by Roger P. Levin, DDS, and Michael C. Smith, MBA, CFP
How much savings do you need to retire securely?
How much money do I need to retire?” is a question that orthodontists frequently ask themselves. Does an orthodontist needto accumulate $2 million to achieve financial independence? $5 million? $10 million? The answer is both all and none of the above. It depends on an individual orthodontist’s goals, spending habits, health, lifestyle, family situation, and other variables.
Practice profitability is the engine that propels orthodontists on their journey toward financial independence. The more successful the practice, the more options the orthodontist has in choosing when to retire. By steadily increasing profitability over the course of a 20-, 25-, or 30-year career, an orthodontist is better positioned to achieve financial independence.
How do you increase profitability? Two key elements in overall practice success and personal wealth accumulation are referral-based marketing and practice systems. Let’s take a moment to examine these two areas.
Every orthodontic practice should have a referral-based marketing program to increase referrals from both patients and general dentists. Practices that set an annual goal of increasing referrals are the ones that can routinely attain significant growth. We currently have clients with practices ranging in gross revenue from $200,000 to $4.8 million. Whatever size the practice, a strong referral-based marketing program is often the key difference between extremely successful practices and those that are struggling. While not every orthodontist necessarily wants to have a $2- or $3-million practice, there is certainly a desire to see consistent growth and profitability. An effective referral-based marketing program is critical to achieving practice profitability, which leads to personal wealth accumulation.
Strong management systems are the basis for long-term practice success. The right systems not only boost practice profitability, but they also increase patient satisfaction, staff longevity, and professional satisfaction. A systematic approach to practice management allows orthodontists to maximize efficiency. For example, the target we give orthodontists for overhead is 49%. Reducing overhead even by 1% can lead to an extra $1,000 in savings per $100,000 of revenue. These dollars can be either considered additional profit or reinvested in the practice.
A combination of referral-based marketing and orthodontic-management systems helps create an optimally functioning practice. No matter what your particular situation is, the more successful your practice, the more you can save and invest for retirement.
Until approximately 1999, orthodontists were able to save a significant portion of their incomes and still fund their overall lifestyles. While each orthodontist has a different definition of a good lifestyle, the ability to fund a given lifestyle and save significant amounts of money began to decline when the dot-com bubble bust and investment returns were much lower than they were during most of the 1990s.
Today, the stock market has improved, but it is nowhere near as dynamic as it was in the 1990s. Investment guru Warren Buffet predicted earlier this year that the overall markets will not return 10% per year for the next 10 years due to the level of the gross domestic product. In interpreting comments by Buffet and other economists, we believe that orthodontists should strive to increase their current income by 20% to 24% to fund both retirement and personal savings while maintaining (or improving) their current lifestyles. All of this relates back to overall practice productivity and profitability.
The Cost of Retirement
How much saved money an orthodontist needs to retire depends on a variety of factors. Let’s examine the retirement scenarios for three types of moderate- to higher-spending orthodontists:
Case Type A
The first type of orthodontist has an extravagant lifestyle and a great deal of debt, which includes student loans, credit cards, practice debt, a home mortgage, and car loans. Without making any judgment, this individual is under a great deal of pressure to maintain a certain income to fuel a lifestyle, which means that the ability to retire becomes secondary. Due to the amount of debt incurred, these orthodontists will practice many years longer and will begin saving much later for retirement than other colleagues will.
Case Type B
Orthodontist B has managed to avoid accumulating a great deal of debt, but has not saved enough to retire at a reasonable age. This individual has made the choice, consciously or unconsciously, to enjoy living at a certain level relative to his or her income. For this orthodontist, retirement has not been a major concern because it has seemed like an event that would occur in the distant future. Unfortunately, the future is approaching fast.
Case Type C
Orthodontist C enjoys spending a certain amount of money each year and also has an excellent savings regimen. But this individual has not maximized his or her investment returns due to a lack of financial planning. Fortunately, with a different investment strategy and increased savings, type C orthodontists will be able to fund their retirement-investment goals while continuing to enjoy a comfortable lifestyle.
Understand that case types A, B, and C are moderate to high spenders. In our experience, most orthodontists, no matter their lifestyles, are not considering the full cost of retirement.
How Much Do You Really Need?
