How much money you end up with eventually is a relatively simple math problem. There are just four variables:
- How much you have now
- How much you save each year
- How many years you save for, and
- Your investment return.
The first you cannot change. Improving the second and third involve additional pain—i.e. cutting your lifestyle, working harder, or working longer. That leads many people to wonder about what they can do about the fourth variable—increasing their return on investments.
For example, let's assume you improve your investment return from 5% real (after-inflation) to 7% real. Assuming you're saving $50K a year over 30 years, that means you end up with 45% more money—$5.1M versus $3.5M. Or, alternatively, you could end up with the same money, but retire 4 1/2 years earlier. Or, you could save 32% less ($34,000 a year instead of $50,000 a year). Those all sound really awesome, right?
Should You Try to Increase Return on Investment?
Unfortunately, there is a rule of thumb out there that basically says there is no free lunch. If you want a higher investment return, you're going to have to take on more risk. While that rule isn't always true—there are uncompensated risks out there, and that higher return is almost always just a higher EXPECTED return—it generally holds true.
One of the worst things that can happen to an investor is that you exceed your risk tolerance. This could cause you to fail to contribute in a down market, fail to rebalance, or worst on this spectrum of bad investor behavior, cause you to actually sell low. There is some wisdom in the suggestion that you should take on just as much risk as you can stand, but not an ounce more. If you're not sure how much risk you can stand emotionally, I would suggest erring on the conservative side until you've been through a bear market or two.
There is some wisdom in the suggestion that you should take on just as much risk as you can stand, but not an ounce more. If you're not sure how much risk you can stand emotionally, I would suggest erring on the conservative side until you've been through a bear market or two.
This post is all about how you can increase your return on investment. Most, but not all of these suggestions will involve increasing your risk. Only you can decide if that is a good trade-off for you. Taking risks that you don't have to take, and then getting burned when the risk shows up, seems awfully foolhardy.
9 Ways to Increase Your Investing Return
# 1 Eliminate Uncompensated Risk
This is one of the easiest to do, and probably the only one that adds on no additional risk at all. There is no sense whatsoever in taking on risk that you are not paid to take on. Two risks you shouldn't expect to be paid to take on include:
- Manager risk (i.e. investing in actively managed mutual funds) and
- Individual security risk (i.e. putting a large percentage of your portfolio into a limited number of individual stocks or bonds).
Timing the market, even using valuations, could also be thrown in with these other uncompensated risks. Eliminating these risks may not improve your long term returns, but they will certainly improve your risk-adjusted returns, and over the long run, probably will both decrease your investing costs and increase return on investment.
# 2 Decrease Taxes
There is very little risk involved in this step too. Most high-income professionals I meet aren't maximizing their use of tax-protected accounts like 401(k)s, cash balance plans, Backdoor Roth IRAs, and HSAs. They also know precious little about investing tax-efficiently in a taxable account.
Becoming smarter about taxes is a great way to boost returns, but there can be additional risk when you decrease your taxes. For example, deferring taxes lowers your bill now, and probably in the long-run, but there is a potential risk there to increase your total tax burden in the long run in some situations.
# 3 Decrease the Cost of Advice
Way too many physician investors are paying too much for their financial advice. That's not even considering the fact that many are getting bad advice despite spending a lot of money on it. Decreasing the cost of your advice by negotiating a lower rate with your advisor, moving to a lower-cost advisor, or learning to manage your own portfolio and becoming your own financial planner decreases your investment costs, and thus boosts your after-fee returns.
There is some risk there too, of course. Firing a good advisor and becoming your own advisor without learning what you need to know to do that effectively could be “penny-wise but pound foolish” but many doctors have boosted their returns, increased their retirement spending, and shortened their required working years by doing their own investments.
# 4 Increase Stock to Bond Ratio
Stocks have higher expected returns than bonds over the long run, primarily because the risk is higher. So the more of your money that you put into stocks (and similarly risky assets) the higher your expected returns, long-term. Want higher returns? Moving some of your money from bonds and cash into stocks and leaving it there will probably work.
