15 minute read
Huge financial changes to impact dentists
By Graham Middleton
Dentists with long memories will remember then-Labor Treasurer Paul Keating’s self-styled “Recession we had to have” of the early 1990’s. It was designed by Treasury and Reserve bank officials to crush high inflation. It accompanied a restructuring of the Australian economy through floating our dollar and deregulatory measures. A host of formerly protected businesses were crushed as Australia converted from a significant manufacturing economy to a service economy. In retrospect, Treasury officials admitted that they had not realised the seriousness of the recession in their cosseted world of Canberra, with its high household income and multitudes of job protected government employees.
I remember a client, an engineer, whose last task for his employer was to photograph, number and pack the manufacturing plant into containers to be shipped to China. He subsequently carried out similar tasks for another business specialising in packing up manufacturing plants and freighting them to China! Manufacturing jobs vanished as non-competitive industries closed in Australia and were rebirthed in China.
Not all bad
Economics teaches us that the world is better off when every country concentrates on producing the goods and services where it has a natural advantage. Australia’s natural advantages have long been in mining and agriculture, but technology has displaced many of the jobs in those sectors. Modern miners use huge machines which have long since displaced large numbers of humans toiling with picks and shovels while agriculture has seen huge aggregations of farms. As such, Australia had to develop jobs in service industries including tourism and education. Many students studied in Australia for the purpose of gaining residency. Tourism benefitted from having alternate seasons to the Northern Hemisphere. Both were successful until COVID shut Australia off from the world.
Is there a coming recession?
Each major financial event starts differently but there is always an impact. The Keating recession had the deepest and longest impact of any economic event since the Great Depression of the 1930s which preceded World War 2.
Other events such as the Asian economic crisis, 9/11 terrorist attacks on the United States, the Global Financial Crisis (GFC) and the initial impact of COVID were of shorter duration. Australia was lucky to have worked its federal budget into surplus and paid down government debt and was therefore able to cope with the GFC, albeit that it recreated government debt and deficits. Measures to assist employers deal with COVID and other government spending has increased government deficits and further expanded debt at a time when interest rates are rising. It is as yet unclear whether a combination of rising interest rates and much higher fuel costs for industry will drive Australia into recession but certainly there will be significant impact.
Don’t fight the Fed!
The US Federal Reserve (the Fed) sets interest rates and monetary policy in the United States and this has global impact. Money flows to the countries with better interest rates and investing conditions. The Reserve Bank of Australia makes policy setting to keep the money flow positive for Australia. If the Commonwealth Government was able to limit its spending (fiscal policy), the RBA would have less need to toughen monetary policy but history demonstrates that politicians tend to overspend rather than save. American financial wisdom is that it is foolish for investors to make decisions which are contrary to the direction of monetary policy, hence the wisdom is “don’t fight the Fed”.
The Fed has made it clear that its direction of interest rate settings is upward, but may be slightly slower than previously thought due to the outbreak of the Ukraine war. Australia’s Reserve Bank has indicated that interest rate increases are underway. This may tip Australia into recession.
If the Fed is increasing interest rates expect share markets to fall
As a long-term effect as interest rates increase, share prices fall. With the Fed forecasting a series of interest rate increases and our Reserve Bank indicating that a series of monthly increases are also likely, expect the share market to weaken - meaning that most superannuation funds if heavily invested in shares as well as managed funds invested in shares are likely to fall over the coming year. My family superannuation fund now has well over half of its assets held in interest bearing deposits and bank hybrid securities despite their low yield. There will come a time when the interest rate cycle stabilises and it will be time to shift to greater equity weighting.
Managed funds fail to beat the share market indexes
Many advisers erroneously recommended managed funds over direct equities despite there being overwhelming evidence that the vast majority of managed funds underperform the share market over both short and long term. Many active fund managers claim to be able to
beat the market, but few do and then generally only temporarily. To be better than share market indices, they have to beat the market by more than their own fee structure which the vast majority fail to do and if they do so it is invariably for a limited time. If you do not want to invest directly in the share market, then exchange traded funds have much lower Management Expense Ratios (MERs) than managed funds. It is important to wait until the worst of the increases in the interest rate cycle have occurred before investing heavily in either the share market or into ETFs based on equities. Patience is a
“Many advisers erroneously recommended managed funds over direct equities despite there being overwhelming evidence that the vast majority of managed funds underperform the share market over both short and long term. Many active fund managers claim to be able to beat the market, but few do and then generally only temporarily...”
virtue as evidenced by the Warren Buffet led company Berkshire Hathaway sitting on vast amounts of cash as stock markets underwent a huge growth in prices. Warren rarely gets the long-term strategy wrong and has been very successful over many years. His recent yearly letters to shareholders are required reading by those trying to make sense of financial markets. They are on the internet.