It may be easier to answer the question, “What is the meaning of life?” than the question, “How much money do I need to retire?” In the world of financial planning, the debate surrounding the amount of money you need to retire has centered on the concept of a safe withdrawal rate from a portfolio. Early theoretical research on this subject defined the safe withdrawal rate as the rate at which an investor could deplete a portfolio that would last for at least 30 years. These early white papers determined that the safe withdrawal rate was between 4% and 5%.
A study performed by three Trinity University professors—Philip Cooley, Carl Hubbard, and Daniel Walz—looked at this issue by analyzing historical annual returns for stocks and bonds from 1926 through 1995. The February 1998 issue of the AAII Journalcontained an article titled “Retirement Savings: Choosing a Withdrawal Rate That Is Sustainable,” which was based on their work. Using historical data published by Ibbotson Associates, the research analyzes the impact of withdrawal rates from 3% to 12% on five portfolios ranging from 100% stocks to 100% bonds over rolling withdrawal periods of 15, 20, 25, and 30 years from 1926 through 1995. An enormous number of scenarios were created to determine the probability of success for each portfolio and each withdrawal rate.
The study showed that withdrawal periods longer than 15 years dramatically reduced the probability of success at withdrawal rates exceeding 5%. The authors reached several general conclusions:
1) Those who retire at a younger age should plan on lower withdrawal rates to maximize the probability of success.
2) Most retirees would benefit from at least a 50% allocation to stocks to create a vehicle for growth and an inflation hedge.
3) Retirees who desire inflation-adjusted withdrawals (not simply x% of the first year’s value) must aim for a reduced withdrawal rate from the initial portfolio.
4) Stock-dominated portfolios using a 3% to 4% withdrawal rate may create large estate-tax burdens at the expense of the retiree’s standard of living.
More recent research has suggested that a rate between 4% and 6% may be more appropriate, although we believe that anything above 5% introduces a level of unacceptable risk. Five percent or lower should allow you to sleep very well at night knowing that your future is secure.
Let’s use the 5% figure to illustrate this concept. Assume that upon retirement you have a $1 million investment portfolio, and that the inflation rate is 3%. You would withdraw $50,000 (5% of $1 million) in year 1, $51,500 ($50,000 inflated by 3%) in year 2, $53,045 in year 3, and so on. A portfolio that contained 75% stock and 25% bonds would have nearly a 100% certainty of lasting throughout a 20-year retirement period—but a much lower probability of lasting for a 40-year retirement period. The probability of the portfolio lasting is reduced as the withdrawal rate increases.
Practice success is critical to funding your retirement. By maximizing opportunities and efficiencies in your practice, you can increase profitability over the long term and use those funds to invest in your retirement. To achieve optimal profitability, we recommend that practices upgrade their orthodontic systems and implement a consistent referral-based marketing program. Your salary and practice profitability are the two revenue streams that will fund your retirement.
The keys to retirement security are setting quantifiable goals, understanding these concepts, and then building a savings plan to reach your long-term objective. First, look at your existing cash outflows and determine your current level of spending. This is your lifestyle, and it is unlikely to change when you retire.
Some of the expenses (such as mortgage and disability insurance) will go away, so you can eliminate the expenses today that will not exist in retirement. Once you have determined your expense level in retirement, find the amount needed in an investment portfolio to produce that dollar amount using a 4% to 5% withdrawal rate. That range becomes your investment target.
Realize that inflation will increase this target each year, so it is not a static target. Working with a financial planner, you can determine annual savings amounts that you need to have in retirement accounts and outside of retirement accounts for you to securely reach your long-term goals. If you go through this process with a financial planner and take the steps needed to implement your plan, you will be better positioned to reach your long-term financial goals.
Roger P. Levin, DDS, is founder and CEO of Levin Group, a dental practice-management consulting firm that is dedicated to improving the lives of dentists through a diverse portfolio of lifetime services and solutions. Since the company’s inception in 1985, Levin has worked to bring the business world to dentistry. A popular lecturer, he addresses thousands of dentists and staff worldwide each year in 100-plus seminars and at the dental industry’s most prestigious meetings. He can be reached at [email protected].
Michael C. Smith, CFP, MBA, is vice president of Levin Financial Services Inc. He can be reached via e-mail at [email protected].