# 5 Choose Riskier Stocks
Just as stocks are riskier than bonds, and have higher expected long-term returns, so some stocks are riskier than others. For example, small value, microcap, and emerging market stocks have significantly higher risks than US Large Cap stocks like Apple, GE, and Facebook. Theory, and long-term past return data, suggest you will have higher returns by including these asset classes in your portfolio, despite their higher costs.
# 6 Choose Riskier Bonds
The equity side is not the only place in your portfolio where you can take on additional risk. Some bonds have higher expected returns than others. While those bonds may not do as well in a financial crisis, and some of their higher return may be due to the fact that those securities are really part equity and part fixed income, the long-term data on their returns is quite clear—taking on additional term and credit risk increases returns.
An extreme example of this includes Peer to Peer Loans, an asset class I invested 5% of my portfolio in for a few years. While my very safe bonds in the TSP G fund made 1-2% a year, I made 8-12% off Peer to Peer Loans, even after the frequent defaults. I eventually liquidated that particular investment (moved it into real estate debt as discussed here.) Lots more risk, but also lots more return. Less extreme examples include just using more corporate bonds and extending the duration on your bond portfolio.
# 7 Add Alternative Asset Classes and Accredited Investments
Ideally, you want to fill your portfolio with assets that all have high expected returns but very low correlation with each other. So when you add an asset class, look for something with low correlation to the rest of your portfolio. That said, a pile of manure has low correlation to your stocks and bonds. If the investment doesn't also offer a decent rate of risk-adjusted return, take a pass on it.
The most common investment added is real estate, which enjoys similarly high returns to equities, but fairly low correlation. In addition, physicians and other high-income professionals, by virtue of being accredited investors, have access to a whole slew of investments not offered to those with lower net worths and incomes. Whether those investments are worth exploring is a matter of debate, but there is no doubt that most of these at least promise higher returns than you can expect in the publicly traded stock and bond markets. Unfortunately, each investment is a totally separate deal and must be evaluated on its own merits. The equivalent of index funds in this space simply does not exist.
# 8 Add Sweat Equity
Another way to boost returns is to put some work in. I'm not talking about work researching Exxon on the internet, I'm talking about putting labor into a business. That business might be an investment like a rental property down the street, or it could be an outpatient surgical center, imaging center, or free-standing ED. It might also be a website you purchased. Real estate advocates often brag about their high returns; however, part of their high return often comes from the fact that they've created value through hard work. Nothing wrong with that—it's a great way to boost returns.
# 9 Add Leverage
Leverage works. Unfortunately, it works going both ways. Borrowing money at 2-5% and earning money at 7-15% is a winning combination. Of course, nobody ever went bankrupt without leverage. There is no doubt there is additional risk when you start levering up your investments.
The classic levered investment is real estate, but there are other ways to lever your investments. For example, purposely carrying low-interest rate student loans or mortgages while investing is leveraged investing. You can also open a margin account or even use some types of options. This may be my least favorite way of boosting returns, but it is an option.
Which of these should you do? It's hard to say. I can tell you this though, I've done all nine of them in some way or other. Don't take any of them to extremes, but increasing your long-term returns by 1-2% a year can make a huge difference in your financial situation.
What do you think? What have you done to try to boost your investment returns? Have you tried any of these steps? Anything else? Is it working? Why or why not? Comment below!
Well Said. Asset Allocation is responsible for 90% of one’s returns. Young docs need to be more aggressive as they usually start later than most, but should fund iras in residency at the minimum. If you have a Roth, invest it ALL in equities. The axiom for AA is 100 or 110 minus age=stock allocation. Simple enough and REBALANCE YEARLY
120-age is the asset allocation for stock percentage that I’ve always seen. Regardless, I concur with your statement of investing more aggressively as a younger investor.
