To Build Wealth Focus on Savings Not Returns: Part I

In medicine we emphasize the wrong things to improve patient care. For example, in the hospital setting we use patient satisfaction scores as a measure of your competence. And medical boards think that completing annual tests and 10-year recertification exams ensures high standards of patient care.

How about we make sure doctors are happy? If you have happy doctors, you’ll have better patient satisfaction scores.

How about we recognize that our residency training, initial board certification and our subsequent real world experience in the trenches trump annual tests?

It’s the same way in investing. Many of you focus on the wrong tactics to build wealth. While the goal of investing is to generate a rate of return that increases the value of your portfolio, it’s actually less important than the one thing that has the greatest impact on the value of your portfolio: the dollar amount of your annual savings.

No matter where you are in your medical career — just out of residency or just about to retire — the size of your investment portfolio has more to do with the amount you save instead of investment returns.

Early career physicians

Let’s say you just graduated from residency last year and will make $250,000 in income this year. You join a group as an independent contractor and open a SEP IRA or solo 401(k) and max it out by contributing your first $50,000 on January 1st of this year. Let’s assume you invest it 100% in stocks.

Suppose the stock market drops 10% this year for a loss of $5,000 on your $50,000 portfolio. Now you’re left with $45,000 at the end of the year. Then you pump another $50,000 into your portfolio on Jan. 1 of next year with another contribution. Now you’ve got a $95,000 portfolio in just two years. While you suffered a loss in your portfolio from a negative investment return, your portfolio value gained 90% from the first year to the next. Suppose every year for five years, the same events happen. Here is the value of your portfolio over those five years:

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You can see that despite annual losses, your portfolio value increases every year from your savings.

Now suppose you have gains of 10% annually for five years. Even in that case the dollar amount of the portfolio value gain from the investment return is far lower than the dollar amount of the portfolio value gain from your savings, as shown in the following table:

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The percentage gain in the value of your portfolio came mostly from your savings not from investment returns.

Next time, I’ll show you how savings impact mid- and late-career physicians.