Podcast #112 Show Notes: The Right Way to Borrow Money From Family

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A listener asked me how to prioritize loans from their parents. I am not a fan of borrowing money from family. I’d hate to owe money to my parents. Paying that off would be a major priority for me. But if you are still going to do it, borrow money from your family the right way. When you borrow money from family, you have to pay a reasonable interest rate and it is a good idea to have written terms. We get into more details about borrowing money from family in this episode but don’t become debt numb just because you are offered money at a low interest rate.

We also answer listener questions in this episode. I hope you find these podcasts and show notes encouraging and not depressing. For a high income earner it is almost never too late to change your habits and build significant wealth before retirement. So don’t be discouraged if you are starting late or have made a lot of mistakes. Your high income can help cover those mistakes and wasted years if you are willing to change. That is what I hope the podcasts inspire you to do.

 

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WCICon20

The White Coat Investor Conference, WCI Con 20, will be March 12-14 of 2020 in Las Vegas at the Paris Hotel. There will be 27 hours of material. We have some awesome big names coming like Harry Sit, Paul Merriman, Rick Ferri, Morgan Housel, and Phil DeMuth. All the top physician financial bloggers and podcasters and Facebook Group leaders will be there. There will be some awesome panels, presentations, and networking for the beginner and the advanced White Coat Investor alike, so I encourage you to sign up for that. Registration opens on Monday, July 8th at 7:00 pm MST.

WCI Facebook Group

If you are a member of our private Facebook group, White Coat Investors, you know that we have been doing some Facebook live events in the group. Sometimes it is just me and other times I’ve brought on a sponsor. Either way, we answer your questions live face-to-face. All you have to do is type them in as a comment and we will answer your questions. It’s like the podcast, except it’s live. Kind of fun. Rather than having to record your Speakpipe questions in advance and waiting a few weeks to get them answered, we answer them in real time. I encourage you to check those out. We try to publicize them at least a day or two in advance. But the best way to know about them is just to be in the Facebook group. So sign up for that today.

The Right Way to Borrow Money From Family

I had an email exchange with a reader that I thought was worth discussing on the podcast. He wondered how to prioritize “dad loans.” He lives in a high cost of living area and bought the house that they were renting for $1.3 million, with $200,000 borrowed from his dad at 3.5% for 30 years.  When you borrow money from family, you have to pay a reasonable interest rate and the IRS defines what reasonable is. It is also a good idea to have written terms even if you’re just borrowing from family.

Two years later he bought into his practice with more borrow money from his father and now they are considering a remodel on the house and Dad has offered another $200,000 loan for that. The reader is concerned because though the rate his father is giving him is really low, none of it can be deducted like a mortgage. But his dad loves loaning money to his children, because he likes to help, doesn’t need the money, and it would otherwise be sitting in a bank account earning less. So by loaning out the money, he is effectively purchasing his own annuity. Another way the reader thinks about it is basically borrowing his inheritance in advance.

This reader wanted to know what I thought about the situation.  I’d hate to owe money to my dad. So that would be a major priority for me to pay it off. This doc seems a little bit debt numb to me. That’s not unusual for a doctor because you borrow so much money in med school and let it ride through residency. It’s particularly not unusual for doctors in high cost of living areas where mortgages tend to be huge because house prices tend to be so insanely high. But even so, this doc seems a little too debt numb for me. The interest rates are low but that is still a lot of debt. I think he can stand to deleverage quite a bit. I’d pay off some debt before embarking on a renovation, for example.

When borrowing money from family is easy, like in this situation, you are tempted to borrow more than you need. You’re justifying consuming more than you otherwise would by the fact that you can borrow at a low rate. If you had to save up and pay cash for that renovation, chances are you’d wait longer and spend less on it. In my experience, very few people borrow their way to wealth. The same drive that causes someone to accumulate wealth, quickly at least, also seems to drive people to pay off their debts quickly. That’s just an observation I made.

So I told him good luck with his decision. Obviously, it isn’t the same as ignoring a 15% credit card debt but debt numbness holds lots of docs back. Go look around for people who paid off their student loans or mortgage quickly and regretted it. There just aren’t very many of them. And of course, to me, it seems silly to have any debt at all with an income of $1.3 million a year.

But my guidelines for borrowing money from family are:

  1. Decide if it is really necessary or if you can be patient and save up the cash.
  2. Set a reasonable interest rate.
  3. Have written terms for the loan.
  4. Pay it off as quickly as possible.

