A powerful source of ancillary revenue

February 12, 2020

4 minute read


Source/Disclosures


Disclosures: Bhatia and Mandell do not report any relevant financial information.


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Sanjeev Bhatia

David B. Mandell, JD, MBA

David B. Mandell

by Sanjeev Bhatia, MD, and David B. Mandell, JD, MBA

With ever-changing healthcare, physicians of all specialties have often wondered how to maintain their incomes and achieve their financial goals while avoiding burnout. Although ancillary income streams have diminished and overhead costs have increased over the years, the most powerful wealth creator in human history has remained constant: compound interest.

Too often, physicians focus on practice-related revenue streams as the only way to build wealth without realizing the comparative power of an accumulating asset class. In some cases, this causes significant stress. By not harnessing the power of compound interest, your financial goals will remain tied to your ever-changing practice environment.

Here we illustrate the magnificent power of compound interest and demonstrate why cultivating it should be your primary goal for wealth building, especially for young physicians and residents.

The power of compound interest

Albert Einstein once noted that the most powerful force in the universe was that of composition. Much like a snowball growing as it rolls down a mountain, a funded asset grows in size year after year as you begin to earn interest income on your interest income. The result is wealth that grows at an ever faster rate.

Simply put, three factors determine the makeup of your money: the rate of interest you earn on your investments (rate of return), the time horizon, and your tax rate. As discussed in previous articles, tax-efficient vehicles such as Roth IRAs, traditional IRAs, 401(k) plans, cash value life insurance, and 529 college savings plans can enable growth. tax-free and sometimes tax-free access.

Saving early makes a difference

For young physicians and residents, investing even a small amount during their 20s and 30s helps them reach their financial goals faster than most other things they will do in their medical career. For example, consider the three doctors who contribute to their Roth IRA (a tax-advantaged retirement vehicle) at different stages of life. Each earns the same 8% annual return on their Roth IRA.

An example of three doctors contributing to their Roth IRAs at different stages of life.  Source: OJM

An example of three doctors contributing to their Roth IRAs at different stages of life.

Source: OJM

The millennial investor contributes $200 a month to his Roth IRA starting at age 26, then contributes $1,500 a month starting at age 33 when he lands his first job. The middle-aged investor contributes nothing to his Roth IRA until he turns 40, after which he contributes $1,500 a month until he retires at age 65. Finally, the deceased investor contributes $1,500 per month to his Roth IRA starting at age 47. At 65, due to compounding, the millennial investor has amassed $3,130,451 in his Roth IRA while the rest are far behind.

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Slowly but surely, we succeed

The interest rate, or rate of return, is one of the most important determinants of an asset’s value at maturity. Although a high interest rate is always beneficial for wealth creation, it is important to avoid excessive risk while optimizing interest rates to minimize devastating losses. One of the reasons the stock market has supposedly been hailed as the greatest generator of wealth in the United States is that historically the Standard & Poor’s (S&P) 500 Index, which is a high-profile asset class of reasonable risk, reported an inflation-adjusted rate of 7% to 8%. annual return.

In this second example, consider three investors who all contribute the same amount to their Roth IRA over a 30-year period. The first investor, the one who does not take risks, does not care to obtain anything beyond a rate of 1%. The standard investor tracks the S&P 500 index and earns an annual return of 8%. Finally, the risk taker earns a staggering 15% annual return by investing in high growth stocks and private investments, but sees their portfolio decline by 15% every 4 years due to cyclical market declines.

An example of three investors contributing the same amount to their Roth IRA over a 30 year period.

An example of three investors contributing the same amount to their Roth IRA over a 30 year period.

As you can see, the Standard Investor is way ahead of the other two due to continuous growth and avoiding devastating losses.

Your best source of ancillary income: simple investment

Finally, it should be noted that a simple investment, started cautiously at an early age, can even crush many lucrative ancillary income streams associated with the practice due to tax advantages and compounding power.

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An example showing that a simple investment started early pays off due to tax benefits and the power of compounding.

An example showing that a simple investment started early pays off due to tax benefits and the power of compounding.

From the age of 35, the investing surgeon begins to contribute $5,000 per month to an S&P 500 index fund generating an annual return of 8% until the age of 65. In contrast, the non-investing surgeon chooses to set aside $5,000 per month from age 35 into a savings account that earns only 1% per year. At 40, however, he chooses to become part owner of a lucrative ancillary income stream that brings in an additional $10,000 a month after taxes until he retires at age 65. This additional income is also deposited in the savings account. Interestingly, despite missing out on the lucrative sideline opportunity and resulting more basic income, the investing surgeon is $2,224,662 more than his 65-year-old counterpart due to the power of compound interest.

conclusion

Physicians too often focus on practice-related revenue streams as the only way to build wealth and fail to realize the comparative strength of a compound asset class.

As these examples show, the awesome power of compound interest is the best wealth-building tool, especially for young doctors and residents who start investing at an early age.

Disclosures: Bhatia and Mandell do not report any relevant financial information.

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