It is Continuing Financial Education (CFE) week once more here at The White Coat Investor. November is that time of year when I put down my daughter's Percy Jackson books and pick up a few financial books. It is also the time of year that I encourage you to do the same. Now if you're doing CFE, that means you must have done some IFE at some point- Initial Financial Education. I see three ways to get this and it usually culminates in you obtaining a written financial plan you understand and can follow.
The first, most expensive but least time consuming, is to hire a good financial advisor to help you draft up a financial plan you can follow. At hundreds of dollars an hour or thousands per year, this is effective, but expensive.
The second way is to take my online course, the somewhat mistitled Fire Your Financial Advisor (since the first section teaches you how to find and interact with a good financial advisor.) At just $499, this is dramatically cheaper than the thousands an advisor would cost you, and unlike the advisor, comes with a one-week, no-questions-asked, 100% money-back guarantee. As usual, we're doing a sale this week. If you buy this course (and obviously don't return it), we're going to give you 12 bonus hours of material from the 2018 Physician Wellness and Financial Literacy Conference (William Bernstein, Jonathan Clements, Mike Piper etc), a $300 value, absolutely free. This good of a deal is never going to be offered again, and it's only good through next Monday (December 2nd).
The final way is the way I became financially literate. I read books and spent hours on internet forums and blogs. It's super cheap, but does require a significant amount of time and effort. If you want to go down this path, I think you should read one book from each of the following categories (and I include a suggested book for each one.)
- Personal Finance: The Only Investment Guide You’ll Ever Need
- Investing: The Investor’s Manifesto
- Behavioral Finance: How to Think About Money
- Doctor Specific: The White Coat Investor: A Doctor’s Guide to Personal Finance and Investing
Money for The Rest Of Us
It is also traditional that I review a handful of books this week, but instead of just reviewing them, I thought this year I would simply take some ideas from the book and discuss them. A review copy of Money for the Rest of Us was sent to me by the author, J. David Stein, who does a podcast by the same name that was recommended to me. As long term readers know, I'm not a huge podcast listener (or even blog reader) as I prefer to learn from books and forums. But I listened to a few of the podcasts and read the book on the plane this month. The backbone of the book is 10 Questions To Master Successful Investing. The book, like many financial books, is a little on the dry side, but I thought the questions were excellent, so I'm just going to talk about them. If you want to have Mr. Stein expound on the questions, then go buy the book already.
Stein says in the introduction that the main goal of the book is “to take a step back and show you how to evaluate investment opportunities so that you can decide whether you should even be trading options, building out a real portfolio, or trying to beat the stock market by investing like Warren Buffett.”
The Ten Questions
Regular readers know I'm a sucker for lists, and many of you are too based on which of my posts are most popular. Let's get to it.
# 1 What Is It?
We have all heard that you shouldn't buy something that you don't understand or that you can't explain to a layman. That's what we're talking about here. Stein says the only reason you should buy an individual stock rather than an index fund is because you believe the price is too low. Then he goes on to explain how despite spending his career on Wall Street, he still doesn't feel like he can really figure out if the price is too low. Guess what? You can't either. If you could, you'd be running a billion-dollar hedge fund rather than seeing patients.
# 2 Is it Investing, Speculating, Or Gambling?
I like this question. He defines investing like I do–buying something has a greater likelihood of being profitable than unprofitable, i.e. a bet with an expected positive return with reasonable statistical reliability.” These are generally the stocks of profitable businesses, interest-paying bonds and CDs, and rent-paying real estate. Speculation is an opportunity where the investment outcome is highly uncertain. Think Bitcoin. Maybe you become rich in 6 months or maybe you go broke. But let's be honest, nobody really knows and it isn't going to produce any useful products or kick off any sort of cash distributions. Gambling is an opportunity that has a greater likelihood of losing money, you know like what you may do in a slot machine at WCICON20 or buying binary options.
