10 Commandments for Financial Independence – Podcast #206

Intro:
This is the White Coat Investor podcast where we help those who wear the white coat get a fair shake on Wall Street. We've been helping doctors and other high-income professionals stop doing dumb things with their money since 2011. Here's your host, Dr. Jim Dahle.
Dr. Jim Dahle:
This is White Coat Investor podcast number 206 – The 10 commandments of the White Coat Investor.
Dr. Jim Dahle:
bhay

This podcast is sponsored by Bob Bhayani at drdisabilityquotes.com. He's an independent provider of disability insurance planning solutions to the medical community in every state and a long-time White Coat Investor sponsor. He specializes in working with residents and fellows early in their careers to set up sound financial and insurance strategies.
Dr. Jim Dahle:
If you need to review your disability insurance coverage or to get this critical insurance in place, contact Bob at drdisabilityquotes.com. You can email him at [email protected] or you can call (973) 771-9100.
Dr. Jim Dahle:
A couple of things I want you to be aware of. We're giving stuff away today, the day this podcast drops. It’s the last day to apply to be a champion for your first year medical or dental school class. We are trying to give away a million dollars’ worth of books to first year students this year. This is the White Coat Investors Guide for Students. So, if you'd like to do that, today is the day to apply. So, email [email protected] and we'll get you lined up for that if your class doesn't already have a champion.
Dr. Jim Dahle:
We're also trying to give away some money to people that are educating their students, residents, peers, et cetera. These are financial educators. You can't be a financial advisor. You can't be a blogger or a financial blogger, podcaster, real estate investor to win.
Dr. Jim Dahle:
These are people who are doing this out of the goodness of their heart, who are teaching their students, teaching their residents about finances, whether they're running a course, whether they're giving lectures, however they're doing it. Whether they're doing it informally, please nominate these faculty members for this award.
Dr. Jim Dahle:
You can send nominations and it can be totally informal. Just a paragraph about why you think they should win to [email protected]. They get a nice certificate. They get some recognition on the blog. They get a thousand bucks. Hey, it's a nice little gesture to say thank you to those who are trying to stamp out financial illiteracy.
Dr. Jim Dahle:
If you haven't heard about it, you may have need for studentloanadvice.com, a White Coat Investor company, just started this month. If you have questions about how to manage your student loans, you can spend an hour with Andrew there and he can help you answer those questions. Should you refinance? When should you refinance? Which income driven repayment programs should you be in? How can you maximize your public service loan forgiveness? How to manage all that, et cetera? How to file your taxes, married filing separately, married filing jointly?
Dr. Jim Dahle:
All those questions he can help you walk through with an hour of your time and a few hundred dollars. You can find more information about that at student loanadvice.com.
Dr. Jim Dahle:
If you're new to the podcast, let me tell you a little bit about it. This podcast is for higher earners. Most listeners are physicians and dentists or they are trainees, but there are lots of tech people, attorneys, pharmacists, other health care professionals, entrepreneurs, executives, and small business owners who also listen.
Dr. Jim Dahle:
The only thing most of these people have in common is that they're in the upper tax brackets. Now let's be honest, 95% of personal finance and investing is the same for everybody, but that 5% is different for those of us in the upper tax brackets. And that's a lot of what we focus on here at the White Coat Investor.
Dr. Jim Dahle:
These people generally do not have an income problem, but often they don't have much wealth. They may even have a negative net worth with massive student loans. We help them navigate our increasingly complicated financial world and eliminate financial worry from their lives. We call BS on Wall Street and Main Street, financial shenanigans, and help you to get a fair shake on Wall Street.

Dr. Jim Dahle:
About half of our podcasts are interviews with selected guests and the other half are driven entirely by listeners. This show is about you and your questions. There's a new episode released every Thursday.
Dr. Jim Dahle:
We also started a new podcast this winter that shows up in the same feed called “Milestones to Millionaire”. In this much shorter podcast, which is released each Monday morning, we feature listeners who have become millionaires, who paid off their student loans, received public service loan forgiveness, or become financially independent or some other milestone.
Dr. Jim Dahle:
We celebrate with them and use their experience to inspire their peers and colleagues to do the same. You'll find the show notes for these podcasts show up on the blog at www.whitecoatinvestor.com along with all of our other resources.
Dr. Jim Dahle:
Today, we're going to talk a little bit about the 10 commandments of the White Coat Investor. And of course, these are not quite as good as those that were given to Moses, but I think that you will find them useful in your life.
Dr. Jim Dahle:
The first one is “Thou shalt realized, thou have a second job”. Most doctors and other high-income professionals aren't going to have any sort of a pension. So, if you want to retire on more than the social security, and I assure you that you want to retire on more than social security, you're going to need to have some sort of a retirement plan. You are a pension fund manager in our 401(k) world. If you don't manage it, nobody else is going to.
Dr. Jim Dahle:
Now, you can hire help. You can hire consultants, let's call them advisors. But at the end of the day, you are responsible for your own retirement, for your own financial independence. This is a second job in addition to whatever your main gig is, which I thank you for, don't get me wrong. I'm very appreciative that you do your main job because it's likely a very important one to our society and required a lot of sacrifice for you to do it. But you've got a second one. You've got to take care of your personal finances.
Dr. Jim Dahle:
All right, commandment number two. “Thou shalt do continuing financial education”. Everybody, no matter whether they choose to rely on a financial advisor or not, needs to do some initial financial education. That means reading three or four good financial books and maybe taking an online course, something like that. But you've got to become financially literate and get a written financial plan in place.
