White Coat Faceoff: Too Much Saving?

One of my favorite websites, and one that I have not mentioned here previously, is The White Coat Investor.

This is a financial site written by an emergency room physician, James Dahle MD.

It’s a niche site to be sure, focused on providing financial advice for physicians.

But I think it’s applicability extends far beyond the medical community, and is a great resource for anyone interested in early retirement to have bookmarked.

Reading through his site, I find that our investing philosophies are very similar. He is definitely of the Bogleheads school of passive index investment, and is appropriately leery of the motivations and advice offered by financial professionals and insurance agents in general.

So I was very interested to happen upon an article that Dahle penned in December 2011 entitled 14 Reasons Why You Shouldn’t Retire Early.

As with all of his articles, it was well-written, well reasoned, and thought-provoking.

Unlike most of his articles, however, I disagreed with him on this one.

So I thought it would be interesting to use a series of posts to investigate his stated “reasons,” and launch a counterargument to each from my own perspective.

So let’s begin at the beginning:

Reason 1: You have to save a lot more of your income.

While it is obviously true that the more you save, the earlier you can retire, to really retire early requires a savings rate that is too high for the comfort of all but the most frugal.  Consider a doctor who gets out of residency at 30, earns $200,000 a year, earns 5% real on his investments, withdraws 4% a year from his retirement stash each year, and needs $100,000 a year of retirement income.  If he retires at 70, he needs to save $22,000 a year, or about 11% of his income.  But to retire at 50, he would need to save $76,000 a year, or about 38% of his income, over 3 times as much.  He not only has half the years to save the money, but also loses much of the benefit of compound interest.

My criticism for this argument is really about the implicit assumptions.

1. I particularly disagree with the part about the doctor needing $100,000 a year of retirement income. 

I don’t think anyone needs $100,000 a year of retirement income. Some may want $100,000/year of retirement income, but they certainly don’t need it. In fact I would make the argument that it is wise not to plan for any more than $80,000 a year in retirement income.

And here are my reasons.

• Once you make over $73,800 a year investment income in retirement you’re subject to capital gains taxes.(Assuming your earned income is in the 15% tax bracket or lower. ) And tax free money is obviously more powerful than taxed money. (I.e. you have to withdraw less to achieve the same buying power.)
• There are many expenses present while you are working that cease to exist after you retire from medicine. (I’m thinking disability insurance, life insurance, transportation costs, professional expenditures.)
• Maybe most importantly is the concept of the marginal utility of wealth. If your house is paid off when you retire, I would argue that it is very unlikely that you will receive much more happiness from $100,000 a year spent  in investment income versus $80,000 a year spent in tax free income.

2. I disagree with the example savings rates presented.  They are not typical in my experience.

Many doctors who make $200,000 a year, are given the opportunity to save in 2 separate tax-deferred accounts.

As an example, in my job I am able to contribute up to $17,500 pre-tax to both a 403B plan as well as a 457 plan.

This is $35,000 a year saved not even counting the 3-6% match offered by my employer.

I have the feeling that Dr. Dahle would agree with me that it would be foolish for our physician not to max out both of these plans to take advantage of tax-free savings.

So what percentage of take-home pay would our physician be achieving in a state such as Oregon with a tax rate of 8%, were he to only max out his 2 tax-free retirement accounts? Almost 24%.
This means that by doing this alone our physician could expect to be financially independent in 34 years (or age 64.)

And what if he were to be smart enough to take advantage of a stealth IRA (An HSA account). This would deduct an additional $546 pre tax from his monthly paycheck.

His savings percentage would now be 28%. And his expected years to retirement would be about 29 years (or age 59.)

And what if he were to be even more ambitious. What if he were to set aside a backdoor Roth IRA to the tune of $11,000 after tax a year total for him and his wife?

His savings percentage would now be 35.4%. Which means he would be on track to retire in 25 years (or at age 55.)

And how much paycheck would he have given up in order to get his expected age of retirement from 64 to 55?

His monthly paycheck Would have shrunk from $9297 to $7982.

In other words he’d have bought himself 9 additional years of financial independence for only $1315 (Or 14% of his paycheck) not spent a month.

Now maybe he really likes cars and would like to lease a Porsche for that money instead of being financially independent 9 years earlier. Or maybe he wants to send his kids to exclusive private schools.  But maybe not.

My only argument is that he should know that he has this choice from the start, so that he can make an informed decision based on his own values and not get trapped by lifestyle inflation.

More to come  (like 13 more reasons to cover) so stay tuned.