office building now qualifies for “rapid” five-year depreciation instead of the “slow” 39-year depreciation. This means that many dentists who either build or purchase new office buildings can save a significant amount in taxes over the first five years.
Dr. Dalin: I know another of your areas of expertise is with pension plans. What options should be considered whether you are a new dental school graduate or a middle-aged practitioner, or whether you work in a small or a large practice?
Hufford: When someone asks me - “What is the first, most important financial principle?” I always respond with “the power of compound growth.” Unfortunately, many doctors have discarded the concept of compound growth because of stock market losses from 2000 to 2002. But that wasn’t a compound growth problem; it was an investment problem. Let’s examine a possible 30-year career, focusing on an age range between 30 and 60, for a dentist. For ease of mathematics, let’s assume that a doctor can fund $40,000 per year in a deductible retirement plan (the maximum in 2006 is $44,000). If a doctor funds this amount, earns a 10 percent annual investment return (don’t let the word “investment” shut down your thinking), and increases savings each year in line with inflation, the savings progression for each five-year period is approximately: $300,000 in five years, $600,000 in 10 years, $1.2 million in 15 years, $2.4 million in 20 years, $4.8 million in 25 years, and $9.6 million in 30 years. We call this progression “Doubling by Fives™.”
Now how much will a doctor have at age 60, if the savings progression doesn’t start until age 45? Let’s say the first 15 years of practice, from ages 30 to 45, are spent paying off debt such as student loans and practice purchase loans. Because the doctor waited 15 years to start saving, he or she only will have $1.2 million at age 60 instead of $9.6 million if he or she started at age 30. The 15-year loss of compound growth cost the dentist $8.4 million! That’s why this principle is so important. Most dentists don’t think about seriously funding a retirement plan until they reach 45 years of age.
Pension plans are extremely important in dentistry. We recommend that dentists begin funding a retirement plan at the maximum level available for their age. There are two basic types of retirement plans: defined contribution and defined benefit. In 2006, the maximum defined contribution amount is $44,000, along with a percentage-of-pay limit. Our rule-of-thumb is that, until approximately age 45, most dentists should have some version of a 401(k) profit-sharing plan that best fits their practice and staff census. This would allow $44,000 to be funded for the dentist, as well as possibly $15,000 in a 401(k) for a spouse, for a family total of $59,000. Because of compound growth, this funding should be done as early as possible.
After age 45, doctors should examine the more complicated dual-retirement plan structures, which add some form of a defined benefit plan. This could provide a total contribution of $100,000 or more annually for the doctor. Because of our graduated income tax brackets, maximum funding of a deductible retirement plan is by far the best way to save for retirement - even with staff costs.
Dr. Dalin: How about accumulating savings to offset costs associated with sending children to college? What are the advantages and disadvantages of some of these methods for saving?
Hufford: You have certainly covered the bases, Jeff. The only thing I like about most of these is that they at least serve as an incentive for parents to save for college. I am going to break from my fellow financial planning peers and recommend that parents maintain control of college savings rather than putting the savings in a child’s name. There are exceptions. For instance, some states offer significant tuition savings by participating in a plan, or for grandparents who save for grandchildren. While there may be some minimal, or even significant tax benefits in these plans, I have seen bad things happen. Issues such as divorce, internal fees and expenses, investment limitations, economic emergencies for parents, or child behavior are reasons I recommend keeping the flexibility of savings in the control of parents.
Some advisors use 529 plans or formal gifting arrangements as an asset-protection device. To me, it’s important for a client to retain control of his or her savings. I like paying wages to children for working in a practice and/or using any number of “deductible” methods of shifting income. Perhaps, in that environment, the tax savings are significant enough to warrant shifting savings to children. But to me, that is one of the few times it is acceptable.
Dr. Dalin: Let’s talk about investments. Many of us are handling investments haphazardly. With numerous magazine articles and the Internet, we are being bombarded with ideas and recommendations. Whom are we to trust?
