CHAPTER 7
Personal Money Management
Rule No. 1: Never lose money.
Rule No. 2: Never forget Rule No. 1.
Warren Buffet
Many financial planning issues that young professional dentists face are the same as those for the general public. However, in other ways the issues for dental professionals are unique. They often start with high debt loads but balance that with high income levels. Dentists are frequently not employed by a company or organization that provides benefits such as medical insurance or a retirement plan. They are typically limited in how much income growth they can expect and must balance their income wants and needs with their desire for personal time. Because of these issues, new dentists must quickly learn how to manage money.
PERSONAL MONEY MANAGEMENT
BECOME A GOOD MONEY MANAGER
Dentists need to become good money managers, in both their business and private lives. The first step is to learn all about money and how to use it. Becoming a good money manager does not just happen; it needs to be worked at, just like becoming a dentist. Dentists should study how to save, how to invest, and how to become wise consumers. They should subscribe to Kiplinger’s or Money magazine. These are the two leading personal financial magazines, and they give valuable tips for saving, making, and investing money.
PERSONAL RECORDS
Dentists accumulate many vital personal financial records. Therefore, they should create a personal record management system, like the one developed for the office. Dentists should not let the paperwork pile up; they should work on records every month. They should get a safe deposit box at the bank, a fireproof safe at home, or a secure cloud storage vault for essential papers. These crucial papers include wills, insurance policies, names of advisors, and certificates of ownership, among others. Dentists should retain all tax records and related items for at least seven years and keep insurance policies as long as they are in effect.
GETTING PROFESSIONAL HELP
As professionals, dentists have skills and knowledge that members of the public do not have. Dentists not only work with patients to take care of their oral health, but also direct and intervene as professional expertise dictates. The same is true for managing financial affairs. A dentist may have a basic understanding of financial management, but there are times when the guidance of someone with expert knowledge in a specific area is needed. Dentists should become actively involved in their financial management and planning but use advisors’ expertise when situations demand it.
Accountant
Most dentists go first to their accountants for advice about practice and personal finances. An accountant can be used to help with tax planning, setting up basic retirement plans, evaluating the numbers of the practice, and personal budgeting. Certified Public Accountants (CPAs) have different interests and expertise. Some work on any business or personal tax affairs. Some concentrate on professional practices (physicians, optometrists, or dentists). This latter group will often be in a better position to help with practice‐specific questions (e.g. “Is it time to hire an additional hygienist?”). An easy way to find an accountant who serves mainly professional clients is to go to the local dental society meeting and ask several members whom they use. One or two names will probably come up repeatedly. Contact them, then interview them to see if they would be a “good fit” with your practice or personal needs and style.
Depending on the background and expertise of the accountant, additional help for investment planning, establishing estate plans, buying or selling or partnership opportunities, and a host of other advanced financial topics may be needed. Dentists often use a lawyer, financial planner, or management consultant.
Investment Advisor
The investment world is very diverse when it comes to advice on and executing (buying and selling) securities. There are full‐service advisors, mutual fund companies, banks, and online Robo‐investment advisors. The dentist must decide how much they want to be involved in regular investment decisions, what the level their current knowledge is, and how much time and effort they want to spend learning about the investment strategy and decision‐making.
Insurance Agent
Dentists frequently have two insurance agents, one for their business insurance and another for their personal insurance. Some agents work only with one insurance company, and others are independent agents who shop around various insurance companies to find the best policy. Some insurers offer a package of products (e.g. various business insurances). Some include malpractice coverage, while others do not. Organized dentistry often endorses insurance plans for members. (This may be life, disability, or office insurance.) Agents are another source of contact with the insurance company. Dental practitioners should ask their colleagues for recommendations, then shop around for insurance coverage. An annual insurance review is prudent, as the need for different coverage changes as someone progresses through their career.
Management Consultant
The practicing dentist will use management consultants for two reasons – to address practice productivity problems and to help with practice transitions (buying, selling, or adding associates). As with other advisors, there will be a few advisors frequently mentioned by colleagues. Using someone with an excellent track record in helping other practitioners with particular issues is generally advantageous.
PERSONAL LIFESTYLE ISSUES
INCREASING LIFESTYLE AND INCOME
New dentists are typically like a kid in a candy store when they first start making money. They have been in college for 8–12 years, may be married, and have put off increasing personal spending and improving their lifestyle while in school. Suddenly, with new‐found wealth, they buy too much (often on credit) and struggle for the next several years to pay higher bills with the growing take‐home pay. The tendency is for lifestyle expenses to increase along with income. Every dollar they make is spent on a bigger house, a newer car, and various toys. It is easy for someone to listen to the tales of classmates and compare themselves to others, even though they may be in entirely different situations. Unfortunately, the solution is not a fun, warm process. Personal life expenses must be kept under control. It is easy to increase lifestyle to meet increasing income. Once accustomed to a particular lifestyle, it is difficult to cut back on spending, such as when starting a retirement savings plan. A solution is to develop and use a family budget. If income grows, the dentist can take half the increase and use it to fund spending or investment plans, using the other half to boost their lifestyle. This way, lifestyle increases (more slowly than without savings), and a savings or investment plan is painlessly funded. This approach does take discipline, however.
