[Editor's Note: There is a crossover point that most people do not reach until they quit their job (and their income drops): the point when their portfolio earns more than they get paid for their job. I still haven't reached that point and possibly never may. Today's WCI Network post from the Physician on FIRE discusses a slightly different but easier to reach crossover point—when your portfolio makes more in a year than you contribute to it. This is also pretty exciting to see and usually reached much earlier!]
I was twelve, maybe thirteen years old. Our elderly neighbors could no longer keep up with the flower gardens and shrubbery surrounding their country home, and I somehow found myself employed.
The job paid $2 an hour. I was small enough to easily squeeze in between and underneath the flora to pull weeds and I knew how to work a hose to keep everything green.
A few hours of work earned me enough to buy a stack of wax packs — that’s how football cards were packaged back in the day — a few weeks’ worth could get me a new LEGO set!
I had no portfolio to speak of. I did have a Joe Montana rookie card (I still have it, in fact) and a growing collection of Space LEGO. I was trading time for money for goods and I loved it.
Fast Forward Nearly Two Decades
At this point, I’m in my early thirties. I still have no portfolio to speak of. The Montana card and LEGO are in storage, but now I’m making more than $2 a minute. I’m trading time for money and loving it!
I’m finally an anesthesiologist, cheerfully getting up early, working late into the night, and doing the things I trained for so long to be able to do.
I start a few small investment accounts, but 99% of the progress in growing my net worth comes from my new job. In fact, in those early years of my career (think 2007 to 2009), those investments were only losing money while I more than made up for it by working my tail off.
It was disheartening to see those early mutual fund investments plummet, but I was familiar enough with the history of the stock market to know that in all likelihood, this too would pass.
Pass, it did.
Fast Forward Another Decade
I’ve heard that the first $1,000,000 is the hardest to acquire. Of course, it is. You have to work for it. I recall passing that milestone roughly seven years into my anesthesia career.
When you join the two-comma club, things happen more quickly. Your money is now working harder than ever, boosting your net worth more with each passing year while your input from the money you earn probably hasn’t changed all that much.
The second million came in less than half the time of that first million dollars. By the time I left my job and retired from medicine, that number had doubled again.
I wasn’t working any harder; in fact, I was working less as a part-timer the last couple of years. Luck certainly played a role; the market was on a historic bull run. The Rule of 72 playing out right before my eyes.
If I hadn’t been saving diligently all along, though, I wouldn’t have had the funds to benefit from the stellar returns that the stock market has given us.
Passive “Income”
Usually, when I talk about passive income, I put the word “passive” in quotes. The “passive” income that is bantered about online almost always has an active component, particularly early on, a fact that Passive Income MD readily admits.
In this case, the income I’m talking about is truly passive, but “income” isn’t the best term for the growth of an investment portfolio.
Essentially, I’m talking about the growth in your net worth that comes with each passing year that your portfolio gains value. Most of it won’t exactly be “income,” per se, as that term implies that the growth is realized as taxable proceeds that you’re free to spend or reinvest.
Regardless of the nomenclature, truly passive income is a beautiful thing, and that term rolls off the tongue much more smoothly than passive portfolio growth or passive net worth gains.
If you play your cards right, at a certain point in your career, you will find that in some or most years, your portfolio contributes more to your net worth growth than your job does. When that happens, you may start to question why you work as hard as you do.
I certainly did.
When Will You Reach the Tipping Point?
Since you’re still working in these years, I’ll assume that you’re invested in a reasonably aggressive fashion, i.e. mostly stocks. You may also be investing in real estate or alternatives and I’ll address that potential later on.
Given this assumption, one can expect plenty of volatility. Some years will be much better than others, and in some years, your portfolio will work against you. To me, it makes sense to break it down into years that are great, good, OK, and bad.
Great Years
2019, when this post was originally published, was a great year. The stock market returned around 30%. Any time you can get 25% or more from your portfolio, I’d call that a great year.
Historically, the U.S. stock market as measured by the Dow Jones Industrial Average (which actually has data going back more than a century) has generated great returns 20% of the time over the last 100 years.
If you are saving and investing $10K a year, you only need $40K in your portfolio to be out-earned by your investment accounts based on this data.