Dr. Jim Dahle:
That's your initial financial education. And after that, you've got to keep up with it. Now, I think the minimum to do that is to follow a good blog. Obviously, I'm partial to my own and to read a good financial book once a year. That's probably the minimum that it takes to do what I call continuing financial education. Now there are obviously courses and conferences and lots of other stuff you can do to keep up but that's the minimum.
Dr. Jim Dahle:
Number three, “Thou shalt save 20% of your income for retirement beginning of the day you leave your training”. Many companies and municipalities have underfunded their pension plans. The reason why is that they have an unrealistic expectation of ridiculously high future investment returns. And of course, they'd like to spend money on other stuff as well.
Dr. Jim Dahle:
Well, as individuals, we're not really any different. The personal pension plans of most Americans are also dramatically underfunded. And the reason why is we don't put enough money toward it. The average American probably needs to be put in 15% of their gross income each year toward retirement. Other savings goals are above and beyond that. College, a house down payment, a Tesla, whatever you want to buy is in addition to that.
Dr. Jim Dahle:
However, for a high-income professional, like a doctor who gets a late start, pays more in taxes, doesn't have as much of their income replaced by social security, you really need to bump that up to about 20% of gross. That's the minimum. That is if you want to retire at a normal retirement age. If you want to retire earlier, it's going to have to be a higher number. So, the commandment is 20%.
Dr. Jim Dahle:
All right. Commandment number four, “Thou shalt insure against catastrophe”. I'm amazed people get insurance completely wrong sometimes. They insure against all these little tiny things that are unlikely to happen, and they don't insure against the true financial catastrophes in their lives.
Dr. Jim Dahle:
Now let me tell you what the true financial catastrophes are. For most of us, disability is a true financial catastrophe. Most of our value economically speaking is our ability to turn our time into money at a very high rate. We have a specialized set of knowledge or skills, and we need to protect that. And the way you do that is disability insurance. Typically, own occupation, specialty specific disability insurance. Make sure you get some.
Dr. Jim Dahle:
Other financial catastrophes. Anybody else relies on that income besides you, you need some term life insurance and a lot of it, a seven-figure amount is what you ought to be buying.
Dr. Jim Dahle:
Liability is a big deal as well. That can be a financial catastrophe. I'm talking about professional liability, malpractice insurance for a physician or dentist, but also personal liability. The liability that comes with your auto policy, your homeowner’s policy, and you should probably stack a seven-figure umbrella policy on top of that.
Dr. Jim Dahle:
Accident or illness can be a financial catastrophe as well. You'd be amazed how quickly I can spend money in the emergency department on you after you have a car wreck. I can spend $10,000 in about 10 seconds. And if you end up in the ICU, it's probably going to be a six-figure bill. That's a financial catastrophe. You need to insure against it. The way you do that is health insurance.
Dr. Jim Dahle:
Any other expensive property you have, like your home should also have property insurance on it. If it burns to the ground, that's going to be a financial catastrophe. However, there are lots of things that aren't financial catastrophe. If you have to bail on your vacation, that's not a financial catastrophe. You don't need to buy vacation insurance. Likewise, it’s not a financial catastrophe if you drop your iPhone into the toilet. You don't need to buy insurance and all these little things in your lives.
Dr. Jim Dahle:
Home Depot makes a lot of money off selling you that insurance on the stuff you buy there. It's probably the biggest markup item they have in the store. But you really don't need insurance on your snowblower if you're making $10,000 or $20,000 or $30,000 a month, you can afford to go buy a new snowblower. You don't need to insure it.
Dr. Jim Dahle:
All right, commandment number five, “Thou shall not mix insurance and investing”. I don't know why, but almost every doctor I know has either been pitched a whole life insurance policy or has already bought one. And as a general rule, these sorts of products offer inferior insurance and inferior investments. It's just not a great combination. And most of the time, you're going to be better off separating them.
Dr. Jim Dahle:
Buy the insurance you need. I'm a big fan of insurance, but don't buy insurance that you don't need. Part of the issue is something like whole life insurance is it pays off no matter when you die, even if you die at age 92. But when you die at age 92, that's not a financial catastrophe. That's an expected event. You shouldn't need to insure against it. And so, you're in essence buying insurance, you don't need. And that's obviously very expensive.
Dr. Jim Dahle:
You can see these combined in all kinds of other products, annuities, index universal life. You can even buy an annuity or life insurance policy primarily to get a long-term care rider. But most of the time, these complex products are products that are designed to be sold, not bought. They pay high commissions and they are so complex that it's difficult for even someone well versed in the financial world to understand exactly what's going on. I assure you that complexity does not favor the buyer. It favors the seller.
Dr. Jim Dahle:
Number six, “Thou shalt favor a passive investing approach”. A wise man, Michael LeBeouf once said, “You should invest your time actively and your money passively”. I think there's a lot of wisdom there. But the studies have shown pretty clearly that passively managed mutual funds, index mutual funds over the long run outperform actively managed mutual funds, especially after tax.
Dr. Jim Dahle:
And if these professional mutual fund managers can't beat the market, what makes you think that you can do it on your own by analyzing stocks? Especially when your analysis generally consists of following along, whatever is being put onto Reddit, by random people running pump and dump schemes. It just doesn't make sense.