SPEND OR SAVE
When someone earns money, they can only spend or save it. As previously mentioned, after years of training most new dentists want to spend it immediately and enjoy it. Instead, they should get into the habit of saving. Dentists should start each budget period by saving at least 20% of their take‐home pay, learning to live adequately on the remaining 80%. As their income increases, they should save as much of the increase as they spend. As Box 7.1 shows, saving even a dollar a day adds up to a sizable sum over time.
Separating Financial Needs from Wants
People want to buy physical goods, such as shoes and televisions, or intangible services, such as vacations or lawn‐mowing services. Some of these are goods and services they need, and others they do not need but want. People need to have reasonable housing, clothing, food, and insurance. They want a weekend getaway, a new designer purse, or a new fishing rod or shotgun. They should purchase these two types of goods and services differently. Everyone should buy their needs first. Only when they have satisfied their needs should they buy their wants. People can borrow to buy their needs if they must. However, they should never borrow for wants – they should only use savings or pay cash. This sounds easy. The problem is determining if a desire is a need or a want. Everyone needs housing, but do they need or want a larger house? People need recreation for their mental health and spiritual renewal, but do they need or want a week’s vacation in Monaco? Often, people find that they can postpone or eliminate “wants” by making informed lifestyle decisions. This allows them to pay for “needs” or save for future “wants.”
FAMILY PLANNING: THE COST OF A FAMILY
For many people, becoming a parent is their greatest adult challenge. These changing responsibilities, obligations, and commitments last a lifetime – once a parent, always a parent. No other life event causes people to become as thoughtful, careful, and focused on the future as having the moral, physical, and financial responsibility of raising children.
Children involve additional direct and indirect costs of increasing family size. Box 7.2 details some of these costs. No matter what people say (“Children are cheap. They hardly eat a thing!”), the simple fact is that having a family is expensive. For the dentist, these costs often come when the family budget is already thin because of the need to pay off student debt and initiate a dental practice. Family income gets squeezed even tighter if one parent quits work to care for children. Some estimates place the cost of raising a child to age 18 at nearly $500 000. This does not include the cost of college, professional, or graduate schooling. Having children is an expensive proposition indeed.
What should be done to prepare for children financially? The dentist should do the same type of financial planning as before children, have a budget, and stick to it. They should have an adequately funded emergency fund, more so now than before. They should expand savings and save for purchases, educational needs, and children’s activities. The family should look closely at the impacts of having one or two working parents. One income means less money to spend and invest, but it also means one parent will be available to care for the children. Daycare is expensive! Family finances will be different (costs such as daycare and work expenses) and the family dynamic will be different. Everyone should balance the trade‐off in finances with the non‐material family life issues.
FAMILY BUDGET
Developing a family budget is the cornerstone of personal financial planning. A budget is a statement of how money has been spent in the past and estimates future income and expenses. As such, budgets become a target for day‐to‐day financial life. They also help identify spending patterns, coordinate savings, and improve living standards by identifying areas of waste. Budgets are most often used when a family is having a financial problem. The family then helps set targets for spending and lets everyone know why spending is limited in one area or another.
Although each budget is unique for that person or family, some general targets for expenditure categories can be developed (Box 7.3). No more than 30% of take‐home pay should be spent on housing costs, 20% on food (groceries and eating out), and 15% on other miscellaneous expenses. Debt payments (including student loan payments) should total no more than 30% of take‐home (after‐tax) pay. The budget should also detail paying 5–10% of take‐home pay into savings (personal and retirement).
DEVELOPING THE BUDGET
Many families develop a budget only after they find a problem. “Where does the money go?” is a common starting point regarding budgeting and money management. Many websites, software apps, and financial self‐help books can guide a family in developing a reasonable budget. Dave Ramsey and Suzi Orman are two famous personal financial planning personalities. Excellent apps that help with the budgeting (and financial planning) process include Quicken, Mint, EveryDollar, Tiller, and Fidelity Spire. All of these work on a common theme – we do not know where we spend our money until we write down where it goes, and only then can we develop a plan to improve our spending and saving habits.
Step 1: Write Down Income
Determine how much income flows to the family each month. Income is not just what is earned but all sources of money coming to the family budget. This may include grants, scholarships, family gifts, or other non‐traditional sources. Often, money may come in a periodic large sum (such as a scholarship). Mast people break this down to a monthly amount for easy understanding.