The lesson
The lesson is that dentists need to avoid advisers advocating managed funds, particularly “active managers with high fee structures”. Always check the MERs of funds and compare them with the MERs of Exchange Traded Funds. If the MER is hidden or unclear, avoid.
Naturally my advice is subject to the caveat of seeking alternate professional advice but be sure that the adviser concerned is not simply directing you to a costly solution involving high fees for them/their organisation.
There is no substitute for being personally familiar with the operation of financial markets. Check on financial advisers pitching for your business by asking them questions to which you already know the answers.
Higher interest rates = Lower house prices
The competition by bank lenders to swell their assets (loans to customers) on their balance sheets together with historically low interest rates to borrowers and zero or near zero rates for depositors resulted in home buyers attending auctions with high loan pre-approvals. This bid-up house prices to record levels by late 2021. From early 2022 indications of rising interest rates and directions by bank regulators to increase stress testing before approving loans to borrowers has begun the wind back of maximum loan approvals. In turn, those seeking to buy have had to reduce the amount that they are prepared to pay and house prices have begun to weaken. The Reserve Bank of Australia has to follow the upward direction of interest rates led by the Fed.
If housing interest rates double from 2 percent to 4 percent, the impact on recent borrower’s personal cash flows is huge. A monthly repayment on a 30-year home
loan increases from $3691 to $4,759 or an additional $12,861 per year. If the home interest rates grow to 5 percent, which is likely in 2023, the monthly repayment is $5346 or an extra $19,860 per annum. In practice the banks will limit new home loans to what they judge the borrower can afford to pay. The result will be falling house prices over the next 18 months as interest rates increase. Those who purchased recently with maximum loans during the house price boom are the hardest hit. They face much higher payments while the value of their house is likely to fall. Those who bought with the intention of upgrading in a few years may be trapped in their current home for much longer by higher repayments and reduced home equity. I have vivid memories of the stress experienced by clients during the Keating recession of about 30 years ago, faced with huge interest rates of 13.5 percent on regulated home loans, 17 percent on new home loans and business overdraft rates of 22 percent coupled with falling home and other asset values. Each generation forgets the lessons of the past. The housing boom culminating in late 2021 was based on a widespread misbelief fueled by the real estate industry that houses continually rise in value. History teaches us that there are significant periods when house prices fall or when the real estate industry stagnates.
After a few good years much of the population forgets the tough times. As interest rates have fallen, those who bought or upgraded homes 5 or 6 years ago experienced a big lift in their net equity but those who bought recently will suffer.
Over many years, I bid at Melbourne House auctions on behalf of long-term clients. Bidding tactics varied according to the state of the market and I always advised the client to give me sensible limits. I have witnessed some bizarre outcomes and many bidders who were unable to read the auction. Selling by auction is favoured in strong markets but falls away when markets are negative.
The home loan lesson compared to business debt
Home loans on which the interest is not tax deductible should be reduced as quickly as possible. At a marginal tax and Medicare rate of 47 cents per marginal dollar, the interest on a tax-deductible business borrowing is almost halved after tax. Hence a housing loan at 5 percent, as is likely during 2023, is equivalent to a loan on practice premises of 9.44 percent. The lesson is clear when borrowing to buy dental premises arrange with the bank to pay interest only on the business loan while agreeing to accelerate repayments of the home loan. If housing interest rates rise beyond 5 percent, the advantage of this strategy increases. Some bank lenders will readily agree, usually limiting the interest only period on the business loan for three years. Dentists who demonstrate that they have run profitable practices usually have little difficulty in persuading their bank or a competitor to continue interest only
business loans after the initial period. Safe secured loans enhance bank balance sheets.
Residential rental property: Avoid, if possible, particularly in Victoria
Residential rental properties seemed satisfactory to some during a period of rising real estate prices but rising interest rates and accompanying falling prices will expose their extremely poor net income yield. In some states, particularly Victoria, legislation which greatly favours the rights of tenants over owners makes rental housing an undesirable investment. As interest rates increase, more rental properties will be thrown back onto the market as owners sell to reduce their home mortgages or take financial pressure off their businesses. We experienced this in the late 1980s and early 1990s.
If you want to help your children buy houses!
It is now the time to encourage children to be patient as interest rate increases and the expectation of increases to come reduce house prices. Those who think that house prices always increase are mistaken. The best time to buy is when interest rates are at their zenith and hence likely to reduce. When interest rates begin reducing the value of houses purchased at the peak of the interest rate cycle increase.
When upgrading your home
Nobody upgrading a home in the current market of rising interest rates should buy before they have a sale on their existing home as there is a risk of failure to sell or having to accept a much lower price in a falling market. If interest rates rise by more than expected, home buyers disappear. The opposite was the case when rates were falling and likely to fall further the housing market was growing and we could afford to buy with bridging finance confident of a quick sale of our existing homes. It is all about the direction of the interest rate cycle.