Dr. Jim Dahle:
The truth of the matter is that you need to make your money primarily with your day job, carve a significant portion of it out and invested in a wise way. A way that is passive, that is likely to give you market returns over the long-term with minimal expenses, minimal taxes, et cetera.
Dr. Jim Dahle:
Number seven, “Thou shall hire only competent advisors”. There are two real problems we have out there with financial advice. The first one is that most financial advice is bad. Most of it is being given by people who are not actually any sort of fiduciary, highly trained professional financial advisors. They are not real financial advisors, despite being able to legally call themselves such. That's the biggest problem. There's just a lot of bad advice out there. And it is really product sales masquerading as financial advice.
Dr. Jim Dahle:
The other problem is that even good advice is often way too expensive. You don't want to overpay for good advice. The typical going rate for financial planning and investment management is a four-figure amount per year. If you're paying more than $10,000 a year, you can almost surely get just as good or better advice for less money. It's still a little expensive stuff though. So, if you can learn how to do this yourself, competently, you're going to save that money. And that of course compounds over time.
Dr. Jim Dahle:
So, when you go to hire a competent advisor, you're looking for someone with high level credentials, right? A CFP, a CFA, a CHFC, or if they're coming from the accounting world, a PFS – Personal Financial Specialist designation is what you want to see. You want to make sure the fees are reasonable. You want to make sure they have a fiduciary duty to you. You want to make sure they don't for some bizarre reason, think their crystal ball isn't cloudy. If their plan for you relies on their ability to predict the future, that's probably not an advisor you want.
Dr. Jim Dahle:
And of course, you want an advisor that has a bias toward low-cost passive investments because it has been shown quite clearly in the academic literature that those are the winning investments.
Dr. Jim Dahle:
All right, number eight, “Thou shall minimize expenses and taxes”. It's amazing how much lower your returns can be once you apply investment expenses and taxes. This is something you need to always be cognizant of. You need to understand what the fees are on your 401(k) and your Roth IRA and your taxable accounts and any sort of real estate deal you get into. You need to really have those down and understand what's too much to pay and what is not
Dr. Jim Dahle:
Also, your biggest expense is often taxes. So, you need to learn about all of the tax protected accounts that are available to you. 401(k)s, 403(b)s, 401(a)s, 457(b)s, individual 401(k)s, SEP IRAs, simple IRAs, traditional IRAs, Roth IRAs, HSHS, 529s, ABLE accounts if you have a disabled kid, an education savings account.
Dr. Jim Dahle:
There are all these accounts out there available to you that allow you to reduce your tax bill now, to reduce the tax drag on your investments and most of the time facilitate your estate planning and asset protection at the same time. These are great ways to invest. Take advantage of them, know the rules. And for many of you recognize that you can even have more than one 401(k). And yes, if you fund it indirectly or through the back door, you can still use a Roth IRA.
Dr. Jim Dahle:
Commandment number nine, “Thou shalt minimize debt and manage necessary debt well”. I'm amazed how badly doctors do at managing debt. And I think part of it is because they get used to living on debt while they're in medical school for years. Then they carry this debt throughout a long residency of three to seven years. And by that point, they're kind of debt numb. And so, they really kind of need a wake-up call to get rid of that debt at a certain point.
Dr. Jim Dahle:
Well, let this be your wake-up call. If you've been carrying debt around thinking it's no big deal, you will be amazed how much more quickly you build wealth, how much more happy your life is and what additional risks and career decisions you decide, because you don't have to make a bunch of debt payments every month. I'm not saying you can't have debt for anything, but chances are good if you're like most of us here in America, you're carrying way too much debt and paying way too much for it.
Dr. Jim Dahle:
Credit cards aren't for credit, neither are for convenience. If you're not paying them off at the end of every month, you've shown that you really can't be trusted with a credit card. Stop doing that. Buy your automobiles, RVs, boats, furniture, and vacations with cash. Yeah, you can put it on a credit card, pay it off at the end of the month, but don't carry a balance on it.
Dr. Jim Dahle:
Try not to have a mortgage bigger than twice your annual income. Minimize your mortgage interest by putting 20% down and refinancing when rates drop using a 15 year instead of a 30.
Dr. Jim Dahle:
Pay off your high interest student loans. Consider paying off your low interest student loans as well. A lot of times people are locking themselves into jobs they don't like just because they have student loan payments. Refinance those loans anytime you can get a lower rate so long as you're not attempting to achieve some sort of government forgiveness program.
All right, number ten, “Thou shalt protect the assets, plan estate and stay the course”. And these typically come after getting your investment plan into place, but they're just as important. If you are abandoning your plan every time the market turns down or every time the market gets frothy, as it has been in 2020 and 2021, you may regret that. You need to get a plan that you can stick with through thick and thin.
Dr. Jim Dahle:
You need to also make sure that you've done the reasonable, easy, inexpensive things to protect your assets. Things like maxing out retirement accounts, titling your home and an investment accounts as tenants by the entirety, if you're married and your state allows that. And making sure that you're not just making these unforced errors when it comes to an asset protection plan. Make sure you have insurance in place. That is the first line of defense.
Dr. Jim Dahle:
Of course, you want to make sure you have a will, maybe a trust, but go through all your beneficiaries for your insurance policies and for all of your accounts and make sure they're the right beneficiaries. If you've gotten divorced in the last year or two, you probably need to change your beneficiaries. So, make sure you pay attention to those details as well.
Dr. Jim Dahle:
All right, those are the 10 commandments of the White Coat Investor. I hope you find that useful.