If you’re a high-income professional, living on half your take home pay in accordance with my live on half challenge, and investing $100K a year, a portfolio of $400K could add as much or more to your bottom line than your work does.
The formula is pretty simple. 100 divided by the percentage your portfolio gains equals the multiple of your annual savings that will equal your contribution to your net worth. That sounds like a mouthful, so let’s apply it to some other scenarios.
Good Years
The U.S. Stock market has returned, on average, roughly 10% per year over many decades. I’d call a good year anywhere from that average of about 10% up to 25%.
When your portfolio is 10x the size of your annual contribution (the amount you save and invest from your job), in a good year, your portfolio will contribute at least as much as you. 100/10 = 10.
In a very good year where your portfolio earns 20%, a portfolio of just 5x your annual savings will match your contribution. 100/20 = 5.
Looking at the last 100 years of US stock market returns, 30 of them have been good years.
OK Years
I’ll define an OK year as one in which you see a positive return in your portfolio, but less than 10%. By now, I suspect you can do the math yourself.
If your portfolio earns 4%, you’ll need a portfolio 25x the amount you’re saving and investing annually for the portfolio to work as hard as you at growing your net worth.
Those of you familiar with safe withdrawal rates should recognize these numbers. We’re not measuring the exact same thing, but the equation is the same. 100/4 = 25. When discussing withdrawal rates, we’re solving for how much you need to accumulate to meet your retirement spending needs rather than matching your annual savings, but the math is identical.
We’ve encountered OK years 18 times in the last century.
Bad Years
If you’re invested aggressively and the market is down, your portfolio is going to work against you in bad years. 32 of the last 100 years have been bad years. No matter how large the portfolio, it won’t do you any favors with a negative return.
Well, you could do some tax loss harvesting, but that’s a different article altogether.
The Role of Diversification
Few people have 100% of their nest egg in stocks, and no one I know is 100% invested in the 30 large cap stocks that make up the Dow Jones Index. I used it simply because it’s an index with more than a century of data.
Adding uncorrelated or inversely correlated asset classes has the effect of decreasing the frequency of both the great years and the bad years. That means more OK and good years, and most people would consider that a good thing.
Fixed income instruments such as bonds and annuities tend to give OK returns most of the time. In some cases, you’ll know exactly what you’re getting in advance.
Real estate runs the gamut, but in most cases, unleveraged real estate can be expected to give you high single-digit to low double-digit returns.
A diversified portfolio that includes multiple asset classes will increase the odds that your sizable portfolio out-earns you more often than not. Your floor (poorest portfolio performance) will be raised while your ceiling is lowered a bit, as well.
The Implications of a Hard-Working Portfolio
What does it mean when your investments make your net worth grow more than you can most years?
It’s both a wonderful and deflating feeling. On one hand, you realize that you could likely get by just fine without the job. On the other hand, it can make you feel like you’re spinning your wheels at work.
You put in all those hours and go the extra mile only to have the contributions you can make to your nest egg pale in comparison to the growth of the nest egg itself. It’s a first-world problem of the highest order, but it’s one that may have you questioning the role of paid work in your life going forward.
For example, let’s say you’re comfortably financially independent with 30x your anticipated annual retirement spending of $100,000 a year saved up and invested.
You accumulated this $3 million portfolio as a super-saver putting aside $100K a year, on average, which you’re still doing now.
In a pretty good year, the market gains 10% and your nest egg contributes $300K whereas your full-time job adds 1/3 of that amount.
In a very good year, the market gains 20%. Your portfolio is up $600K without you lifting a finger. In a great year… well, you get the idea.
You realize that your future net worth depends far more on market returns than whether or not you’re working. There are many reasons to work that have nothing to do with money, but at some point, you realize that the money you earn doesn’t impact your financial future much anymore.
Has Your Portfolio Made More Money Than You?
- If your portfolio is 4x the size of your annual contributions, it would have happened once every five years.
- If your portfolio is 10x the size of your annual contributions, it would have happened half of the time (50 of the last 100 years).
- No matter how big your portfolio is, a 100% stock allocation has lost money nearly one-third of the time.
