Albert Einstein is famously quoted as saying: “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”
But it seems dentists, like most Americans, are slow to appreciate the wonders of compounding. According to the American Dental Association, only 4% of dentists are in a position to retire at the age of 65 and maintain their current lifestyle. By the time many dentists get around to retirement planning, they’re forced to adopt a strategy of “better late than never.”
However, when it comes to retirement savings, the key phrase is “the sooner the better.”
Here’s an example. Let’s say you wait until age 45 to start saving. You invest $1,000 per month for the next ten years, stopping at age 55. You then earn 7% on your savings for the next ten years. At 65 you’ll have $375,000.
But in another scenario, you save $1,000 per month from the age of 25 until you turn 35, then you quit saving but earn 7% interest until age 65. How much would you have? The answer is $1.5 million. Thanks to the wonders of compounding, starting a savings plan early makes a huge difference.
And when contemplating the compounding of your savings, consider how taxes cut into the compounding effect. Establishing tax deferred accounts, like a 401K, could save you hundreds of thousands over the course of your career.
Today’s dental school graduates, faced with the immediate demands of building a practice, too often don’t make financial planning a priority. This procrastination could come back to haunt them in the future.
For dentists starting their careers, it’s imperative to build a strong foundation for the future by devising a well thought-out financial plan early on. The young dentist’s financial priorities should be: managing student loans; managing risk; establishing an emergency fund; saving for retirement; managing wealth; and hiring the right team of specialists.
In the early years of their practice, a big concern for dentists is typically managing the loans that financed their education. Today’s dentists graduate school with debt ranging from $150,000 to $250,000. This deficit is often financed at rates as high as 6-8%. Once a dentist has obtained full-time employment, the smart move is to refinance this debt load to a lower rate, and pay it off as quickly as possible. As Albert Einstein pointed out, the sooner a young professional can change from paying interest on debt to earning interest on savings, the better.
A key part of a financial plan is dealing with risks. And one of the major risks that dentists face is becoming professionally disabled, so disability insurance is a must. Initially, insurers will only offer limited coverage to dentists with low incomes. However, the more a practitioner earns, the lower the rates become. A mistake dentists should avoid is neglecting to provide for additional coverage as his or her income increases. It’s important to review disability insurance needs and rates regularly.
Life insurance is another important risk management decision. Life insurance provides a means to protect one’s family from student loan liability, mortgage debt, and loss of income in the event on an untimely death.
Saving for short-term emergencies is also crucial. Every young dentist should establish an emergency fund. For households with two incomes, keeping three months’ worth of living expenses on hand is a recommended guideline -- twice that for households with one income.
As we’ve seen, the majority of dentists wait until later in life to begin saving for retirement. It can’t be stressed enough that instituting a savings program early in one’s career is essential. Lack of foresight can keep dentists tied to the dental chair, when they could be enjoying retirement traveling or spending time with their families.
Beginning a retirement savings plan late in life will force a dentist to save significantly more of his or her income to catch up. After years of working so hard building a practice, no professional wants to have their lifestyle pinched because a big chunk of income must go into the retirement fund.
Dentists must be excellent businessmen to succeed in an increasingly competitive environment. And part of running a successful business is assembling a great team. Finding a trusted financial advisor to help manage wealth accumulation and protection is a smart move. The services of a good estate planning attorney and a CPA are also essential.
For the recently graduated dentist, building a practice is a demanding and exciting time of life, and retirement seems a distant event. But by creating a sound financial plan early on, the young dentist will help ensure that his or her days as an older dentist are rewarding and enjoyable.
This article was originally published in the North Carolina Dental Society’s Gazette.