Reader and Listener Q&A

Is it Too Late to Build Wealth for Me?

A reader is feeling overwhelmed with doom and gloom about starting so late to build wealth. He is depressed about the 15 years he wasted after residency. He wonders if he should just surrender to the fact that he will never be affluent?

Here is the truth of the matter. No doc is ever really more than about ten years away from financial independence. The reason why is, if you become a super saver, you can start saving 60, 70, 80% of your net income, and become financially independent in a very short period of time. Look at the Physician on Fire,  ten years out of residency and financially independent, doing nothing more than practicing medicine and saving a big chunk of it.

Do you actually have to make some changes? Yes. Your life is going to have to change if, in your first 10 or 15 years out of residency, you haven’t put anything away. Give that another 10 or 15 years of doing the same thing, and you’re going to get what you’ve always gotten.

But if you are willing to change your behavior, maybe even downsize your house, maybe move, maybe work a little bit more or ask for a raise. Work on all these aspects of it, saving more, earning more and making sure your investments are working as hard as you do, you can certainly make a huge difference in your life. So I would not feel like 47 is old or you’re past the opportunity. All these same principles that I talk to 32-year-old residents about can be applied just as readily with a 47-year-old doctor. Now if you’re 67, maybe we need to start talking about how you missed out on a lot of chances, but at 47 you still have 20 years of your career ahead of you. Lots of doctors become financially independent in less than 20 years. I would not feel discouraged if you’re just picking up this podcast and you’re 45 or 50 or 55 or even 60. You still have a lot of time, not enough that you can waste any, but a lot of time that you can use to build wealth. That physician income can overcome a lot of financial mistakes, including screwing around for 10 or 15 years in the beginning of your career.

Dave Ramsey’s Portfolio Recommendations

“I was just wondering if you could give your opinion on Dave Ramsey’s portfolio recommendation, which from what I understand, is 100% stocks for everyone, made up of 25% growth, 25% growth and income, 25% aggressive growth and 25% international.”

There are a few issues with this portfolio recommendation. The first one is no one actually knows what it is. Growth and income is this category that’s used by mutual fund companies to mean all kinds of different things. Sometimes it means large growth stocks, sometimes it means large value stocks, sometimes it means large blend stocks, and sometimes it means a balanced fund with 25% bonds or maybe 75% bonds. Depending on what mutual fund company you go to, their growth and income fund may be dramatically different so this isn’t really like recommending an asset class, it’s like recommending a type of mutual fund that people used as a description back in the ’90s. Nobody really uses this anymore and so I think in general what he’s referring to is large caps stocks. We’re talking an S&P 500 index type fund.

His next category is growth and if you pin him down on this, it seems like what he’s talking about is mid cap and large cap growth stocks. He is talking about putting that first 25% into growth and income (large blend or a large value) and the second 25% into mid cap or large cap growth stocks. The third category is aggressive growth and this is really hard to pin him down on. Sometimes this means mid caps stocks, sometimes this means small cap stocks. Sometimes this can mean emerging market stocks and so it’s really unclear exactly what asset allocation he’s recommending here but I think most of the time when I’ve heard him talk about it he’s talking about small cap stocks. So now we have a quarter of your portfolio in large value, a quarter in mid to large cap growth stocks, and a quarter in small cap growth stocks. Then the last quarter is in international. That is a little more straight forward.

The problems with this asset allocation is it is hundred percent stocks. Yes, that has the highest long-term expected return but that’s assuming you can tolerate the volatility of this portfolio and the vast majority of investors cannot. You don’t really know what your risk tolerance is until you’ve been through a big nasty bear market and that is a terrible time to find out that your tolerance is not as high as you thought it was. I’ve got three partners who basically sold all their stocks low in 2008 and it had a dramatic effect on the size of their nest eggs. It’s really held them back in their financial lives. You are far better off having a less aggressive portfolio than you are having one that’s just a little too aggressive for you. So I’d encourage you to dial back the risk a little bit by adding some bonds to the portfolio, at least until you’ve been through a bear market and know how you behave in that bear market.

The other problem with David Ramsey’s recommendation here is that he’s generally recommending actively managed mutual funds and the data’s pretty clear on this, over the long run, you only have about a 10% chance of choosing an actively managed mutual fund that beats a low-cost index fund in that asset class. If you multiply that by multiple asset classes in your portfolio, the likelihood of choosing winners is even lower.

