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Wealth Extractions: Saving early and often

Feb. 10, 2011
When discussing wealth, there are basic tenets that apply throughout your life, but there are also optimal times for specialized considerations. Here, we begin a series of useful ideas for investing across the ages.
By J. Haden Werhan, CPA/PFS
Among the many factors to consider when treating your dental patients is age. Certainly there are some essentials that apply to everyone, regardless of age, but your role is to build on those essentials and recommend specialized care when it can have a great impact on a patient’s long-term health. The same goes for your wealth. There are basic tenets that apply throughout your life, but there are also optimal times for specialized considerations. Here, we begin a series of useful ideas for investing across the ages. Let’s begin at the beginning. Saving early and oftenWhile we’re comparing dentistry to investing, here’s another parallel: the younger you apply good financial habits, the greater the impact you can expect them to have on your lifelong wealth. Saving is overwhelmingly the most important of these good habits. While that’s in some respects a no-brainer, it’s also a young dentist’s biggest challenge. Between juggling college debt, practice start-up costs, family life, and personal interests, it can seem there is nothing left to set aside for the future. Before I offer some tips on how to pull off this sleight of hand, let’s explain why youthful saving is so important. The power of compound interestImagine if you told your patients it was OK to wait until they were 40 to start brushing and flossing daily. Would you want to be in charge of their long-term outcomes? I wouldn’t either.As you know, good early dental habits are critical to preventing small problems from becoming enormous ones over time. With investing, you can flip that idea on its head. By setting aside even modest amounts when you’re young, the power of compounding (plowing interest and dividends back into your original investment for boosted growth) allows your small savings to accumulate in exponential ways that only time can afford. To demonstrate the effect of compounding, consider the following scenarios:• Sally, age 25, sets aside $50,000 by saving $5,000 per year for 10 years.• Sam, age 35, sets aside $150,000 by saving $5,000 per year for 30 years.• Jane, age 45, sets aside $260,000 by saving about $13,000 per year for 20 years. • John, age 55, sets aside $380,000 by saving about $38,000 per year for 10 years.Who do you think will come out ahead when each of these people reaches age 65? If you guessed Sam, who began relatively young and saved for the longest period of time, guess again. Assuming 7% annualized returns, Sam’s savings would grow to $505,000 by the time he’s 65. Not bad, but all of the other scenarios would result in portfolios of about $563,000. Even though Sally only put in $50,000 total, because she started so young, her small savings enjoyed 45 years of compound growth, handily keeping pace with the considerably larger amounts set aside by those who started saving later in life. Of rabbits and hatsOf course if it were easy to save, everyone would be doing it. And yet, too often it falls through the cracks. Here are two practical tips on how to take your savings plan from theory to reality:Pay yourself first – Think of your future, your savings, as simply another obligatory monthly bill and pay yourself first. A modern way to apply this strategy (a timeless expression introduced in George S. Clason’s 1928 classic, “The Richest Man in Babylon,”) is to establish a recurring bill-pay from your checking into your savings or brokerage account, before you even have time to miss the funds. Go for the big wins – It’s good to be frugal when you’re able, but focus on the end value rather than the immediate costs, so you can determine which financial efficiencies are likely to matter the most. For example, instead of worrying about saving 10 cents by buying a lower-quality brand of a product you love, redirect that energy into establishing excellent credit, so any necessary loans can be acquired at minimum interest. By saving large amounts on unnecessary interest payments, you will find you can save and still buy that latté you love. An entertaining but substantive source for learning more is Ramit Sethi’s “I Will Teach You To Be Rich.” (Don’t be fooled by the casual, sometimes blunt writing style; there is much solid advice here.)Invest like you mean itIn my next Wealth Extractions, we’ll address how young investors of modest means can take their savings and effectively put them to work through the essential tenets of prudent investing.Editor's Note: To read more of Werhan's "Wealth Extractions" series, please click here.
J. Haden Werhan, CPA/PFS is a partner at Capital Performance Advisors and Thomas, Wirig, Doll & Co., CPAs. He regularly lectures and provides seminars to the dental community which he has been serving his entire career. By supporting dentists in their tax and accounting strategies, practice transitions and, ultimately, their lifelong wealth planning, Mr. Werhan and his partners assist dentists in achieving financial freedom. More information about his firms’ services can be found at Haden can be reached at [email protected].