For over forty years, Collier &
Associates has provided legal, tax and consulting advice to dentists
and their advisors. Through our twice-monthly newsletter, the
Collier Advantage, and our continuing education seminars, we keep
dentists current with the latest on tax savings ideas, investing,
practice transitions, retirement and education savings, insurance
(what you need and what you need to avoid), estate planning and asset
This e-Newsletter is on “Saving and Investing.” (The topic of the first part in the series
Transitions.” This was a comprehensive review of all of the key
issues affecting a young dentist joining a practice as an associate
or contemplating buying into a practice. It was sent by email on
November 2, 2011).
The purpose of the current
e-Newsletter is to expose students to some of the basics of investing
and the importance of long-term savings. With very few exceptions,
it will be nearly impossible to one day retire comfortably unless you
understand (and follow) the basics. Many of our clients tell us that
they wish they had this sort of instruction while they were in dental
school, rather than learning the principles through trial and error
over a long time period.
Understanding Money At The Most Basic Levels Can Help Make Some Of Your Most Important Decisions Easier
are only three ways
to make money:
our own labor.
Once you graduate and start working, you will certainly make money this way.
the labor of others.
This is easier for a business- person. The possibilities are more limited for professionals.
our money grow and work for us through compounding. This is
critically important. In time, our money can make more for us in a year than what Nos. 1 and 2 can produce. Wasting this is criminal.
Money Grows (#3 Above)
There are three ingredients
that will determine how much your money will grow to:
much you save each year.
save, the bigger the amount at the end.
well you invest your savings.
investment rate of return, the more you will have at the end.
long you let your money compound. Interestingly,
this is likely more important than Nos. 1 and 2. Sadly, by the time many most people grasp this power of compounding, they have squandered the early years - the most potent part of compounding=s
next two items show how these most basic principles can help a young
doctor understand the incredible power of getting into the habit of
saving something every year.
Power Of Compounding
was once asked what was the most powerful force in the universe. His answer:
Compound interest. Some approximate rules of thumb: at 6% money
doubles every 12 years; at 7% every 10 years; at 8% every 9 years; at
9% every 8 years; and at 10% every 7 years.
Doctors - The Ease And Power Of Starting Early
The goal is to get as many doublings as possible. The earlier we
start, the more doublings we get. True, the amounts saved early are
lower than what we can afford to save later, but the more doublings
of the early, smaller amounts can more than make up for that. Too
many young doctors think saving small amounts is unimportant. They
implicitly are saying AI=ll
wait until the amounts I can save are meaningful.@
Thus they fall into the trap of beginning their careers with the
habit of spending everything they make. That is a terribly difficult
habit to break. Somewhere in their fifties, reality sets in and they
must catch up with very large savings. They
squandered the early years when compounding would have done their
heavy lifting - either out
of ignorance or an unwillingness to tell themselves or their spouses
that we can=t
spend everything we make.
it right is not much more difficult for a young doctor than just
rising standard of living a year behind one=s
rising income. That
permits us to save something every year. If we set our standard of
our yearly income, we save nothing. Delaying
gratification by as little as one year is the difference between
becoming wealthy and not becoming wealthy. Benjamin Franklin called this the
difference between happiness and
Example For A Younger Doctor
assume a 50 year old can save more ($50,000 per year) and can invest
at a higher rate of return (10% or 12% or 15% - this is probably
unrealistic in the current economy, but these growth rates are being
used to prove a point); vs. a 30 year old who can save less ($20,000)
and can invest at a lower rate of return (7%). Who has more at age
65? This shows the power of compounding - that starting early can
more than overcome saving less per year and earning less on it:
Saving Rate of Return Number
of Years Amount at Age 65
30 Year Old
Year Old $50,000
50 Year Old
50 Year Old
Year Old $50,000
match the $2,764,738 of our 30 year old, the later starting 50 year
old would have to save $110,022 per year if earning 7%; $87,017 if
earning 10%; $74,162 if earning 12%; and $58,107 if earning 15%. The
combination of starting early, staying the course, and letting
compounding do the heavy lifting is so powerful, it should be part of
professional school education (and spouses and significant others
should be required to attend the course).