Dr. Jim Dahle:
On most of these episodes, we also go through a few reader questions. We have them leave those on our Speak Pipe and it's a chance for them to record their questions. We play them here on the podcast and then I answer them. So, let's take our first one. This one comes from Ricky off the Speak Pipe. He's asking about emerging markets investments.
Ricky:
I was wondering if we could do a really deep dive into emerging markets and if that should be part of my asset allocation. For myself, I'm a hundred percent equities. I really was able to tolerate the grown of bear and was 80/20 at that time and went to a hundred percent equities because it didn't really phase me.
Ricky:
I also added a 10% small cap value to my portfolio, but I'm also 65% total U.S. and also 25% international. Among that total international there's a ready 30% that is in emerging markets. I do want to boost my return as much as possible on a risk adjusted basis. I'd like to boost as fast as possible to, or as long as possible so my wife could actually maybe stop working.
Ricky:
The emerging markets I know is less correlated to the rest of the international as well as the total U.S. Although will that really decrease risks in terms of not just decreasing volatility, but actual what you're exposed to emerging markets, I can tolerate volatility. So, I don't really require the difference in correlation. I know that emerging markets have a small value factor compared to other more developed markets. But also, it seems like you might be increasing risk. In a lot of emerging markets mostly is China invested.
Ricky:
There's also the inflation – deflation – confiscation risk of these governments. Also, currency risks. I was wondering if it's really worth adding any to really get a premium on a risk adjusted basis.

Dr. Jim Dahle:
Okay. So, we're talking about emerging markets stocks here. What does that mean? Well, let's take a look at what is in the Vanguard emerging markets stock index fund. If you look at that, you will see that 44% of the fund is invested in China. And another 17% is invested in Taiwan. Now whether Taiwan is part of China or not depends on your political perspective, but the bottom line is more than half of the fund is in China and Taiwan.
Dr. Jim Dahle:
So, anytime you were over-weighting in emerging markets in your portfolio, what you're really doing is making a bet on China. And so, if you think China stocks are going to outperform the rest of the world? Sure. Overweight emerging markets. If you don't think so, if you think they're going to underperform, underweight emerging markets. If you have no idea, like I do, just buy them at the market weight.
Dr. Jim Dahle:
And so, I have a specific emerging markets allocation in my portfolio. I own all the emerging market stock, but I do so through a total international stock market index. And what you get when you do that, when you have that sort of a fund is you get a fund that is approximately, I think it's 26% or 27% emerging markets right now. The rest is in Europe and in the Pacific rim, mostly Japan. And then of course the rest in emerging markets.
Dr. Jim Dahle:
So, is there a premium for tilting your portfolio toward emerging markets? Well, this is a fascinating question because you have two options to figure this out. The first one is you look back at the past and see if there was a premium in the past. And given their relative under-performance against U.S. stocks over the last 15 years, you're probably not going to see one. That's a totally different question then as to whether you're going to see a premium for tilting your portfolio toward emerging market stocks going forward.

Dr. Jim Dahle:
So, I think everybody agrees that the Chinese stock market is going to become a larger portion of the overall world stock market over the next 10 or 20 or 30 years. Of course, we also thought that about Japan back in the 80s, and once it peaked that hasn't necessarily been the case.
Dr. Jim Dahle:
But most people agree that China is probably going to be a bigger part of the world stock market in the future than it is now. That doesn't necessarily mean the returns are going to be higher though. There are a lot of unique risks in emerging market countries that don't exist in developed world countries, much less in the U.S. And so, you should be cognizant of that.
Dr. Jim Dahle:
I think for the most part, most U.S. investors are not equal weighting their portfolio across to all equities in the world. Most of them have a significant tilt toward U.S. equities. And I think that's fine, especially if you plan to spend dollars in your retirement rather than another currency.
Dr. Jim Dahle:
But it's interesting, if you look at the performance over the last 15 years of the us stock market, you'll see that the average return has been 10.2%. And if you look at the performance of emerging market stock over the same time period, the return has been 5.74% per year. So, it is significantly lower, not quite half, but pretty low.
Dr. Jim Dahle:
I would not however make the mistake of assuming that's going to be the case going forward. It would not surprise me one bit to have emerging market stocks outperformed the U.S. stock market over the next 10 years. In fact, if I had the bet, I would probably bet that way. Luckily, I don't have to bet. My financial plans don't require me to know whether emerging markets are going to outperform the U.S. over the next 10 years in order to reach my financial goals.
Dr. Jim Dahle:
And I would encourage you to set up a financial plan such that you don't have to know that either. You talk about wanting to have your spouse stay home? The best way to get there reliably as close to guaranteed as possible is to stick with a reasonable investment plan and fund it like crazy. If you really want to reach a goal faster, the better way to do it is usually to earn and save more money rather than to try to take on more investment risk. It just doesn't move the needle nearly as much.

Dr. Jim Dahle:
So, I own emerging market stocks. I think it's a great asset class. I think it belongs in your portfolio. For the vast majority of people, I would be a little bit hesitant to really put a huge amount of your portfolio into it. So, in my case about one third of my stocks, so about 20% of my portfolio is in international stocks and apparently about 26% of that is in emerging market stocks.
Dr. Jim Dahle:
So, what does that work out to? I guess about 5% of my portfolio is in emerging market stocks. If you want to put 10% in yours, I don't think that's crazy. If you want to put 25% of your portfolio into emerging market stocks, I think you're probably making a mistake.