The worst part about it is that when these funds beat the index funds, they usually don’t beat them by very much. When they fail to beat the index funds, they often fail by a lot. And so there’s a lot of risk trying to pick active mutual fund managers that are going to beat an index fund. Frankly, I don’t even think it’s worth the risk. I just buy index funds. Yes, I know that in a long time period, five or ten or fifteen percent of the funds are going to beat my index fund. But I don’t have to try to guess which funds those are in advance. I don’t have to monitor those funds over the years and I can basically ensure that I get the market return, so that’s what I’ve chosen to do.

Closed Vanguard Funds

Some of the Vanguard funds are closed at times. A reader didn’t think there were good equivalent fund to invest in and asked me for suggestions to manage this problem.

If you go through Vanguard’s list of mutual funds you will see that some of them are closed. For the most part, these funds have been around for a long time and have done pretty well. They have pretty good records and the mutual fund managers have thought the funds are just getting too big. They cannot deploy these funds into their best ideas any quicker than they already are so they are not taking new money. I looked at Vanguard the other day and this includes their dividend growth fund, their prime cap fund, their prime cap core fund, and the capital opportunity fund.

I don’t actually invest in any of those closed funds. They’re basically all actively-managed funds. Or sector funds sometimes get closed temporarily so I don’t invest in those. So this isn’t really an issue for me. I just buy the index funds and they don’t seem to have a problem ever closing. So that’s option number one that you have, you can just use index funds.

Option two is you can watch for future openings. After the funds start performing badly people start pulling their money out and all of a sudden you can put more money in there. Or after a market drop, a lot of times, they will take new money as well. So if you have a bear market, you might check again and see if those funds are open if you really want to invest in them.

You might also find an exception in a 401K. Sometimes a different type of account still has access to that fund, maybe it’s a 529, maybe it’s your 401K at work, maybe it’s an individual 401K. If you already have some funds in there you can probably reinvest your dividends or maybe you can still invest more money. It just depends on the rules of the closure, but if you really want to get into a fund it might be worth looking into that.

Lastly, you can use an alternative actively managed fund from other companies that use a similar strategy. If you really like that strategy and that’s how you want that portion of your money to be managed, chances are good somebody at Fidelity or somewhere else is doing something similar, so you can do that.

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But remember there are no called strikes in investments. There are no magic investments. There are no must-have investments. Avoid the fear of missing out that causes you to do dumb things with your money. Just because a fund is closed and had good past performance doesn’t mean you have to get in there to be financially successful. Far more of your financial success is about getting the high income, saving a big chunk of it, and investing it in some reasonable way rather than picking the exact perfect mutual fund that’s going to eke out another point three percent per year in return.

 

Retirees in 100% Stocks

“My retired parents in their early 60s, having a hundred percent of their 401Ks in stock equities and low-cost index funds. Both of them have pensions through their work and social security as well, which will cover the bulk of their living expenses in retirement and I think that these guaranteed payments can act like the bonds in their portfolio, allowing the rest of that principle to grow at a higher rate by being invested a hundred percent in equities. What do you think about that?”

I don’t think it’s a question for this reader but a question for his parents. What was their behavior like during bear markets? Were they able to tolerate those losses? I remember in 2008 I was helping my parents manage their portfolio. Their portfolio was 50% stocks, 50% bonds. They lost about 18% of their money in 2008. I think I lost 30 something percent in a more aggressive portfolio. Mine was about 75% stocks.

Realize that going a hundred percent stocks you could lose, quite easily, in a nasty bear market, 50-55% of your money and I think for a retiree, that’s very difficult to do and stay the course, even if you have pensions. Yes, if you can somehow have the mental manipulation to say, I’ve got a pension. I’m okay. I don’t need to sell. Then maybe you can pull it off, but I think for the most part it’s a good idea for any investor, and especially a retiree, to have at least some of their money in bonds.

Now if that money is truly not money that they’re going to be spending, it’s money for their heirs or charitable desires, they’re living one hundred percent off that pension, then sure you can invest it more aggressively. But I’d be pretty careful going a hundred percent stocks for a retiree.

Expense Ratios of Target Retirement Funds

“What’s the expense ratio of target retirement funds? Is there an additional expense ratio above and beyond the expenses of the underlying funds?”

A listener asked this question and asked about cost basis but I think he meant expense ratios. Remember the cost basis is what you paid for an investment and matters when you’re investing in a taxable account and you’re trying to figure out how much of the sale is exempt from capital gains taxes but that is not the same thing as an expense ratio.