I guess I’ve done all of these things! Some seem bigger bang for the buck (decreasing cost of advice, taxes) and some are too early to tell (small-cap skew).
Can someone explain to me as if I were a high school student how to evaluate correlation between asset classes? And risk adjusted return of a given investment?
I found the most intuitive explanations in the “Uncle Fred” sections of William Bernstein’s “The Intelligent Asset Allocator.” His use of graphics makes the subject far more comprehensible than any written answer you will get here.
Various asset classes have various correlations with each other that vary at times. That is, the correlation may be 0.8 at some point and 0.5 at another point. Ideally you would have a portfolio made of up assets that all have high returns and low correlations (0 is no correlation, -1 is perfectly uncorrelated- when one goes up the other always goes down and vice versa). So there is no way to know in advance what the correlation will be between any given set of assets over the next year or the next 30 years.
There are many ways to calculate the risk adjusted return. Perhaps the most common is the Sharpe Ratio. It is the average return in excess of the risk free return (think short term treasury yield) per unit of volatility.
Counterpoint: You’ve written, rightly before that physicians don’t need to gamble but rather merely to invest. If one can get to financial independence through sticking to index funds (and my favorite, robo-advisors such as Betterment that have a more complex portfolio than most would undertake on their own) then why bother with alternative investment classes? It’d probably save on estate planning, too, if you don’t leave much of one… (semi-serious)
The point of the game is to reach financial independence, and a simple index or even target date fund strategy in maxed out tax-deferred accounts + something like Betterment on the taxable side will do it with minimal fees and minimal sweat equity.
Nice article. A couple of comments:
~P2P loans are not bonds, maybe a distant cousin at best. I believe classifying them as such is misleading. It would be more accurate to include P2P loans in your alternative asset class.
~As much as I enjoy Ken’s comments, I could not disagree more strongly with his statement. Behavior, at least in my world, accounts for 90% of returns. I include annual rebalancing under the behavior descriptor. Dalbar studies indicate the same.
I have to agree 100%. Most studies show that most investors do not even meet the returns of the active managed manager on their own, let alone that of the index. Why? They exceed their risk tolerance and pull out at the wrong time. Frankly you are your worst enemy when it comes to investing and controlling your reactions to the market are the key driver of your success or failure.
They’re certainly not stocks. They’re a loan, just like a loan to a government or corporate entity or a mortgage borrower. Loans are bonds. P2P Loans are bonds. Very risky bonds.
Are you kidding me. All loans are not bonds. p2p loans (lending club) are unsecured loans that are backed up with nothing (big fat zero asset or personal guaranty)
So, the money we lent to our family/friends as loans should be counted a bonds in our portfolios?
I disagree. A bond is a loan, a loan is a bond. Some bonds have higher yields than others. Some bonds have a higher likelihood of returning your principle than others. Some bonds/loans are backed up with an asset and others are not.
Whether it is wise to invest in any particular loan/bond is obviously debatable. But what it is is not. A bond is a loan. A loan is a bond. A risky bond is not a stock. It’s a risky bond.
Bonds have coupons. All bonds are loans but not all loans are bonds.
True, but a minor issue. A loan provides you no equity, thus it is far more bond like than stock like. This is really an argument over semantics and I need to go pack for Belize, so you guys can win this one. I’ll try to remember to call P2P Loans “fixed income investments” instead of bonds.
Enjoy your trip! I thought “alternatives” was a good solution.
Kind of a broad term. Alternative to what? Who gets to decide what is alternative and what isn’t? Some people consider international stocks “alternatives” for instance whereas most of us think they’re pretty mainstream.
I was referring to your point #7 above, actually.
Enjoy the trip
Just to beat the dead horse one more time, you can loan out money without interest and be in compliance with IRS regulations.
Although the interest not charged is subject to gift tax rules.
And yes, the trip is awesome so far! The really cool thing about a “job” like WCI is being to do it even in a Belizean Jungle. I went SCUBA diving today for the first time. Can’t figure out why insurance companies want to charge so much more for that activity. Seems way safer than backcountry skiing and canyoneering that they don’t ask about at all.
