The return that dentists achieve from this investment depends on countless decisions that have been or will be made throughout the remainder of their careers and afterward.
Of course, there are other reasons dentists select the profession, such as wanting to help others or feeling passion for this particular field. But they also want to earn a living and be able to do the things they enjoy in their working years and beyond.
As such, I evaluate financial decisions that dentists face along their paths, from residency through retirement, from the perspective of how to best convert human capital into investment capital.
I’ve spoken with many new dentists who often ask the following question: “Should I save or pay down my loans?” The return you generate from your investment, in time and money and in years of education and training, will be impacted by this decision. Not only is it a complex decision that depends upon several factors, but it is a dynamic decision that changes from year to year or even month to month.
What you need to consider
Financial decisions at their most basic level involve comparing your cost of capital to your expected return. During the last decade, several dynamics have been working against you. While reimbursement rates have declined, costs of running a practice have increased. On top of that, the costs of undergraduate and graduate school have skyrocketed. One of the redeeming factors is that the current low interest rate environment has kept down the cost of capital.
While your cost of capital is integral to your decision, it is not always easy to determine. With the decision of paying off student loans versus savings, the cost of capital is explicit—the weighted average interest rate on your loans. The same holds true for a debt-financed practice acquisition, it is the interest rate on that loan. However, when financing is done through equity or a mixture of equity and debt, it is not as easy to calculate.
The other side of the equation is the expected return. Certain decisions, such as whether to acquire a practice, can be modeled out to estimate expected ROI. Others, such as whether to pay down debt or invest, are less clear cut. Where you are in the business cycle, valuations in various markets, and potential financial risks are a few of the variables that impact your expected returns.
Whether it is student debt, or a loan for a practice acquisition or practice expansion, debt is leverage and leverage is risk. Risk is most commonly measured as volatility, or the standard deviation in returns on your investment. How much risk can you afford to take? Just as importantly, how do you feel about risk? While it’s one thing to create a plan and investment portfolio that meets your goals and risk capacity, it doesn’t benefit anyone if those investments are causing anxiety. I can’t imagine it’s easy to concentrate on a root canal when you’re worried about declines in the stock market.
People are not their own best estimators
Furthermore, and quite surprisingly, people are very poor estimators of their own financial risk tolerance. That is why I use a PhD-developed risk assessment tool that provides a more accurate view of someone’s feelings toward risk, which enables me to create the optimal allocation between debt and savings that is right for someone.
You will have other questions down the road. For instance, there will likely come a time when you want to sell your practice and retire. How do you structure the sale? Are you getting the sale price you deserve? What should you do with the proceeds, what return can you expect on those proceeds, and what are the tax implications? All of these decisions are part of the larger journey of converting your human capital into investment capital.
It seems strange to discuss retirement in the same article as paying down student loans. But all financial decisions during your career impact the return you realize as you convert your human capital into investment capital. The time will go by more quickly than you expect and having a plan that is built around your specific cost of capital, tax scenario, and risk tolerance will have an enormous impact in the investment capital that you accumulate.