A target retirement fund is a fund of funds. Basically, it’s a mutual fund that buys other mutual funds to make a mix, a diversified portfolio all in one mutual fund. So Vanguard has a series of these, they’re called target retirement funds. You can buy them at other places like Schwab and Fidelity as well.

At Vanguard, the expense ratios for these target retirement funds range from 12 to 15 basis points, so that’s .12 to .15 percent per year, pretty cheap mutual fund. It’s not absolutely the cheapest you can get. At Fidelity, you can now buy an index fund with a zero percent expense ratio. But most of the cheap funds are .03 to .1 percent per year.

So this 12 to 15 basis points in the target retirement funds is slightly higher than what you could build those portfolios for yourself. In exchange what do you get? Well, you get automatic rebalancing. You get a lower minimum then you would have into all those funds and you get a professional recommendation on asset allocation, so I think that’s worth something. A few basis points don’t seem unreasonable to pay for that.

What you need to know, though, is that every fund family answers this question differently, as to whether you pay an additional expense ratio in addition to the expense ratios of the underlying funds. Unlike many fund families, the Vanguard ones don’t have any additional fees. You’re not paying both the underlying expense ratios and the target retirement fund expense ratio. That’s not the case with all companies. A TSP and T. Rowe Price, they do it similarly to Vanguard and the TSP fees are so low anyway, it really doesn’t matter. I think Fidelity and American Century in the last year or two, have also adopted this approach, which is a change from the way it was before. I think Schwab also now is doing it this way but it’s a good idea to know how your fund of funds addresses this issue and the only way to do it is to look at their prospectus and see or even call them up and ask them. But the big fund companies, the ones where most of the money is in these target retirement funds, they’re moving toward doing it the right way for the investors.

 

Spoiling Your Children Through Inheritance

“Do you worry that you will debilitate or otherwise spoil your children through giving, especially now that you are a super saver? What do you think about leaving your children nothing?”

I have a plan to give my kids a fair amount of money in their 20s but I haven’t really decided what to do after that. In fact, all they may get by way of an inheritance is the opportunity to manage a charitable foundation that we leave behind. But what they are going to get for sure is financial literacy. I’m going to teach them not only how to make money but what to do with it once they’ve made it. That’s probably the most valuable inheritance I’m going to give them.

But we’ve also been funding Roth IRAs for them with any earned income they earn. We give them a daddy match on that. They get to spend the money they earn or an equivalent amount to the money they earn that I give them and the money they earn actually goes into the Roth IRA. They also have 529 accounts that we’ve funded to help pay for their college and then they have a 20s fund that we invest in a UGMA or a UTMA account. This is basically a taxable account for a minor, that at age 18 or age 21, becomes their money to spend on whatever they want.  It’s up to them, really, when they reach that age. But that’s their 20s fund and our hope is that they’ll spend that on something good. A car, a home down payment, summer in Europe, missionary work, that sort of thing. Our hope is at that time in life, when you don’t have a lot of earning capacity, but you have a lot of need for cash, that that money will help fill some of the need.

Now, do we plan to leave them millions? Well, it probably is going to come down to how well they show us they can manage money throughout their lives. If not, it may all just go to charity. But can you spoil your children? Absolutely.  I think that’s something we all struggle with and a lot of it comes down to teaching them as you go along. You have to teach them how to use money effectively. You have to teach them what money means. You have to teach them where money comes from. You ask any of my kids where money comes from and they’ll answer that it comes from work and so I think it really comes down to how you’re teaching them as to whether you can get away with leaving them a large inheritance or not. I think you probably can with the right people. I think there are some people that you absolutely can’t leave them anything or they’ll go spend it on heroin. So you really have to know your kids.

This doctor says I worry a little bit about giving them so little because they could be really far behind in an era when many people are inheriting substantial sums. I think you’re absolutely right. That a lot of people these days, especially as the baby boomers pass on, are going to be starting life a few steps ahead than people that don’t have these sorts of inheritances and so if you want your grandkids in the nice schools, you may have to help them with the down payment on their house but try to find moderation in all things and focus on what the kids are learning.

RSP Total Stock Market ETF

“There is a total stock market ETF called RSP. It’s an equally weighted ETF. I wanted to hear your thoughts on that versus something like VTI. It’s posted better returns over the last ten years or so and it is a total stock market index fund. It does have a greater expense ratio.