Advice to Dental Students
When we lecture to senior dental classes, we
always make a point of
telling the students that they should get into the habit of saving
money every year – starting now. This is often met with a look of
bewilderment by students who plan on graduating with hundreds of
thousands of dollars in school debt. We are not talking about saving
a lot of money. If you can save $20 per month (an amount you can
probably live without having), that is $240 per year. And even with
the power of compound growth, it will take a very long time for that
to amount to much. But, that’s not the point. More important than
the amount you are saving is the fact that you are actually starting
the savings habit. Getting into the habit of saving something every
year is the key.
you graduate, you may take an associate job paying $100,000 per year.
That will feel like a tremendous amount of money. You will
discover, however, that it is very easy to spend all of $100,000
whether it is used to pay down student loans, to buy a home or to
simply buy then things that make you happy. As you progress in your
career and your income rises, you will find that you are fully
capable of spending all of $200,000 or even $300,000. In other
words, you can spend everything you make in which case you will never
start the savings habit.
IRAs for Students and New Dentists
you have not done so already, open a savings account at one of the
discount brokers or mutual funds families like Vanguard, Fidelity or
Charles Schwab. If you have any earned, W-2-type income, you are
eligible to open a Roth IRA. This will be your savings account of
choice. Savings put into a Roth IRA go in with after-tax dollars,
but the long-term growth can be withdrawn in retirement tax-free. If
your earned income is modest, you may not be subject to any current
income tax. For 2012, the standard deduction, which all taxpayers
are eligible for if they don’t itemize their deductions, is $5,950
for individuals and $11,900 for married couples. If your earned
income is below these thresholds, you will pay no income tax, and you
get the long-term tax advantages of the Roth IRA cost-free.
Investing Simple and Straightforward
it comes to investing this money, if you are investing relatively
small amounts, you can simply put all of it into a broad based stock
index fund like the S&P 500 (500 of the largest U.S. public
corporations) or perhaps the Wilshire 5000 (the total U.S. stock
market from large caps all the way down to small and micro caps). In
terms of having exposure to foreign markets, you can own a foreign
stock index fund. However, many U.S. companies are now generating
over half of their income from overseas. This makes them a good way
to invest in foreign and emerging markets which have faster growth
rates than the U.S. and the more developed Western countries.
a student or a young doctor, we generally recommend against owning
bonds. Currently, the interest being paid on bonds (their yields) is
near their all-time lows. But more importantly, the benefits of
owning bonds, such as their lower volatility and their predictability
of interest payments and bond maturities, are important to an older
person planning a retirement. They are relatively unimportant to a
younger person who is investing for long-term growth.
Market Volatility is Stomach-Churning but is the Friend of the
volatility that comes with stock investing can be harrowing for
someone approaching (or in) retirement, but it should be a non-issue
for a young doctor on the cusp of beginning a career. Stocks will be
volatile investments. But that does not mean that they are risky
investments. The concepts of “volatility” and “risk” are
often thought of as meaning the same thing, but they are very
different concepts. Volatility measures how much a particular
investment might move up or down in price. Risk, on the other hand,
is harder to quantify. Risk is the likelihood that an anticipated
investment outcome will not come to pass. Stocks are always going to
be volatile, but this does not necessarily make them risky.
factor is your time horizon. For example, if you know that you will
need money in a couple years to make a down payment on a home, then
do not put this into stocks. Over a short time period, this will
indeed be a risky move. However, if you are investing your savings
for your eventual retirement, then investing in stocks is not risky.