Dr. Jim Dahle:
All right, let's do our quote of the day. This one comes from Larry Swedroe, who said, “Anyone who says active managers can win, should wear a t-shirt that says ‘I can't add’.” And I agree with that. Obviously on average active managers are not going to win. And that certainly is not the way to bet, especially over the long-term and especially in a taxable account. Fewer than 10% of active managers are likely to beat an appropriate index fund over the long-term in a taxable account.
Dr. Jim Dahle:
All right, let's take our next question. This one comes from Jackie. She wants to talk about HSA contributions.
Jackie:
Hi, Dr. Dahle. This is Jackie from Seattle, and I have a question about HSA contributions. My question regards the two-month lapse that I will be covered under a high deductible health plan between finishing my chief year and starting at a new employer as a full-time attending.
Jackie:
Currently, I am a chief in internal medicine and I'm covered by my work group plan. My husband is covered both on my plan, and then it has double insurance on a high deductible plan at work. We can't currently contribute to an HSA because he's covered under my work plan, additionally, given some medical needs that we need the additional insurance.
Jackie:
However, there will be a two-month lapse where I will be covered under his high deductible plan until I start at my new employer. My question is if I'm on this high deductible plan with him for two months, is that long enough to qualify to be able to make an HSA contribution? If so, I would love the opportunity to contribute that $7,500 to that account. Thank you for what you do. I have been a fateful listener.

Dr. Jim Dahle:
Great question, Jackie. I hope Seattle is treating you well up there. You should be able to contribute, but it's not going to be $7,000. It's going to be two months divided by 12 months, times $7,000. And yeah, you could put that into an HSA, I guess if you wanted to.
Dr. Jim Dahle:
I don't know that I would necessarily bother. I think it's a lot of hassle for very little bang for your buck, unless your new plan, when you get to your new employer is going to involve you guys being covered by a high deductible plan. You didn't mention what your new health insurance plan was going to be, but if it's going to be a high deductible plan, then sure, you might as well get started on using an HSA.
Dr. Jim Dahle:
And I'd encourage you to do that. I like high deductible health plans. I think they're great for docs for the most part. We can afford to meet the slightly higher, or dramatically higher sometimes out of pocket expenses. And a lot of times we have the health system savvy to be able to know when we really need to spend dollars on healthcare and when we don't. And so, it can be a good option for docs.
Dr. Jim Dahle:
But if you're going from a regular low deductible plan to a low deductible plan at your new job, I don't think I'd bother with messing around with this. It's a lot of hassle for very little real benefit there. I mean, what are you going to be able to get in there? 800 bucks or a thousand bucks or something like that. It's probably not worth the hassle to deal with an HSA in that situation.
Dr. Jim Dahle:
But really get the details on your new plan and what's your plans going to be once your new employer plan kicks in. It might make sense for you to just move onto your husband's plan completely and get them to pay you a higher salary instead of providing you with health insurance benefits. Whether the employer can actually do that or not, obviously varies by the employer, but that's what I would advise you to do.
Dr. Jim Dahle:
All right. Our next question comes from Cam who’s apparently dealing with a tax audit. That doesn’t sound very fun. Let’s listen.

Cam:
Hi, Dr. Dahle. Thanks for all that you do. I recently received a letter from the IRS and unfortunately it was not a Christmas card. It was a notification of a tax audit. I'm wondering if it is best just to pay a professional tax audit defense from the beginning, or should I try and do this myself? I feel my taxes have been paid fairly, but as with most legal matters, it is better to hire a professional. I'm wondering if this is the same kind of circumstance. Any advice would be greatly appreciated. Thanks.
Dr. Jim Dahle:
All right. Well, I'm sorry to hear about your audit to start with. Let me talk just briefly about audits. It's not the end of the world to get an audit. It's not the end of the world to get a letter from the IRS. I probably get a letter from the IRS about once a month. It happens all the time. And the reason why is my tax situation is rather complicated. Between corporate income tax returns and personal income tax returns and all the forms that you got to send in for employees, et cetera. And it's not unusual at all for me to make an error either.
Dr. Jim Dahle:
What I've learned over the years, however, is that it's not unusual for the IRS to make an error either. So, we're about 50-50 when they send me a letter, as far as who's made the error. So, don't assume that this is some terrible thing to start with just because you get a letter from the IRS.
Dr. Jim Dahle:
Secondly, some audits are really just them asking for a little bit more documentation. The state might send you something like this. I got one the other year asking about a 529 credit that I had claimed on my state income taxes. And it didn't match up with the form they had gotten from the state 529 people. Well, the state 529 people send them the wrong form. Well, it was the right form, had the wrong amount on it. So, I just had to get the state 529 people to fix their form and send it to them. It really wasn't a big deal. I certainly didn't need a big-time tax audit defense professional attorney, accountant, et cetera, to defend me in that case.
Dr. Jim Dahle:
If you are paying somebody else to do your taxes, to prepare your taxes, that's the person who should be dealing with this right now. That's part of the reason why you're paying them is to deal with these sorts of problems. And so, if you're not doing your taxes yourself, yeah, get that letter into the hands of your tax professional, let them deal with it.

Dr. Jim Dahle:
If you are doing your taxes yourself, which isn't necessarily a bad thing, especially if you have a relatively simple tax situation. I've done my taxes myself for many, many years, including some fairly complicated returns. It's not that hard most of the time. As long as you are doing your very best to try to pay the taxes you owe, they're not going to throw you in jail if you make a mistake. It sounds to me like this is the situation you're in.
