You may have heard the phrase “a home is the best investment you can make” or something similar to this. The reality is a home is not an investment; it’s an expense. This doesn’t mean you shouldn’t own a home; there are many good reasons to do so, but having the right perspective is critical. Similarly, owning a nice car, boat, or other personal asset is not helping you grow your net worth, and it is important to understand how all these assets truly affect your net worth in the long run.
Prioritizing Your Goals
I began working with John just as he was finishing his residency. During our initial meeting, we discussed his goals, which included paying off debt, saving for retirement, and helping his parents pay off their house. He was single at the time, but he hoped one day to start a family and wanted to lay a good foundation financially while he was still single. These are all great goals, and we worked together to create a plan that he was excited about.
However, at a subsequent meeting, he informed me that he had bought a 6,000+ square foot lake house and a $70,000 car. Remember, he was just finishing residency, and while he had a job offer, he hadn’t started working yet. While he was able to take out loans to buy both the house and car knowing he would soon have enough income to pay for it, these purchases, or even the desire to make them, had never been mentioned during our initial meetings. In fact, they were in direct conflict with some of the goals he had stated and required some significant alterations to some of his other goals and the budget we had initially designed.
Unfortunately, this is not the way to start your career. As a dentist, your high income can cover up many ill-advised decisions, but the first ten years of your career are absolutely critical to your ability to build wealth and realize true financial freedom.
Keeping up with the Joneses
What I believe happened here is a simple case of keeping up with the Joneses. In a profession like dentistry, it’s normal to see peers and colleagues buy fancy cars, nice houses in great locations, and the works. It’s easy to compare yourself to others, look at your income, and believe you should have that nice house or car, too.
Often times, what you don’t see is what happens to your colleague’s actual net worth over time.
Buying a fancy car and home early in your career can take up a significant amount of your income. Add to this any loans you’re paying off, as well as living expenses, and oftentimes, you’re not left with much to save and prepare for your future.
For this particular client, he was buying personal assets at a rate that did not allow him to meet the financial goals he’d originally set – paying off debt quickly, helping his parents with their mortgage, putting aside money for retirement, and most importantly, laying a good financial foundation so he could have the financial freedom he desired when he had a family.
A home, a car, and other personal assets are going to be part of most dentists list of financial goals, but it’s important to approach these purchases thoughtfully and evaluate them within the context of your other goals. This is especially important during your first 10 years in practice, as this lays the financial foundation for the rest of your career and future retirement.
Buying a House
While buying a house is rarely a great investment, there are still number of good reasons to buy a house. Before you do, there a few factors to think through first:
- How does the home fit into your overall goals and cash flow? Rather than designing your budget around your home, prioritize your budget, then determine how much is available for housing expenses.
- Don’t forget to factor in all your expenses. This includes mortgage interest, taxes, home insurance, and maintenance and repairs. Maintenance and repairs is usually the category that is forgotten or under-budgeted. Maintenance and repairs will typically be 2%-4% of the home value per year. Remember, that’s a long-term average. Some years will be much less; some years much more.
- While lenders will gladly approve you for a loan that would result in total home expenses in excess of 40% of your income, this doesn’t mean that’s how much you should spend. I recommend keeping your total home expenses below 20% of your income and preferably much less, especially as your income rises.
The big idea is not to spend so much on a house that you are left feeling anxious about not being able to pay off debts quickly, left unable to save as much you’d like for retirement, or robbed of having the freedom and flexibility you’d like both today and in the future.
These ideas generally apply when considering buying a car as well. However, a vehicle’s value quickly depreciates, so there is even less motivation to spend a big chunk of your income here.
The infographic below provides some additional perspective. It depicts several net worth tiers and how their assets are allocated. You will notice that as net worth increases, the finances reserved for a house and car (dark and light orange) decrease, as their worth is increasingly allocated primarily to various types of investments and business interests. To become truly wealthy, saving and investing, which includes investing in your practice, is essential.
Again, it’s okay to have a nice car and nice house – but understand that being ‘house poor’ is often a side effect when people don’t take the time to prioritize long-term financial goals when shopping for that new home.
While wealth is about more than just money and investments, prudently managing cash flow allows you to build the financial wealth that provides greater freedom to build wealth in other ways as well, through relationships, experiences, and by serving others, that wouldn’t otherwise be possible. This is especially true for younger dentists, as the decisions you make today will determine the wealth and freedom you will have for the rest of your life.
So, before you buy that new house, take time to look over your long-term goals and consider what financial freedom means for you. Do you want the majority of your finances to be tied to your home and car? Or, do you want to have some cash saved up for the unexpected, for growing your business, or for investing in other opportunities?