Over one-year, three-year or five-year time periods, there is no
telling where stock prices may be. However, over longer periods, we
know that stock prices will be higher and usually substantially so.
stock prices may be all over the place from year-to-year, over long
periods, they move higher. Looking at the last 85 years (1926-2010),
stocks have ended the year higher than they started 61 times. This
is 72% - nice, but hardly something to bank on. Interestingly, as
the measuring period expands (five-year rolling periods, ten-year
rolling periods, etc), the riskiness of investing in stocks
decreases. Since 1926, there have been 81 five-year rolling periods
(1926-1930, 1927-1931, etc.) and in 70 out of these 81 periods,
stocks have ended the five years higher (86% of the time). In 72 out
of the 76 ten-year rolling periods, stocks ended higher (95% of the
time). And in all
66 of the twenty-year rolling periods dating back to 1926, stocks
ended up. This includes the years of the Great Depression, the high
inflation and low growth era of the 1970s, and the current economy of
the Great Recession.
you have some perspective about stock market history and you also
know that major volatility in stock prices is
normal, you will be better
equipped than most new investors. You should realize that when there
are big drops in stock prices, this does not mean that stocks are
suddenly “risky” long-term investments. Instead, you will be
able to take advantage of these occasional times when everyone else
is frightened to add stocks to your portfolio when they are selling
at bargain prices. In other words, for a long-term investor (which
is what you are), volatility will be your friend, not your enemy.
vs. Paying Down Debt
you have some money to invest, you will inevitably wonder whether you
should use the money to invest or to pay down debt. Like many things
in life, the answer is “it depends.” Ben Franklin was right when
he said that a penny saved is a penny earned. Prepaying a debt with
a particular rate of interest is the equivalent of investing in a
bond that pays the same yield. But, from a purely economic point of
view, you should put the money to work where you think it will earn
the highest long-term rate of return. Stocks have historically
returned around 10% per year – though this is far from guaranteed.
Prepaying an 18% credit card debt is actually an 18% guaranteed rate
of return, and all of the available money should be used for that.
However, if the choice is between a “hoped for” 10% return in
stocks vs. a guaranteed 5% prepayment of a student loan, then the
answer is much more nuanced. You may be of the mindset that your
stock investments will yield the long-term higher returns and put all
available cash into building up your stock portfolio. Or you may
have more of an old world mentality about being out of debt as soon
as possible, so you put all available money into that. Unless you
are using the money to pay off a very low rate (and tax deductible)
home mortgage, there is nothing wrong with this approach. On this
issue of investing vs. paying down debt, do what feels right for you.
By definition, that will always be the right decision.
These are exciting times! Graduation is in
sight and you
will soon begin a fulfilling and successful career. The last thing
on your mind is retirement. That’s understandable, but you should
begin taking the steps now (even in dental school) to put yourself on
the right financial track.
on over 40 years’ observation, the doctors who have retired the
wealthiest got rich slowly by doing three very basic things: (1) they
saved something every year.
They did not save excessively to the point that they deprived
themselves of the things they wanted or needed; (2) they
invested the money simply and sanely. These doctors did not exotic with complex
investment strategies but
invested with a long-term approach in a sensible mix of stock and
bonds; and (3) they avoided
the big mistakes that drained capital or took years to recover from. The single biggest financial mistake
dentists make is getting
divorced. Half of what has been built up over their career walks out
the door. Unfortunately, there are dentists who never learn, and get
divorced on a repetitive basis. For a multitude of reasons, be
certain that you get the biggest choice you will have in your
lifetime (the selection of your future spouse) right.
is the Time to Start!
the third and final C&A e-Newsletter on PRACTICE AND FINANCIAL
MANAGEMENT, we will summarize the real-world advice that we’d give
to a young doctor at the beginning of his or her professional career.
Collier & Associates Doctors’ Newsletter (the “Collier
Advantage”) is now free to dental students. The bi-weekly Collier
Advantage is the widest read dental newsletter of its kind, covering
the latest on tax savings, investing, insurance, transitions,
practice management and more. Call our office at 216-765-1199 or