Obviously, past performance is not predictive of future returns, and a diversified portfolio will alter the equation to some extent.
The take-home message is that at some point, you’ll have a hard time keeping up with the work ethic that your investment portfolio seems to have.
If you want your money to work for you, put in the work yourself, save a substantial chunk of what you earn, build a diversified portfolio, and reap the benefits.
Eventually, your hard work will pay off, and you won’t have to work so hard to grow your net worth. Your days of pulling weeds and filling the watering can are over. You can sit back and watch your garden grow.
Compound interest is a wonderful thing.
Has your investment portfolio out-earned you yet? Does it happen more often than not? Does recognition of that fact change how you feel about your career? Comment below!
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Not in the 2 comma club yet, but getting close. In a very good year (20% plus), my portfolio is capable of returning more than I contribute already. That’s a nice milestone to know about for sure. I guess the key thing to continuing to work/contribute moving forward is for the opportunity to contribute during a “bad year” when the market is down. That’s where having an income will make everything feel alright. Since I started saving/investing/paying attention to my net worth, I have yet to have a truly bad year. Even 2020 has panned out to be a good year for investors, especially those who used March/April as a massive buying opportunity.
“Slow but steady wins the race.”
Starting early as possible is key. I’m well past the point of the portfolio outpacing saving even though I max 401k, IRA, along with a defined benefit plan and a taxable acct. Now I work when I want, how much I want. 2 weeks a month for 4 years to finish out the DB plan, then likely a week a month for a few more, earning enough to let the portfolio run while still adding 401k & IRA money. I still like what I do, but the key is being able to work because you want to, not because you have to. Time is your friend early on, not so much later!
Inherent in the number is a plateauing income. If your income keeps rising, you could be well beyond FI, have your portfolio providing more than you spend, and still not have your portfolio contributing more than your earned income to the portfolio.
Other investments… time and that lovely dinosaur still present in US government but few other jobs, the defined benefit pension. Spouse invested 20+ years which gives 1/7 to 1/3 of our ‘portfolio’s’ value to us (counting it less productive than stocks, more than bonds), my years (with 5 vesting I complete in 3 weeks) adds another 1/12th or so to it. Hard to calculate that which fully or partly vanishes at death of one part of couple- of course of no value as an inheritance to our kids unlike the rest of the portfolio. Though with vesting, he contributed nothing for 20 years then with each extra year another 5% of the large addition at 20 years. And until we have nationalized, socialized medicine (and perhaps the US Army will give us a discount even on that) his 20 years also got us health care which we could value as producing $10K a year, $20K when the kids were all covered.
However as docs and FIRE folk, even though mostly government work, our portfolio should never produce more than our jobs did- if it does, we waited too long to retire! (but that 20 year vesting plays havoc with FIRE).
“waited too long to retire”
Or were working for reasons beyond just having enough to retire.
“You put in all those hours and go the extra mile only to have the contributions you can make to your nest egg pale in comparison to the growth of the nest egg itself.”
I look forward to this day. It’s hard to know if this will make me appreciate my job more, or desire to work less, or not at all. I bet I’ll become less tolerant of things like overnight call and overtime.
Perhaps at that time I’ll feel free to move onto another career or allow my hobbies to grow into actual businesses. In any case, it’s a great problem to ponder.
It’s made me appreciate my job less. I’m in a funny place where I am well into the 2 comma club and my investments earn more than my salary. But I am about 10 years away from my (very) fatFIRE goal.
It was easy to swallow the undesirable aspects of work when I needed the money to pay rent. It’s hard to keep the motivation alive when I’m working for a nicer life in early retirement, not earing my daily bread.
I have acknowledged to myself (all I’ve told my boss is ‘I’d prefer time off awards to cash ones’, and it’s already too late for the current job to address this lifelong issue anyway) that I’d still be working, and planning to for 10-30 more years, if I were paid a lot less. But we traded as we expected (with some disappointments re things changing over the years and decades) and if I were only paid as well as a high school teacher, well, I might have become a high school teacher (especially if the pay started 7+ years earlier than as a BC doc).
Doctors are great at working hard for their money.
Posts like this can help them understand that making their money work for them is at least as important.