This statement disappoints me. Surprisingly disappointed. WCI, you surely know better than to say that just because a loan is not a stock it is a bond. For once, I agree with Sam.
As a finance lawyer, I find this conversation quite amusing. If loans were bonds (i.e., securities) the entire loan market would cease to exist overnight for a variety of reasons. But admittedly, loans and bonds are very closely related as far as the basic economics are concerned. They are both debt instruments (speaking from the borrower/issuer perspective) and that’s what they should be called. P2P loans are definitely “alternatives”, though. You just can’t lump them together with bonds, it’s a completely different product.
You can get the same portfolio with Vanguard than you would get with Betterment at much LOWER FEES!
Respectfully disagree ITS YOUR ASSET ALLOCATION that is responsible for 90% of your wealth creation
Betterment’s portfolio from their website is compromised mostly of Vanguard Funds
Why pay the fees?? Which over 30-40yrs compounded is a boatload of money
lol, you don’t have to shout.
Q: If asset allocation (conventional wisdom) is 90%, why do most people with beautifully diversified portfolios have sub-optimal results?
A: It’s because they cannot control their behavior.
All you have to do is flip your numbers. Asset allocation = 10%, Behavior = 90%. Asset allocation is a piece of cake. You can learn the proper way to balance your portfolio in under a minute with Google. It’s the emotional aspect that separates investors from their money.
How about pick a a reasonable asset allocation and stick to it? That should cover make anyone wealthy over the long term.
Avoid the temptation to tinker. That tinkering bug is driving me crazy recently. I shed the complexity of of a financial adviser almost 2 years ago and then placed all of my investments in simple low cost 3 fund portfolios. 80/20 stocks/bonds, with 1/2 of the equity total US and 1/2 total international. But that is so boring. What if I start adding in value and REITs and emerging markets? Doesn’t that sound exciting? Everybody else is doing it.
No, I am going to stick with my simple portfolio. My wife understands it perfectly, so let’s leave it at that.
You nailed it. However, you may regret the fact that you have 805 allocation to stocks (even if you are still an teenager). Anyway, good luck
I’ve had a taxable account at Vanguard for several years. Recently opened a smaller taxable account at Betterment. Acquired $700 in harvested tax losses in the last month. I harvested $0 at Vanguard; just not worth the time/hassle for me to TLH there except in the event of a major market decline (major enough for me to know about it w/o following the market daily or even weekly). After my 6 month free trial at Betterment, I’ll pay 0.25% in annual fees, which will drop to 0.15% once the balance reaches $100k. So far, anyway, my tax savings for the year more than pay for the fees.
So, Tax Loss Harvesting might be added as #10, although it really falls under #2. And TLH is unlikely to have a major effect on overall investment returns. Guess I, like certain Presidential candidates, try to pay as little in taxes as possible 🙂
I do 1, 2, 3, 4, 7, and 8. I suppose I choose riskier stocks in a way by tilting towards EM & small value. I only buy passive index funds, though, no individual stocks (except Berkshire Hathaway).
I used to have leverage, but I prefer to be debt free.
Have a great weekend!
-PoF
I just feel if you put your portfolio on AUTOPILOT with yearly rebalancing and a stock allocation of 100 or 110 minus your age, emotion CAN be taken out of the equation or use a Target Dated Fund if you are very very lazy
Sub optimal results=not following your plan=foolishness=lack of discipline
Guess most would do better with Anyone but themselves, but its so darn simple to learn and implement, why throw away hundreds of thousands in fees!
From William Bernstein’s “The Investors Manifesto:
“Who’s our biggest enemy when it comes to investing? It’s not the stock broker or even Wall Street. Bernstein notes it’s the enemy in the mirror – ourselves. And in the forewarned is forearmed department, the book gives some great advice on how to protect our nest-egg from ourselves as well as from Wall Street. He covers the one technique of going against the crowd that actually works – rebalancing. It’s simple but not very easy to overcome our emotions.”