The share market, Bitcoin and superannuation
Crypto currencies have multiplied in number but have no intrinsic value other than speculating in other crypto currencies and making those who successfully promoted them wealthy. Recently crypto currencies numbered in the thousands, some domiciled in tax havens. Apart from being havens for money laundering and used for criminal activity, they are an unregulated maelstrom which at early signs of substantial global economic slowdowns shed value. I am reminded of the Dutch Tulip Bulb and English South Sea Bubble implosions and a variety of other historic failures. Inflation particularly in the price of basic necessities and rising interest cost snuffs out speculative bubbles. Crypto currencies are difficult to
regulate because they exist in cyber space and their domicile can change quickly. Their value can collapse quickly.
Financial markets and history lessons
Warren Buffet, arguably the world’s greatest investor, observed in 2002 that it is only when the tide goes out that we see who has been swimming naked. Warren was referring to the result of rampant speculation when investors paid inflated prices for assets with too little income to service their debts. The greatest period of this, in my lifetime, was the era of the 1980’s Australian Entrepreneurs who bought companies and other assets with huge amounts of borrowed money and shamelessly exploited their small shareholders with management agreements which took away their income. The October 1987 global share market collapse followed a couple of years later by strongly increasing interest rates and falling company profits exposed these entrepreneurs as swimming naked with insufficient means to service their debts and unable to sell assets except at huge losses. They were unable to continue refinancing by shuffling asset ownership. The period saw huge liquidations, forced by bank lenders and collapses of companies. Some entrepreneurs fled from Australian legal retribution to foreign exile, several went to jail and lots were destroyed financially. That period saw Alan Bond jailed, Christopher Skase in exile in Spain, Abe Goldberg in exile in Poland, Laurie Connell dying in jail and a host of other bad endings.
Success in dentistry: The dental quad
Overwhelmingly, successful dentists concentrate on owning four assets which are: 1. Their family home with accelerated repayment of mortgage; 2. Their dental practice debt financed; 3. Their dental premises also debt financed with possible exceptions for some country practices with very low rents; and 4. Their superannuation fund, which dependent on cash flow, they fund with a combination of concessional and nonconcessional contributions.
Practice ownership is vastly more lucrative long term for most than being a corporate dentist.
It provides the opportunity to employ spouses, superannuate both and benefit from growing practice goodwill value and the value of practice premises. Corporate claims to the contrary do not stand up to examination.
There are a plethora of advisers clamoring to do business with dentists but simple truths need to be restated: • The key to practice profitability is the fees generated by the practice owner personally, since they do not have to pay another dentist a substantial amount to do that work. Practice owners are generally the best dentists in their prac-
“The key to practice profitability is the fees generated by the practice owner personally, since they do not have to pay another dentist a substantial amount to do that work. Practice owners are generally the best dentists in their practice with the most patient relationships. And the best privately-owned practices are more profitable per dollar of fees than corporate practices...”
tice with the most patient relationships; • The best privately-owned practices are more profitable per dollar of fees than corporate practices; • Don’t let assistant dentists spread their appointments over more sessions than the work requires. An assistant dentist with 2.5 days of appointments spread over 4 days costs 1.5 days extra chairside assistant time. Keep practice support staffing to a minimum; and
Measure the number of follow-up appointments generated by assistant dentists and their number of personal referrals. Some assistant dentists are practice builders, others are not.
Best wishes to all dentists and specialists.
General Advice Warning
The information contained in this article is unsolicited general information only, without regard to the reader’s individual financial objectives, financial situation or needs. The information contained on this article is general in nature and you should consider whether the information is appropriate to your needs, and where appropriate, seek professional advice from an accountant or financial adviser. It is not specific advice for any particular individual and is not intended to be relied upon by any person. Before making any decision about the information provided, you should consider the appropriateness of the information in this article, having regard to your objectives, financial situation and needs and consult your professional adviser. Any indicative information and assumptions used here are summarised, are not a product illustration or quote and also may change without notice to you, particularly if based on past performance. This notice must not be removed from this article.
About the Author
Graham Middleton disposed of his interest in Synstrat group on 30 June 2020 and won’t be starting another business. He spent the later 33 years of his working life advising health professionals on business and financial matters. Dentists were the most numerous of his clients. He is the author of the recently published Financial Success for Dentists. Dentists may obtain a copy by making a donation of a minimum of $60 to the Delany Foundation, a registered charity which assists schools in Ghana, Kenya and Papua New Guinea, then email Graham at graham. george.middleton@gmail.com. A copy will be sent to you. All proceeds go to the Delany Foundation for its good work. Graham has paid for the printing and mail costs personally.