Saving more and more each year gets easier because less of your W-2 income needs to be saved to reach annual saving goals. The rest can come from the portfolio.
Having your portfolio save more than you do from work is great.
Having your portfolio earn more than you spend is even better. That’s F.I.
Having your portfolio earn more than you do working full time is the ultimate.
Personal capital and financial capital both serve a purpose in building wealth.
I have a monthly spreadsheet that has a row for each month since 2/2003. Columns show the components of the monthly change. The goal is to in one row understand the change in the balance (gain/loss is wild). Added is cumulative from today from historic balance. Additional column shows annual performance.
Just has a hoot, I put a target number to shoot for and how much is left in dollars and %.
This is a huge motivator in long term performance.
The key is to remember that much of that hard earned paycheck doesn’t hit the spreadsheet, only the deposit/withdrawal column. Behavioral finance you are subconsciously pushed to make the numbers bigger. Yes, market change will dwarf your contributions, you will see the impact even with the large swings in market gains/losses.
Then you go back to life, do I want to spend or save?
It’s not a tool for monitoring investment performance. It’s reality. OMG I made more in a month than I grossed in a year. Mental candy is addictive.
Man, you guys are definitely killing it! I’m nowhere near my returns exceeding what I put in savings. but when it does, not sure if it changes my financial plan really. I will just keep to my written financial plan.
However, kind of nice milestone to celebrate! will definitely make a dinner with the wife when we accomplish this.
I’m wondering though if tracking your returns meticulously might lead to fall victim to behavioral finance traps. I might have to avoid looking at my returns in those bad years!
Working was the primary means of growing wealth in my first decade as a doc. In the second decade, growing our wealth was a balance between investment performance and work. Now, in the third decade, we have reached the next level where the investment decisions and growth are far more significant than any earned income from work. I continue to work because I enjoy it, but I do it on my own terms.
How do you figure out the numbers when your passive income portfolio is making more than your active (earned) income?
“The “income” I’m referring to in this post is the total return that your portfolio gives you in a given year. It’s the amount that the value of your investment portfolio increases not from new contributions, but from the increase in net asset value and reinvestment of any dividends.”
I’ve been looking at the overall growth of all accounts (401k, Roth IRA, 529, taxable, private REITs) and then subtracting all my active contributions (from earned income) to arrive at the PI #. Is that what everyone else is doing or is there a shortcut?
That sounds like the right way to do it to me.
Personally, I’m fine with generously rounding everything for comparison purposes since getting past the tipping point doesn’t have any impact on my financial or work decisions. It’s really just an arbitrary categorization. If you’re still working and saving, any year with negative returns means the portfolio failed to exceed your own active contributions. That’s going to happen about 1/3 of the time based on the numbers cited in the post regardless of how much you’ve saved over the years.
Hopefully, it’s clear that the timeframe for comparison is completely arbitrary. POF uses annual returns based on calendar years because that’s how the market returns are reported. It could just as readily be two year periods, lunar cycles or two presidential birthdays. If you want to stick with year-end cutoffs, it’s probably easier to just compare last year’s investment returns with this year’s retirement contributions. That would eliminate most of the calculations you’re currently doing along with automatically handling the reality that some of this year’s portfolio returns are coming from the contributions you made earlier in the year. That seems a bit like double counting.
In the end, the “crossover point” is just a fun talking point during good years.
I’m in business rather than medicine (I just like the website!) In the business world at least, there is a frequent dynamic where the income is chasing the portfolio higher.
20 years in, my portfolio today throws off as more dividends in 2 months than I earned in a year at my first job (teaching – you can’t convince me teachers aren’t under-paid! That job was way harder than working in technology, finance, or pharma!). But, our family’s earned income has grown fast enough that we’re still contributing 5%+ each year to the nest egg, plus covering all expenses. At some point this dynamic may change, but as long as we’re fortunate enough to keep it up, it keeps the day job feeling quite impactful.
Oversaved in my IRA to leave to kids as a stretch that was killed recently
Just hope to live enough to convert a boatload to Roth
A good problem
A professionals easiest path to wealth is a ret plan and passive investing and hi savings rate
as a fla resident paying an effective tax rate around 20% on 320k income is just fine