I think this is the first Brinson, Hood, and Beebow study which Ken references via his “allocation explains 90%” comments:
http://www.cfapubs.org/doi/pdf/10.2469/faj.v51.n1.1869
Toshi? I agree with you philosophically. 🙂
We all have faced or will face how to asset allocate at retirement age.
The pundits say you have a 30yr horizon, god willing but we know that’s not always the case
Emotions do come into the equation when you have no earned income and depend 100% on ira distributions and ss
Very conflicting / contradictory advice in this article. You state to keep it simple, avoid actively managed funds/avoid manager risk and market timing. Then you go all crazy and tell folks to increase exposure to stocks, and buy riskier stocks and riskier bonds. You also recommend to look into alternative asset classes. Basically, although unintentionally, you are introducing complexity, management risk by portfolio owner rather the mutual fund manager) as well as market timing.
Let me tell you all, and please never forget this, the only two asset classes that most of you need for risk management and consistent diversification are stocks (sp500 fund or global stock fund) and treasuries. Gold, physical real estate, commodities, international bonds, emerging market, these are all off shoot of stock and US treasuries.
Once you have enough experience, then dabble into extreme opportunities stock and bond market through at you. For example, late last year I bough gold miners (they will be sold soon), and municipal bond CEF from my home state ( they were selling at discount of 22% from NAV), now the same CEF is selling at 3% premium to NAV.
Besides my regular monthly investment, this year I bought mid stream master limited partnerships and nothing else, and have locked in 24% annual dividend payout which is expected to increase by 8% annually as long as oil price does not drop below $40 dollar per barrel
Writing calls and leverage are a good thing, for the very seasoned investor
Typically, I do not invest more then 40% in stocks, rest in US treasuries, and just hang out tight until market has another sale. I am hoping and preying for a bear market. This is when the real money is made b/ folks with 70 and 90% of portfolio in stocks learn realize that their risk tolerance is not at robust as they presumed it to be.
Lastly, and especially if you are <45 yrs old and in good health whole life insurance.
Thank you for sharing your opinion on what a wise investment portfolio looks like. I’ll let the reader determine what they wish to invest in. I suggest you do the same.
And I thank you, because not withstanding this particular blog, this web site has done a good job informing both the novice as well as seasoned investor.
Wait so you’re suggesting investments in gold, oil, whole life insurance and less than 50% stocks? I think you may have misjudged the audience of WCI. I’m interested, what experiences have lead you to these recommendations? Did this change after a significant down turn like early 2000s or 2008?
In the medium to long term I would love to get into hard money loans. What has your experience been thus far? I know you have done a number of real estate investments, but how much of your real estate investing at this point is in shorter term hard money? I’m reading about real estate note investing and thinking about that as a possible opportunity in the future
WCI, where do you find your hard money loan deals? How do you evaluate the ability of the debtor successfully pay you back? Do you subscribe to a credit scoring company like Equifax, or do you base the decision on things like net worth and previous deals?
I’ve moved on to using funds primarily for that asset class. I basically hire a professional to make those assessments and pay him a fee. This also spreads my bets across dozens or even hundreds of loans and several managers.
Thanks for the reply. I imagine that the professional likely prices out a lot of younger investors like me. Perhaps a post in the future on the mechanics of hard money loans is in the works? As always, appreciate the good content!
Depends, minimums are not always high. AlphaFlow for instance has a very low one. Others are higher. See my real estate updates twice a year or so for details.
Absolutely will do. Thanks again
Is this a good time to move money from annuity to the stock market?
That question doesn’t make any sense, but I think I can tell what you meant to ask and the answer to that would require a working crystal ball.
I suggest you get an investing plan that doesn’t require a working crystal ball for you to reach your financial goals. This post may help:
https://www.whitecoatinvestor.com/investing/you-need-an-investing-plan/