Step 2: Write Down Expenses
The family should track their expenses for 30 days, placing each expense into a category (food, housing, car, etc.). This allows a better understanding of where they spend money each week and month. Start by listing all the family’s expenses. Think about regular bills and irregular bills, and those bills that are paid bi‐monthly or quarterly. Add these costs together with other costs, like food, gas, and entertainment. Every dollar spent should be accounted for. Software apps can quickly help families track large and small expenditures. Debit and credit card statements often help categorize expenses. This is an eye‐opening experience as some families learn for the first time how much they are spending in each category.
Step 3: Look for Problem Areas
Subtract monthly expenses from income. Every dollar should be accounted for and placed in a category. Many families use a zero‐based budget, which means they start at zero for each category (the base amount is zero), then justify all expenses in the category. Some expenses are necessary (“must‐haves” such as food, shelter, clothing, and transportation) and some are optional (wants such as dining out or taking a vacation). If the family places all expenses in the “must‐have” category, then additional sources of income or significant lifestyle changes are in order.
Step 4: Set Financial Goals
Effective money management starts with a goal and a step‐by‐step plan for saving and spending. Financial goals should be realistic, specific, have a timeframe, and imply an action to be taken. Each family should decide the financial goals that they are working toward. Some of these goals might be long term, like retirement planning; some might be short term, like saving for a car or a family vacation. The budget should not only include income and expenses, but also take into account the financial goals that the family has set.
Step 5: Monitor Progress
Even after someone starts a budget, they still need to stay on top of their expenses. Some people use spreadsheets or online tools to track their spending. Others follow Dave Ramsey, a popular radio host who teaches his clients to spend cash on food, gas, and entertainment items. He uses an envelope system to help people manage their day‐to‐day spending. Once the money in the envelope has been spent, they are done spending in that category.
SPECIAL CONSIDERATIONS
Many people work as independent contractors or are self‐employed, which means they may have an irregular income. An irregular income comes in at different amounts, times, or both. When they make a budget, they need to base their income on their lowest‐paid month from the previous year. They list their expenses and put an amount next to each item. They then can prioritize the expenses (must‐haves or wants).
Once they have a bare‐bones budget, they can plan for any additional income they bring in over the worst‐case scenario. They might ask themselves: “If I had enough money for one more thing, what would it be?” They keep a prioritized list of what those items are. When they have additional money, they go to that list and use it as a guide to what they will use the rest of that money for. The list will change, and items will move up and down the list based on what is essential at a particular time.
HOW TO IMPROVE SPENDING HABITS
Whatever the present financial situation, there are only two things someone can do to improve it: earn more or spend less. Assuming they have maximized short‐term earnings, there are several steps they can take to improve their spending habits. First (again), they must develop a budget. They should examine their spending patterns, looking for areas of wasteful spending or items that can easily be cut. They should write down their plan for financial improvement; it is too easy to devise a vague plan. Unless the plan is written down on paper, it does not mean anything. A person who wants to improve their spending should not use credit cards; many people get into severe financial trouble using credit cards. They should use checks or debit cards instead. Shopping trips should be separated from spending trips. Impulse buying leads to bad financial decisions. Expensive purchases should be compared on the internet or on a shopping‐only (not purchasing) trip. No purchases should be made on the initial trip. When a decision has been made, the buyer should go on a buying trip to purchase the item; this way they will make a better buying decision. They should also quit smoking and other costly habits. Saving a dollar or all pocket change daily will quickly accumulate savings.
DEVELOPING PERSONAL SAVINGS
SAVING VERSUS INVESTING
Saving is holding on to money, stashing it away so it will not be lost. Gain is not expected. Investing is buying an asset (such as a stock or share of a mutual fund) that may increase in value over time. When someone invests, they hope for a gain but realize that a loss is possible. Both saving and investing are worthwhile goals in the right situation. If building an emergency fund or holding on to money for a short‐term purpose, the safest bet is to ensure it is not lost. Money should be saved in a low‐risk fund, such as a savings account or money market fund. If retirement is planned for 30 years hence, then the long‐term gains hoped for by investing in a mutual fund are the better route. The value of the mutual fund may go down tomorrow, but it will hopefully (with wise fund choice) increase over the longer term. When someone invests, they take a calculated risk. This is not a pure gamble or game of chance. A saving method is more appropriate if they cannot afford to lose money.