Dr. Jim Dahle:
So, I would look at what the audit is asking for. If they're looking for a little more information or they think you did your calculations wrong or whatever, and they're telling you, “You owe another a couple thousand bucks”, you may want to look back at it, maybe they are right, look at your calculations. If you just obviously screwed up then say, yeah, you're right. And send them the check and be done with it.
Dr. Jim Dahle:
But if you're not sure exactly what's going on, or you think they're wrong, or they're wanting to audit everything, this is going to be a big deal audit, sit down across from the auditor, then sure, it wouldn't be a bad idea to at least go talk to one of these professionals. Whether it's an accountant or whether it's an attorney.
Dr. Jim Dahle:
And talk to them about having to go over your taxes, pay them a few hundred bucks to give you a little bit advice about the situation. Maybe it's really simple and you can still handle it yourself. Maybe you're better off paying them a few thousand dollars to take care of it for you. That really comes down to the situation.
Dr. Jim Dahle:
Now, if you're in tax trouble, if you owe tens of thousands of dollars, you've been doing your taxes wrong, or the IRS thinks you've been evading your taxes is time to go get a pro. If you're in that situation, go get somebody in your corner that knows what they're doing, that's experienced no matter what they cost and get this taken care of.
Dr. Jim Dahle:
The last creditor you want to have is the IRS. They have powers that are not available to most of your creditors, like seizing assets, seizing salary, those sorts of things. So, don't mess with the IRS and play around with them when you really are in trouble, don't ignore the letters they're sending you and get somebody that can give you good, solid advice in your corner. Hope that's helpful, Cam. I hope everything will go as well. Let us know what happens in the end.

Dr. Jim Dahle:
All right. So, for those of you who have been on the front lines of COVID, I hope you are feeling a lot less pressure. Now we're recording this in March a few weeks ago, just because we needed to get it done a little bit in advance, but the other day I was on shift and the hospitalist told me there were no COVID patients admitted in our hospital, which is pretty exciting. I think a lot of that is due to the vaccination efforts. We're vaccinating the people that are most likely to be admitted to the hospital first. And so, I think that's really awesome to see that happening.
Dr. Jim Dahle:
But just the case counts at this point are dropping rapidly in Utah. At the time we're recording, this is actually late February we're recording this, we're down about 90% from our peak. And it looks like that sort of a thing is happening all across the nation. So, I hope that trend has continued, between the time we record this and when this podcast runs.
Dr. Jim Dahle:
But congratulations to those of you who have really put in a lot of time and effort to keep the rest of us safe and healthy during this pandemic. And thanks for what you do. I know it costs a lot of docs a lot of business, a lot of money due to this pandemic. And it was a real sacrifice to go to work and worry about bringing home potentially fatal disease to your family every day. So, thanks for what you do.
Dr. Jim Dahle:
All right. Let's take our next question from Andy, who is thinking about investing in index funds. He wants to talk about investing in index funds.
Andy:
Hi, Dr. Dahle. I currently max out my 401(k) every year and take advantage of the employer match. I also max out mine and my wife's backdoor Roth IRAs, and my children's 529 accounts. I make around $250,000 a year and I'd like to start investing in index funds. We already have an eight-month reserve account in place for emergencies in case initiative arise.
Andy:
I want to be mindful of any tax implications from the gains in index funds. And could you advise on how to best prepare on paying taxes on any capital gains that I would receive at the end of the year from investing in index funds?

Andy:
I like to keep my payment to the tax man low. So, every year I only get about $1,000 to $2,000 back from the IRS because I monitor my deductions very carefully. Thanks much for your advice regarding this matter.
Dr. Jim Dahle:
A lot of good questions there, Andy. Forgive me for reading between the lines. I tend to do this a lot. I get questions like yours and the way the question is asked reveals a few things to me that I think we ought to clarify as part of the answer. I can just answer the question you asked, but I think I probably I'll also answer some of the questions maybe you should have asked.
Dr. Jim Dahle:
First let's address something you mentioned about tax withholding. Remember that what is withheld for taxes during the year is completely different from what you actually owe in taxes.
Dr. Jim Dahle:
April 15th is basically just the date that you settle up with the government. If you ended up having more withheld or paid more in quarterly estimated payments, then you actually owe in taxes, they send you a refund as a result of filing your tax return by April 15th. If you have not had enough withheld or had enough paid in quarterly estimated tax payments to cover your tax bill for the year, then you have to send them a check on April 15th when you file your tax return each year.
Dr. Jim Dahle:
But those two numbers are totally separate. What you owe in taxes, is actually withheld. So, keep that in mind. It's great if you can estimate it very closely, I envy you that. I can't get anywhere near the right tax bill each year. My tax situation is just entirely too complicated. My income is too variable. I'm not even close. I don't think I've been within five or six figures of having the right amount paid in taxes in the last couple of years.
Dr. Jim Dahle:
And so, a lot of it is a guess for many of us with variable income. And sometimes we have to write pretty big checks come April 15th, and sometimes we get pretty big checks back. So, the goal for that is to stay in the safe harbor so you don't have to pay any penalties and interest. You'd still obviously have to settle up and pay any taxes you owe but the goal is to avoid penalties. And the way you do that is by staying within the safe harbor.