Hufford: Great question. “Whom are we to trust?” To me, this is the crux of the matter. If a person wants an authoritative answer on an issue concerning clinical dentistry, that person might refer to The Journal of the American Dental Association or the Academy of General Dentistry. Would an equipment salesperson be considered authoritative on clinical dental issues? Of course not.
Likewise, for the science of investing, most investment professionals turn to The Journal of Finance or to concepts developed by Nobel Prize winners in economics. For the professional investor, investment emphasis is more on portfolio design to achieve long-term goals while controlling risk. Professional investors are not concerned about forecasting markets, or selecting “hot” mutual funds or stocks. Studies have proven that investors who try to actively ride hot investment opportunities or hot mutual funds or stocks make investments that perform poorly compared to market averages over time.
My favorite book for the lay person on investing is “The Four Pillars of Investing” by William Bernstein. Bernstein provides a thorough analysis of investment techniques that professionals use. They can be used by anyone to build a high-performance portfolio with low costs.
Dr. Dalin: Hugh and Brian, I know that our readers will continue to get good advice and information from your columns each month in Dental Economics, as well as at each of your presentations around the country. Is there anything else you would like to add?
Dr. Doherty: There are three reasons why dentists fail to retire properly and are unable to maintain the lifestyle they are accustomed to living. In fact, only 4 percent of dentists will accomplish this goal.
The first reason is starting a retirement program too late. This is the biggest problem. Unfortunately, most doctors think literally, not exponentially. Einstein said that compound interest (returns on your returns) is the greatest wonder of the financial world. The sooner you start investing in your retirement, the better off you are.
The second reason is living beyond your means. It is too easy to get into debt. For doctors and their spouses, the biggest problem is spending. They go into personal debt fearlessly. In other words, it is easy to buy a bigger house (or a second house), a new car (instead of a used car), take expensive vacations, or buy a condo before establishing and implementing a qualified retirement plan. Obtaining these items is fine, as long as you are on track for retirement. If you cannot pay cash for luxury items, you should not buy them. Lenders use ratios to determine if you qualify for debt. The ratios are rules of thumb that keep them safe. The ratios are not designed for people to accumulate wealth. Just because money can be lent to you doesn’t mean that you should take it.
The third reason why dentists fail to retire properly is because of improper debt management. Paying off debt fast will not make you rich. You never want to reduce your personal or practice cash flow so that there are not enough dollars to invest in your personal portfolio and your qualified retirement plan. Wealth beyond your wildest dreams is possible if you will learn the “golden secret” - invest 10 percent of all you make for long-term growth. If you follow that one simple guideline, you could become a rich person in the future. You should not pay off debt until the annual gains on your investments exceed twice the amount you are investing annually. If you have several different practice loans or short-term debt that exceed $700,000, you should restructure that debt to maximize your cash flow. You should invest that cash flow in a tax-deferred vehicle (a qualified plan). Do not restructure your debt and then buy another liability. A liability is a noncash-producing item (like your home, condo, car, plane, or boat).
Hufford: It’s a privilege to serve in this “golden era” of dentistry. For long-term financial success, doctors should focus on how much they save, not how much they make!
Hugh F. Doherty, DDS, CFP®, is a Certified Financial Planner™, national lecturer, financial advisor to the health-care profession, and CEO of Doctor’s Financial Network. For more information on his upcoming “Financial Boot Camp,” e-mail him at email@example.com.
Brian Hufford, CPA, CFP®, is president of Hufford Financial Advisors, an independent, fee-only planning firm dedicated to helping dentists achieve financial peace of mind. Many dentists attend Hufford Financial Advisors’ Financial Breakthrough Workshops. Contact him at firstname.lastname@example.org.
Jeffrey B. Dalin, DDS, FAGD, FICD, practices general dentistry in St. Louis. He also is the editor of St. Louis Dentistry magazine, and spokesman and critical-issue-response-team chairman for the Greater St. Louis Dental Society. Contact him by e-mail at email@example.com, by phone at (314) 567-5612, or by fax at (314) 567-9047.