Extreme Saving -- Part 2

March 16, 2011
Setu Mazumdar, MD

Last week I introduced a simple saving strategy to build wealth by focusing on saving early in your career. But let's say you didn't save much early on and now you're worried that you won't have enough for retirement. There is still hope, because you can use these two powerful savings strategies.

Last week I introduced a simple saving strategy to build wealth by focusing on saving early in your career. But let’s say you didn’t save much early on in your career. There is still hope, because you can use two powerful savings strategies.

Save Often. Let’s compare three physicians at different points in their careers: a 30 year old (newbie), a 40 year old (mid-career) and 50 year old (late-career). Each makes $200,000 in income annually, and each wants to reach $2 million by age 65. So each year they have to save $11,500, $27,000, or $73,000, respectively, assuming an 8% annual rate of return. (Again, to make it simple I’m ignoring taxes and inflation.)

The above analysis assumes once per year contributions to savings. Let’s see what happens when each physician invests a weekly sum, instead of a yearly sum. The 30 year old would need to invest about $200 per week, or $10,400 per year, to reach $2 million at age 65. The 40 year old needs to save about $480 per week, or $25,000 for the year. And the 50 year old needs to save $1,300 per week, or almost $68,000 per year.

Notice that by investing more frequently -- weekly rather than yearly -- all three physicians can reduce their annual amount of savings and still reach the same goal. For this reason, it is important to invest savings immediately after paying expenses instead of waiting.

Also notice that there is a greater impact on reduction of savings to the 30 year old, than the 50 year old. For example, the 30 year old physician can save 10% less per year if he or she invests weekly, but the 50 year old physician can save only 7% less. The 50 year old still has a huge disadvantage, because he or she still needs to save almost 35% of income every year, whereas the 30 year old needs to save just 5% of gross income.

Save More. Going back to the original assumptions, let’s see how long it takes for the young physician to reach $2 million if he or she increases the amount saved. It takes 35 years to reach $2 million if the physician saves about 6% of annual income. Doubles the annual investment to about $22,000, it takes roughly 27 years to reach the same goal -- cutting the number of years of saving by 20%. Going further out, if the physician saves 20% of income, or $40,000 per year, it would take only 21 years, slashing 40% off the original time frame and making the doctor a multimillionaire by age 50. The mid-career physician can probably still increase his or her savings rate, but the 50 year old has very little room to do so.

Finally, let’s see the awesome results when combining the three “S’s” of savings: the 30 year old EP (saving early) saves 30% (saves more) of his gross income or $60,000 per year and invests it on a weekly basis (saves often). He’ll be a millionaire at age 40, and a multimillionaire in his mid 40s. By age 50 his portfolio is worth over $3 million, and at age 65 his portfolio is valued at an incredible $11 million!

This week’s financial prescription: Make wealth building simple by saving early, saving often, and saving more.