Dr. Jim Dahle:
All right. So, let's ignore all of that a little bit and just talk about the taxes you actually will owe from the way you invest in your taxable account, rather than trying to figure out the whole withholding piece.
Dr. Jim Dahle:
It's also important to distinguish between accounts and investments. And I'm not sure you have this entirely clear. Think about accounts as luggage. And account is a trunk, a backpack, a suitcase, a briefcase, whatever, a carry-on bag. For every different kind of trip, you go on, there might be a different type of luggage that is appropriate for that trip.
Dr. Jim Dahle:
But you can put any type of clothing you want into any type of luggage you want. You can put a tuxedo or a swimsuit or a ski jacket into any of those types of luggage. Think of the clothing as investments, think of the luggage as accounts.
Dr. Jim Dahle:
So, you mentioned you have a 401(k) and a Roth IRA, and it sounds to me like you now want to invest in a taxable account, which is fine. A taxable non-qualified brokerage account is where you have to invest once you've maxed out all of your tax protected accounts.
Dr. Jim Dahle:
Okay. So now the question comes, what should you invest in within that taxable account? And luckily your chosen investment index funds, especially broad-based low-cost index funds aren't excellent holding for your taxable account. In fact, the vast majority of my taxable account is composed of index funds.
Dr. Jim Dahle:
So, I think it's a great thing to put in a taxable account. And there's a few reasons why. The main one is that aside from being excellent investments, they are very tax efficient. For example, the Vanguard total stock market index fund has not distributed capital gains since 2001. It's been 20 years and they haven't sent you any capital gains. This is something that most actively managed mutual funds send you every year. Sometimes it's a substantial portion of the value of the fund.
Dr. Jim Dahle:
I know of one aggressive fund has pretty high turnover, about 125% a year that has had capital gains distributions as high as 20% of the value of the fund. So, if you've got a hundred grand invested in this fund, they might send you $20,000 in capital gains that you got to pay taxes on in a given year. That is not a good holding for a taxable account.
Dr. Jim Dahle:
On the other hand, the total stock market index fund only has turnover of about 5% a year. And so, it distributes a very few capital gains. The Vanguard index funds are also particularly tax efficient because they have an exchange traded fund share class that allows them to flush some of the capital gains out of the fund instead of distributing them to the fund investors.
Dr. Jim Dahle:
So excellent investments, the Vanguard total stock market fund, the Vanguard total international stock market fund. In addition to those benefits that you get with the domestic fund, you also get a foreign tax credit with the international fund, which helps make up for the fact that its dividend yield is a little bit higher than the domestic fund.
Dr. Jim Dahle:
So really the only distributions assuming you don't actually sell these funds, the only distributions you get are dividends that come each year. It's around 1.8% to 3% is what the dividend on these sorts of index funds are. They're qualified dividends almost entirely. And so, you'll add your qualified dividend rates 15%, 20%, 23.8% if you count the Obamacare tax, but pretty tax efficient investments.
Dr. Jim Dahle:
Now you can make them even more tax efficient by avoiding ever selling those funds because when you sell them, obviously you're going to pay long-term capital gains. If you've held it for at least a year, you're going to pay long-term capital gains taxes on the sale of those investments. So, you want to avoid doing that if you can.
Dr. Jim Dahle:
There are a few ways you can avoid doing that. One, if you give to charity every year, instead of giving cash, you can give these appreciated shares of investments. You get the full deduction for the full value of the contributed shares. You don't pay any capital gains taxes on the gains, neither does the charity. It’s really a great deal and you can turn around the next day and buy those shares right back. There's no wash sale rule when it comes to donating shares to charities. So that's one way you can avoid selling them.
Dr. Jim Dahle:
The other way you can do it is by dying. If you die, your heirs get a step up in basis at death. And again, nobody pays the capital gains taxes on those investments. Now you're probably actually investing to be able to spend more money later down the road. And so, you're probably going to sell them at a certain point, but hopefully you're in a lower capital gains bracket at that point. And so, you pay less in taxes on it. Maybe you've been able to tax loss harvest as you went along. So those can offset some of those gains and that can help you to invest very tax efficiently in a taxable account.
Dr. Jim Dahle:
So, I think you're doing the right thing. Once you've maxed out your retirement accounts, go ahead and invest in a taxable account. Do so in a tax efficient manner, don't turn your investments in there. Don't pick investments that churn themselves and you can keep your tax bill down and keep your money working for you. I hope that's helpful to you.
Dr. Jim Dahle:
All right. So, by the time you're listening to this, it's going to be mid-April. And if you're trying to get a hold of me for the next month, you're probably going to run into some pretty severe difficulties. And the reason why is I'm going to the Grand Canyon. So, I'm going to go run the river for a few weeks.
Dr. Jim Dahle:
So, don't be surprised if you're sending me emails that you're not getting the response that you're used to getting. I'll get back to you eventually, I assure you, but there's going to be perhaps the longest delay we've had since I've been doing the White Coat Investor beginning in 2011.
Dr. Jim Dahle:
All right, let's take one more question from Sundar. This one's about a Roth 401(k) to a Roth IRA rollover.
Sundar:
Hi, Dr. Dahle. My employer has been allowing us to execute the mega backdoor Roth maneuver since last year. The way it's set up for us is that if I want the money to end up in the employer sponsored Roth 401(k), they will automate it for us. If I wanted to end up in my Roth IRA, however, I will have to call them every paycheck and move my after-tax contributions over, before they make any gains.