# 3 What Is the Upside?
Know where your return is coming from. There are only a few drivers of returns — cash flow, cash flow growth, a change in valuation, leverage, credit quality, term, etc. While it is good to know what an investment returned in the past, be very careful projecting historical returns into the future. We tend to become most interested in an investment with historical returns, especially recent historical returns, that are higher than the average expected return of that investment.
# 4 What Is The Downside?
Good investing is far more about controlling risk than seeking returns. The downside of an investment consists of its maximum potential loss AND the personal financial harm caused by that loss. That's one reason some investments are only available to accredited investors — the personal financial harm of a complete wipeout is much lower. Risk is more than just volatility, it is the idea that “more things can happen than will happen.”
“Contemplate the wide range of potential outcomes, acknowledge there are outcomes we haven't considered (i.e. surprises), and then act based on what we expect to happen…Risk management should be a process of dealing with the consequences of being wrong.”
# 5 Who is On The Other Side of the Trade?
When you buy or sell an investment, there is somebody who thinks you're wrong. That's who you're buying from or selling to. By knowing who is selling you the investment, you can avoid financial instruments where success is dependent on knowing the future and/or outsmarting other investors. Basically, buy index funds.
# 6 What is the Investment Vehicle?
There are lots of vehicles out there. Investment vehicles are things like annuities, mutual funds, ETFs, and private funds. It is critical to understand their liquidity, costs, structure, and pricing. The vehicles themselves often add risks or costs above and beyond the underlying investments. For example, ETFs may be subject to flash crashes, annuities have mortality charges, and closed-end funds are subject to selling at a discount to the underlying asset value.
# 7 What Does it Take To Be Successful?
Successful portfolios have a diversified mix of dependable return drivers that were identified beforehand. It is important to not confuse strategy with outcome. A bad decision can lead to a good outcome and vice versa. You would be foolish to think you can be a successful lifetime stock market investor without enduring some pretty significant losses. Even a cursory review of the historical data would show you that on average the market drops 20% every 3 years and 10% every year. If you can't handle that, you're not going to be successful investing in stocks. Similarly, you're not going to be successful investing in private real estate funds or syndications if you can't handle being illiquid for years. You need to understand what it will take to be successful in advance and make sure you are up to snuff BEFORE you invest.
# 8 Who is Getting a Cut?
Fees matter and they matter a lot. All else being equal, the less you pay in fees the higher your return, and that includes advisory fees. This is a critical principle of all investing. But it is also true that the return that matters is the post-fee return. Better to pay double the fee if it results in higher after-fee performance. Taxes act just like fees, and successful investors do what they can to reduce the taxman's take by taking advantage of retirement accounts, qualified dividend rates, long term capital gains rates, depreciation, 1031 exchanges, tax-loss harvesting, the donation of appreciated shares instead of cash to charity, and the step-up in basis at death.
# 9 How Does It Impact Your Portfolio?
Too often investors choose investments before determining their goals and their asset allocation. The return that matters is the overall portfolio return, not the return of its individual components. Forgetting that often leads to the classic investment mistake of buying high and selling low. I love Stein's analogy of approaching asset allocation like landscaping. There isn't an optimized flower garden. There are rules of thumb and principles, but there is also huge leeway for artistic interpretation. When designing a portfolio, pick something reasonable and stick with it. Beware of those who dogmatically insist on a certain asset allocation whether it be 100% stocks, 100% real estate or an interesting tilt to a set of factors. There are many roads to Dublin.
# 10 Should You Invest?
Even after finding an attractive investment opportunity, we still need to decide when and how much to invest. This is often based more on personal factors than market factors. It might be a great investment, but if you've got 8% student loans or 15% credit card debt sitting around, it probably isn't a great idea to invest. Likewise, don't get into the habit of wholesale portfolio changes. Assuming your original plan was reasonable, any changes you do should be small and after great thought. If you are like most investors, they are at least as likely to hurt you as help you.
If you want to read more about each of these questions pick up Money For the Rest of Us Today!
What do you think? Do you like this framework for investment selection? Why or why not? What did you read this year for Continuing Financial Education? Comment Below!
