“Time Value of Money” and its Importance to Physicians

We all know the premise that physician’s don’t start earning significant incomes until somewhere around their thirties.  Previous to becoming attending physicians, accumulating significant amounts of debt, to the tune of an average of $180,000¹ by the time of residency (however that can vary dramatically depending on your course of training).  Because physicians have a larger hole to climb out of with less time is the reason that the principle of “time value of money” is so important.  Not only can you make it work for you as it applies to wealth accumulation, it can also work against you by accumulating interest for the Department of Education, or another institution if you have private debt.

The principle of “time value of money” is the idea that the value of a dollar in the future is greater than a dollar today, due to its earning potential.  The future value of today’s $100, given a 5% rate of return per year, is $105.  This could be a result of growth in value of the underlying investment, or from income through dividends or interest payments.  Easy enough right?  So let’s say you want annual growth or income of $150,000 to use in retirement.  

But wait, what about the effects of inflation?  Inflation has a negative effect on the future value of a dollar, so by the time you retire, that $150,000 doesn’t get you what it would today.  However, factoring in inflation goes beyond the scope of this post and makes the following examples more complex than is necessary to illustrate the principle of “time value of money”, so I’m going to save that for another post and ignore the effects of inflation today.  

So, what amount of money would you need to produce $150,000 in annual growth or income?  Let’s use the 4% rule for simplicity’s sake, this rule assumes a conservative annual rate of return of 4% and that you consume that amount.  So you would divide $150,000 by 4% to get $3.75 million.  Meaning it would take an investment of $3.75 million earning 4% annually to get $150,000 of income every year in perpetuity.  So now that you have the goal of saving $3.75 million dollars by the time you retire, we now need to determine how many years you will work and what rate of return you will earn during those years.  I’ll give you some options, the table below tells you how much you would need to save every month to get to $3.75 million.


Hopefully you aren’t intending on retiring in five years if you haven’t started saving yet!  But the point is that if you look at the first row where retirement is 5 years away, there isn’t a lot of disparity ($56k and $51k, or 11%) between how much you have to contribute relative to your expected rate of return.  This makes sense because there just isn’t a lot of time for the time value of money principle to work it’s compounding magic.  In contrast, if you worked for 40 years, the contribution has a much higher disparity ($3k and $1k, or 195%) between the necessary contributions relative to your expected rate of return.

What about debt though?  If you’re in a typical situation of having six figure debt, it’s difficult to make the contributions illustrated above.  To further the above example, let’s say you’re a new attending physician earning $200,000 and you have $180,000 in debt.  Federal student loans provide a lot of options as to how you tackle this debt, but again, that’s another topic altogether so we’re going to assume you won’t be going for any type of loan forgiveness through public service or an income driven repayment plan and will refinance to private loans with lower interest rates.  As I write this, refinancing rates on student loans is around 3.5%.  The table below illustrates how much interest is paid in relation to how many years you choose repay at that rate.


Now the question becomes about where whether you should focus on savings or paying off debt.  From a strictly objective standpoint, it becomes a question of arbitrage, or where you should allocate your available resources depending on where those resources will work harder for you.  By paying more than the minimum payment is to effectively earn a guaranteed 3.5% by way of savings because the extra principal you pay off will no longer be subject to interest.  But what if instead you put that extra amount into a savings account where it gets invested in a mix of stocks and bonds that pays 6%?  While 6% is better than 3.5%, it isn’t guaranteed.  So from a more subjective standpoint, aggressively paying off loans and relieving yourself from the shackles of debt with a guaranteed rate of return can provide immeasurable peace of mind.  Your preferences likely fall somewhere inbetween, but everyone is different and it just depends on your attitudes and goals.  

I will say, however, that as I write this, investing in stocks is particularly risky as stocks are relatively expensive².  This means there isn’t a lot of upside potential, but there is a lot of downside risk.  So in the short term, perhaps both the objective and subjective minds would agree to put an emphasis on debt repayment and effectively guaranteeing that 3.5%, or whatever your rate is.

Current market conditions tangent aside, the point of this article is to illustrate the long-term strategy of wealth accumulation.  The final idea I’d like to put forward is that of resisting the temptation to increasing your standard of living as dramatically as your income increases upon completing residency, but rather to take a few years to maintain a lean lifestyle and focus on a combination of savings and debt repayment.  The following examples compare the trade off between allocating your resources towards savings/debt reduction or toward increasing your standard of living.  Both scenarios assume your income increases by 3% annually and your total taxes amount to 40%.

Scenario 1:  The new attending physician pays $22,000/yr to pay off debt over ten years, then begins to save $40,000/yr toward retirement for the next twenty years.  The physician will be able to enjoy a higher standard of living from the beginning and ends up with $1.7 million to retire with.  Using the rule of 4%, that will provide $68,000/yr.


Scenario 2:  The new attending physician pays $35,000/yr to pay off debt over six years, and  saves $40,000/yr toward retirement for the entire thirty years.  The physician standard of living continues around the same as in residency, then jumped up after the student debt was repaid.  At the end of thirty years, ends up with $3.35 million to retire with.  Using the rule of 4%, that will provide $134,000/yr.


There are a lot of different ways to play out these scenarios, but the point is that the first ten years of saving for retirement meant the difference between $1.7 million and $3.35 million.  The greater the amount of time you give the “time value of money” principle to work for you, the more dramatic it will be.

So what do you think?  Does this help you to better understand how important it is to carefully and systematically allocate your resources from the very beginning of your career to harness the power of the “time value of money”?  Please send me your thoughts and feedback.


  1. AAMC Debt Fact Card, 2015
  2. CNBC: “If you follow Warren Buffett’s methodology, stocks are significantly overvalued”