Sundar:
To do this I have been calling Fidelity every paycheck. And being on hold for something like 20 minutes every paycheck has been annoying, painful, and against my principle of automating my savings as much as possible.
Sundar:
I recently learned that I'm able to automatically contribute to the Roth 401(k), but periodically roll it over into my Roth IRA. This might mean less phone calls for me, but is there something I need to look out for here? What I have to pay taxes on the gains when rolling over from a Roth 401(k) to a Roth IRA? What I have to be aware of some time period to wait or something like that, that's different from the regular Roth IRA withdrawal rules? I understand this rollover will not be considered a withdrawal for tax and penalty purposes. Is that correct? Thank you very much, doctor.
Dr. Jim Dahle:
What a great 401(k) you have, that you have all these options. Most people's 401(k)s they're happy that they can even make a Roth 401(k) contribution for their employee contribution, but you can apparently not only make after tax contributions, but you can either pull those out into a Roth IRA or do an implant conversion into your Roth 401(k). You have every possible option available to you. That's awesome. And here you are complaining about having to be on the phone to Fidelity.
Dr. Jim Dahle:
Well, there's a few ways you can avoid doing this. One, you can put all that money in there at once and only get on the phone with Fidelity once and have that money in your Roth IRA. There's nothing that keeps you from writing a check into the 401(k) for whatever you want to do. It's probably what? $38,500 I'm going to guess is how much you want to do a mega backdoor Roth with every year. You can write that check once into the 401(k), and then you can subsequently do a rollover out into your Roth IRA. That might be a best option for you. One phone call.
Dr. Jim Dahle:
Two, you can just do the in-plan conversions. This sounds like it's a pretty awesome 401(k). What's wrong with using the Roth 401(k) instead of getting it into your Roth IRA, unless you're trying to do some sort of an investment in it that requires a self-directed Roth IRA. Your Roth 401(k) is probably just as good as your Roth IRA. You've probably got some great investing options there and probably pretty low fees, if this 401(k) really has all these options that you're mentioning. So maybe you should just do that. That's what I do now with the White Coat Investor 401(k) is we just leave it in the plan.
Dr. Jim Dahle:
The other benefit is in many states, a 401(k) has significantly more asset protection than an IRA does. So check your state's asset protection laws and see if a 401(k) gets more asset protection than an IRA. If so, you probably want to use the 401(k).
Dr. Jim Dahle:
The other thing to keep in mind is 401(k)s have some different estate planning and RMD rules. For example, once you separate from the company, you can pull money out of your 401(k) starting at age 55 without any penalty, but you got to wait till age 59 and a half for an IRA. So that's one reason you might want to use the 401(k) instead.

Dr. Jim Dahle:
However, keep in mind. After age 72 Roth 401(k)s have required minimum distributions and Roth IRAs do not. So, there's a few slight differences there where you might prefer one over the other.
Dr. Jim Dahle:
Obviously moving money from a Roth 401(k) to a Roth IRA is not a taxable transaction. There's no tax due for doing that. And so, I wouldn't let that play into the part at all. Whether you take that money from the after-tax account into the Roth 401(k) or into a Roth IRA, the tax consequences are going to be exactly the same.
Dr. Jim Dahle:
So, at any rate, congratulations on having such a great 401(k). I hope you can use it to maximize your retirement benefits down the road. I'm sorry there's some hassle involved. This is actually a big problem for most White Coat Investors. We just have multiple investing accounts and it's hard to really automate our investments as much as we would like to.
Dr. Jim Dahle:
But on the plus side, we're often able to save dramatically more money than people who are only investing in a Roth IRA or only investing in a 401(k) because that's all the money they're saving any given year. So, I guess we should count our blessings as far as that goes.
Dr. Jim Dahle:
This podcast is sponsored by Bob Bhayani at drdisabilityquotes.com. He's an independent provider of disability insurance planning solutions to the medical community in every state and a long-time White Coat Investor sponsor. He specializes in working with residents and fellows early in their careers to set up sound financial and insurance strategies.
Dr. Jim Dahle:
If you need to review your disability insurance coverage, or just need to get this critical insurance in place, contact Bob today by emailing [email protected] or by calling (973) 771-9100.
Dr. Jim Dahle:
Remember today is the last day to register as a champion for your class whitecoatinvestor.com/champion for details. And also, you have until April 30th to nominate your favorite financial educator as the doc that's doing this without getting paid for it, educating their peers. Last day is April 30th. So, email your nomination to [email protected]. If you need studentloanadvice.com, be sure to check out that new service as well.
Dr. Jim Dahle:
Thanks to those of you who have left us a five-star review on the podcast. That really does help spread the word to others and for telling friends about the podcast. A lot of our growth has been just word of mouth.
Dr. Jim Dahle:
Our most recent review came from EDJRX, who said, “Lots of valuable information! Happy to have found your podcast in 2020. I came across it while listening to other financial podcasts and have learned so much on here and on your website. I’m not a physician but work in healthcare. Empowered by the information you provide as I try to reach financial independence. Thank you, Dr. Dahle!” I appreciate that five-star review.
Dr. Jim Dahle:
Keep your head up, keep your shoulders back. You've got this and we can help. We'll see you next time on the White Coat Investor podcast.

Disclaimer:
My dad, your host, Dr. Dahle, is a practicing emergency physician, blogger, author, and podcaster. He’s not a licensed accountant, attorney or financial advisor. So, this podcast is for your entertainment and information only and should not be considered official personalized financial advice.