[Editor's Note: Here's a re-published post from WCI Network partner, The Physician Philosopher and is about the advice I gave back in 2011 for young docs to “live like a resident” for their first few years after residency. Enjoy TPP's fresh reminder on the principle!]
Chances are that if you are reading this blog, you have heard it said time and again that when you graduate you should “live like a resident.” The truth is that this is really solid investing advice. The White Coat Investor has said on more than one occasion that he can predict your financial future with “surprising accuracy” if you tell him what you did in the first couple years after you finished residency.
That’s all well and good, but where’s the proof that you should live like a resident after residency? Well, the proof is in the pudding. Let’s look at the ingredients to see if the pudding tastes as good as it sounds.
Pudding Ingredient Number 1: Savings Rate
The first ingredient in the Live Like a Resident pudding is a giant dash of savings rate. Your savings rate is the main determinant of your initial success in investing. Later on, your money will start to work for you once you’ve saved a substantial amount.
Why is this initial savings rate so important right after you finish? Glad you asked.
The 2 Million Dollar thought experiment:
Your goal in this thought experiment is to get to $2 Million Dollars. Here are the assumptions. You save 50K annually each year and earn 8% interest growth (we could assume less, it’s just the number I chose). Given these assumptions, it would take you 19 years to get to that goal (you’d actually be sitting at $2,072,313 at the end of year 19).
To understand the following numbers, here is the key to the following tables:
The First Decade
Even after ten years of savings, your annual savings rate (that $50,000 you save each year) accounts for ~70% of the entire total of your accumulated savings.
Why should you care?
- This means that the major determinant of your retirement nest egg in your early years is your savings rate (it accounts for 70% of your savings at 10 years).
- With these assumptions, you have not even gotten halfway to your goal of $2,000,000 in TEN years of saving. In fact, you stand at less than $800,000.
- Remember, though, I have to add another 1.2 million dollars in 9 years and I only saved $800,000 in TEN?
The next decade is where the magic happens.
In the graph, you’ll notice that year 17 is the break-even point where the total amount saved coming from your contributions starts to dive below 50% of the total value and compound interest starts taking over as the predominant factor determining your total savings.
The take-home here is that the further along you get, the less your savings rate has to do with your total accumulation. This is because your compounding interest begins to really shine from all those hard years of saving early while you lived like a resident.
Saving Early Matters
For those that prefer visual representations, the following figure may explain it better.
The blue bars are the % of your total savings that comes from the money you have saved (i.e. your contributions). The orange bars are the % of your total savings that comes from compound interest.
Time in years is on the X-axis, percentage of your total savings is on the y-axis. Note that the first year you start investing the entire bar (100%) is blue, because all of your savings came from your contribution from that first attending paycheck.
As noted earlier, in year 17 these two points (the blue bar and the orange bar) are even at 50%. From that time point forward, compound interest is more responsible for your total savings than your contributions.
What happens if we extend the math further? Well, after 30 years, this savings plan ($50,000 per year for 30 years) was started, the total savings would be $5,641,161.
Of this total, 73.5% would be due to compound interest (or $4,164,161) and only 26.5% would be from your contributions (a total contribution of $1,500,000, or 30 years at $50,000).
You read that right. You contributed 1.5 million dollars over 30 years and made over 5.6 million dollars. THAT is the power of living like a resident and earning compounding interest.
What accomplishes a large total savings is having a high savings rate in your early years, and a high savings rate is best accomplished early in your career by living like a resident when you finish.
Pudding Ingredient Number 2: Grindin’ Debt Like a Resident
Of course, your savings rate is only part of the pudding. Your savings rate could be even higher than $50,000 per year if you didn’t have those pesky student loans.
This is why it is so important to make a plan to deal with your student loan debt early! And, if you don’t know what to do, then get a student loan consult! The sooner you have a plan, the sooner you can take the next steps.
This is important because the % of your money put towards debt and your savings rate help determine your Wealth Accumulation Rate (WAR). The higher your WAR, the faster you’ll be obtaining your financial independence.
After all, after you live like a resident and that debt is paid off you can then put that money towards others important things, including:
- A higher savings rate that will allow you to reach your financial goals faster. If you had started out investing $75,000 per year, you would have reached the 2 million dollar mark by year 15 instead of year 19. That could save you four years.
- You can make a big purchase, such as a bigger home, with the increased monthly cash flow (though I don’t encourage you to think about money in terms of monthly payments).
- Invest more in your kid’s 529 or perform your first backdoor Roth IRA.
- Use some of that money (via The 10% Rule) to enjoy a little more of life. Maybe take that vacation you’ve been waiting to take.
You can do whatever you want with the additional money once your student loans are paid off. Odds are that once you have built the kind of financial muscles it takes to live like a resident, any financial goal is within reach.
Ingredient Number 3: A Pound of Earnings
One of the big advantages that you have coming from residency is that you are “used to” living and working like a resident. If you can keep that work pace up for even an extra 12 to 24 months following residency, you’ll likely make a lot more money. That is one of the ways that I paid off $200,000 in student loans in 19 months after I finished training.
This additional work could be through locums tenens work, picking up extra shifts, or working a side hustle or three. For example, some ways that I’ve earned additional income since finishing training include my side hustles including picking up extra shifts, performing medical malpractice expert witness work, and my The Physician Philosopher blog.
The point is that when I finished training, I was used to working resident hours. Keeping that going really helped us achieve our financial goals sooner.
Putting Living Like a Resident Together
The more of Ingredient Number 3 (work ethic) you have the more you can add of Ingredient 1 (Savings Rate) and Ingredient 2 (Grindin’ Debt) to the recipe.
Since this post hasn’t had enough math yet…let’s add some more here. Let’s say you earn an extra $1,500 per month from your extra shifts or side hustles. This would leave you with a couple of choices:
One choice is to pay off more debt. Say you came out of medical school with $200,000 in debt. You were smart and refinanced your loans to 3.5%. At $4,000 per month, this will take you 4.6 years to pay off. If instead, you worked a little harder and made some extra cash, you might be able to pay $5,500 per month. This would pay off that same amount of debt in 3.3 years. It would also save you about $4,000 in interest as well.
Alternatively, if you invested that extra $1,500 per month for three years after residency (total of $54,000 over that time) this would turn into $404,643 after 30 years at 8% compounding interest.
Either way (paying down debt faster or increasing your savings rate) you are building your wealth much more quickly. This is why it is so important to continue to work hard after residency. You can accomplish your goals faster.
Take Home: Live Like a Resident
Many readers will already understand these principles, but for anyone early in their career, I hope this serves as a solid reminder. What you do in those first few years after you finish is fundamental to your financial success.
If you need help figuring more of this stuff out, then I encourage you to go and purchase The Physician Philosopher’s Guide to Personal Finance. It’ll teach you the 20% of personal finance doctors need to know to get 80% of the results.
What did you do right after you finished? Did you buy the big house and the nice cars? Did you put the extra money towards grindin’ debt or investing? If you had a time machine, what would you do? Leave a comment below.