When it comes to personal finance, some things matter more than others. The secret to wealth is no secret, and getting rich slowly works best. The path to wealth is to make a lot of money, save a lot of it, and to make your money work as hard as you do. Consider the decisions made by two physician partners and the eventual effects on their wealth level. Let’s start them out at age 35, perfectly equal in the same specialty, practice, and net worth. They both just finished paying off their student loans. They are both currently grossing \$300K per year.

Doctor Rich

Doctor Rich decides he is going to pick up some extra shifts (or call), increasing his income by 20% to \$360K. He also decides he is going to save 25% of his income each year. He reads a few good books and learns about investing and decides to run his portfolio himself, using a reasonable collection of index funds and earning a 5% real (after-inflation) return on that portfolio.

Doctor Average

Doctor Average decides he would rather have the time off than pick up the extra shifts (or call), so he maintains his income of \$300K a year.  He decides he is going to save 15% of his income. He mistakenly hires a mutual fund salesman and an insurance agent as his financial advisors, and doesn’t realize his mistake for 10 years, so his portfolio earns just 1% real for the first ten years.  After that, he hires a good fee-only manager who charged 1% on a portfolio similar to that of Doctor Rich, so he then earned 4% real on it.

If they both work to age 65, how much more will Doctor Rich have? If Doctor Rich decides he wants to retire early, how much sooner can he retire on the same retirement income as Doctor Average?

The Future Value Function

Heaps Canyon, Zion National Park

The best way to answer these questions is to use a good financial calculator or spreadsheet with the Future Value (FV) function. The inputs to this function include:

1. Annual Interest Rate Earned
2. Number of years
3. Present Value
4. Annual Contribution
5. Whether the money is contributed at the end of the period vs the beginning

The function looks like this in Microsoft Excel:

Future Value = FV(interest rate,number of years,annual contribution,present value,1)

The annual contribution and present value numbers should be negative. The timing of the contribution is 1 if done at the beginning of the period, 0 if done at the end. so for Doctor Rich, it looks like this:

FV(5%,30,-90000,0,1) = \$6.28M

If you apply the 4% rule, that means he will have \$251,000 in today’s dollars to spend each year in retirement.

for Doctor Average, it looks like this:

FV(4%,20,-45000,-FV(1%,10,-45000,0,1),1) = \$2.44M

Using the 4% rule, that’s an income of \$97,000 per year in today’s dollars. Is that enough to retire? Almost surely. Is it very different from Doctor Rich’s stash? Less than 40%.

Early Retirement

What if Doctor Rich only needed \$97,000 in income (same as Doctor Average) to retire? How much sooner could he retire than Doctor Average?

FV(5%,17,-90000,0,1) = \$2.44M

It turns out he could retire after just 17 years, at age 52. He gets 13 more years of financial freedom than Doctor Average. Did Doctor Rich have to impoverish himself to do this? Not really. He probably paid something like 25% of his income in taxes, and put 25% of it toward retirement. That left him \$180,000 to live on, or \$15,000 a month. If Doctor Average paid 20% of his income in taxes, and put 15% of his \$300K income toward retirement, he only had \$195,000 a year to live on, or \$16,250 a month, a similar spendable income. He did get an extra 3 days off each month and didn’t have to read any investment books, but neither of those seems like a huge sacrifice to retire 13 years earlier or 2.5 times richer.

There is no right answer to how much extra you should work, what percentage of your income you should save, or whether or not you should use a good adviser (although no one should use a salesman as an advisor.) But there are very real financial consequences to your decisions. The Future Value function helps you understand what they are. Be sure to use after-inflation numbers when running your own scenarios.

What do you think? Have you used the Future Value function or a similar financial calculator to run your own numbers? What did you learn? What surprised you? Comment below!