EMERGENCY FUND
One of the most important financial tasks is establishing and saving an emergency fund. The emergency fund should consist of three to six months’ take‐home pay, depending on the amount and type of disability income insurance and other liquid assets available in emergency cases. The money should be put into a low‐risk liquid investment such as a money market mutual fund or checking account. (Although this is not exciting, it is safe.) It is a form of savings used for emergency needs and not as a speculative investment. This fund might cover emergencies, including a car that dies, a short‐term disability, or paying for medical treatment. It is not a vacation or Christmas savings plan. Other than emergency purchases, this fund allows the person to increase deductibles on all insurance policies, which saves substantial money in premiums. Establishing the emergency fund is one of the most critical initial financial planning jobs.
Get Adequate Insurance
Chapter 8 details the types of insurance a dentist might need. As a rule, dentists should not buy extended service contracts, a type of insurance. The dealer will try to sell an extended service contract when buying a television, refrigerator, automobile, or any other major purchase. These cover most repairs needed over the term of the contract. It is better to see if the item fails and then to pay to repair or replace it. The dentist should also never buy additional (credit or mortgage) insurance. These policies ensure that if one dies or becomes disabled, the policy will pay off a mortgage or car loan. These are expensive life insurance or disability policies. (Dealers sell them because they get a cut of the premium.) The dentist should have adequate life and disability insurance for their needs and then remember to refuse these additional insurances when buying a major item. They should never buy insurance from someone who calls, because insurance policies should be investigated before buying. As a rule, consumers should shop around for insurance because it is a commodity item.
PERSONAL BANKING
BANKS
Many new graduates have never had the problem and luxury of managing significant amounts of personal money. Establishing a personal checking account and a professional (office) account is paramount. All checking accounts are not the same. Banks require different minimum amounts in an account, charge different service fees, pay different rates of interest, and may limit the number of checks that can be written. The dentist should shop for a bank that meets all their needs. Initially, they should find a checking account with low fees and minimum balances. They should look for accounts that pay more interest and charge lower fees as assets and savings grow. Many banks allow and encourage patrons to bank electronically, establishing monthly payments and transferring funds electronically to vendors. If the dentist is in private practice and borrowed money from a bank, that bank may require them to keep all accounts there. In this case, “private” banking services can also be used, which adds tremendous convenience to banking.
BANKING SERVICES
Banks provide many services besides checking accounts. Most offer e‐banking, which improves convenience, and most banking can be done online. The banks loan money for small businesses or personal purchases and develop mortgages for large purchases. They offer credit cards for spending and often have accounts for credit card payments from patients. Many banks have unique small business divisions that offer payroll and other services to the small business owner. They have safe deposit boxes for critical personal and business records. They typically have investment advisors and retirement plan specialists to help people develop and nurture these accounts. One of the first professional relationships that a dentist should make is with a banker.
MANAGING CREDIT
CREDIT RATING
Establishing a credit rating is another crucial step in financial planning. The major credit bureaus keep credit ratings on all Americans using their Social Security numbers. This lets potential lenders quickly assess borrowers. The lender can decide if someone is a reasonable lending risk by looking at how much they have borrowed before and if the loan was paid off promptly. The dentist should nurture their credit rating by paying off all debts and credit cards on time. A bad credit history will haunt a person for many years. It can lead to the denial of a practice, home, or other loan, of insurance or employment, or even of the right to cash a check or open a bank or credit card account.
The lending companies commonly report a credit rating using a Fair, Isaac, and Company (FICO) score, which was named for the company that developed the scoring system. (Some agencies use other, similar systems.) Scores range from 300 to 900, with most people in the 600–700 range. The higher the score someone has, the better their creditworthiness. A higher credit score means that it will be easier to get loans (and other forms of credit, such as credit cards), and the loans acquired will be at lower interest rates. Depending on the type of loan, lenders use the credit score, along with the entire credit report, differently. They place more (or less) emphasis on particular components of the score, depending on their product. If someone borrows $200 000 for a house, the lender will look at the person’s score and history differently than if it was a loan for a $10 000 limit credit card.
Five major factors go into the calculation of a FICO score:
- Past delinquencies
If someone has failed to make payments in the past, they are more likely to repeat the pattern.
- How the credit has been used
If someone is close to the limit on a credit card (or worse, maxed out), they are at a greater risk.
- The age of the credit file
Someone who has had credit for a long time has a track record and is therefore a better risk.
- How often credit is asked for
Something may be awry financially if someone repeatedly asks for credit over a short time.
- The mix of credit
With only one credit card, a person is riskier than someone with several forms of credit, such as a home mortgage and other loans.
All credit scores essentially begin at zero. Credit history is built up; it does not start at the top and is subtracted by poor credit choices. So, without borrowing money or having any credit (e.g. a credit card), a person does not have a credit history and is considered a poor credit risk in the eyes of the rating systems. With no credit history (i.e. someone who has never borrowed money), the banker will probably deny the application for a loan because the creditor does not know if the person is a reasonable credit risk.
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