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Tuesday
Jul192011

The Art of Extreme Saving

“The most powerful force in the universe is compound interest” -- Albert Einstein

I always find other people’s stereotypes about doctors amusing. Here’s one typical encounter that happens every so often:

As I’m placing the last chart in the discharge rack, a nurse unexpectedly asks me “What car are you driving home?”

“What car do you think I drive?” I respond. “I bet he drives a Beemer,” shouted a tech.

“I parked next to a BMW, but I drive an 11-year-old Honda with over 200,000 miles on it,” I say.

“Yeah right. Then what do you do with all that money?”

“After buying my groceries at Sam’s Club, I save it,” I reply, as I wave my still remoteless keys.

I’ve met many physicians who think “save” is a dirty four-letter word. They spend everything and live paycheck-to-paycheck. So let’s explore what some of the few simple principles of saving can do for you.

Over the past 10 years of practicing emergency medicine, I’ve realized one of the most powerful but underrated techniques to achieve financial independence: Making the most of compound interest. Compound interest simply means the interest which accrues on interest.

For example if you have $1,000 invested at an annual interest rate of 10%, then after one year you would have $1,100 ($1,000 original investment and $100 of interest). After the second year you would have $1,210 ($1000 original investment, $200 of interest on the original investment, and $10 of interest on the first year’s interest).

Combining saving with compound interest leads to my three “S’s” of saving:

1.    Save early
2.    Save often
3.    Save more

How effective are these principles of saving? Let’s consider three physicians in different stages of their career: a 30 year old (newbie), a 40 year old (mid-career), and a 50 year old (late career). Let’s assume that each one wants to retire at age 65 with a $2 million investment portfolio and each has a gross annual income of $200,000. Let’s also assume an 8% annual investment return. For this discussion, we will ignore inflation and taxes.

Save Early

For the 30 year old to reach $2 million by age 65, he would need to invest about $11,500 per year, which is less than 6% of his gross income. The 40-year-old physician would need to save $27,000 per year, or about 13% of gross income -- still an obtainable goal. The 50 year old would need to save more than $73,000 per year, or a whopping 36% of his income.

If the 50 year old has two-college aged children and a home mortgage, he may need to delay retirement, cut expenses, underfund college savings, or work more to earn more income (assuming that he stays healthy enough to do so). Looking at it another way, the 50 year old needs to save over six times more money per year than the 30 year old to achieve the same portfolio value at age 65. How many physicians can do that?

Next time, I’ll discuss the other 2 principles of saving.

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