This is an equally weighted exchange-traded fund. If you look this up you see the returns over the last 15 years are 9.52% versus the Vanguard total stock market index fund of 9.12%. What you need to know about a fund like this is that the higher expenses are guaranteed. You’re also going to have higher transaction costs in the fund because they are going to be buying and selling things a lot more frequently in order to keep the equal weighting among the different stocks. It is not going to be nearly as good in a taxable account because it’s going to be distributing a lot more capital gains and particularly short-term capital gains.

The other thing to keep in mind with an equal weighting strategy, where rather than a capitalization-weighted is when you own an equally weighted strategy, you actually have a lot more of your money in small stocks and value stocks then you otherwise would. Now if you paid any attention to the literature on factor investing, you’ll know that small stocks and value stocks are considered riskier and thus, over the long-term, have had higher returns than large cap and growth stocks and so you would expect a fund that has more of your money invested in smaller and value stocks to have a higher long-term return than a total stock market fund. It shouldn’t be any surprise at all to you, that over a 15 year time period, you see a little higher return out of this.

Personally, I think you’re probably better off just buying a total stock market fund and if you want to tilt towards small and value stocks, adding a small value index fund on top of that. But it’s not crazy to do this sort of an equally weighted ETF in a tax-protected account if you really want to give it a try. Just realize there is some additional costs there and realize where your extra return is likely to come from. It’s not the magic equal weighting. It’s just a small and value tilt.

Simple IRA

“I know you’re not a huge fan of the simple IRA, but it is an extra tax account that is available to small employers such as myself that isn’t terribly expensive to administer. Your biggest critique of the simple IRA has been that it prevents you from doing back door Roth IRAs. Is there anything wrong with contributing to a simple IRA and then rolling it over into a 401K? Is there a specified period of time that the funds need to be in the simple IRA account and as long as you get to a zero balance by the end of the calendar year, you avoid the pro rata rule implications?”

Simple IRAs have their issues.

  1. Low contribution limits.
  2. You can’t do rollovers for two years.
  3. It gets counted in the pro rata calculation for your backdoor Roth IRA so you can’t do a backdoor Roth IRA. s

Sometimes it makes sense for a small practice with a few employees, but in general, this is one of my least favorite self-employed retirement accounts.

 

Using a Home Equity Loan to Refinance Student Loans to a Lower Rate

A listener’s wife has $300,000 in student loans at 5-8%. They might be able to refinance these loans to 6 to 7% for 15-year terms. Or they could use a home equity loan and wanted to know my thoughts.

He says they are renting so first of all, if you’re renting, where’s that home equity going to come from? It doesn’t magically appear when you buy the home. Home equity either comes from a down payment you put in there, from mortgage principle that you’ve paid down or from appreciation on the home. There’s no instant equity as soon as you buy it, unless you bought it for a price much less than what it’s worth. So I wouldn’t necessarily go first to that. I think I might look into refinancing first, if you can get a lower rate, or paying them down and then refinancing.

That said, if you’re in a position where you have a bunch of home equity, a home equity loan is a pretty good way to lower your interest rate. Regulations have changed a little bit recently. It used to be you could deduct a certain amount of a home equity loan that wasn’t necessarily being used to buy or improve the property. They’re tightening that up quite a bit. However, money is still fungible.

I’d probably put every available dollar toward her loans and let the 2.5% ones that he has ride. The attitude to take when you get married is this is our money. It’s our loans. They’re our assets. They’re our income. Combine it all. Assuming this marriage is stable and looks like it’s going to be long-term, and work on it together. Working together matters a lot more than what each person brought into the marriage.

Using a Whole Life Insurance Policy as an Emergency Fund

“I am a physician in my mid forties who is considering buying a whole life insurance policy. My thought was to take my emergency fund dollars and invest it over the next five to ten years in this whole life policy that could be borrowed against, should an emergency or crisis situation arise. My thought was that I would get a return that was better than my options in a liquid bond portfolio or a savings account at the bank, while also having the advantage of a death benefit should something unexpected happen. I know that in general life insurance policies have a lower return but I wanted to hear your thoughts, betting this against other vehicles, for holding an emergency fund.”

I don’t think you should buy a whole life policy in the first place, for any purpose. So I certainly wouldn’t put your emergency fund money in there. One of the big downsides of a whole life policy is that your returns are negative for the first few years. Even on a good policy, your returns are negative for five years. On a bad policy, they might be negative for 15 or 20 years. An emergency fund is supposed to have stability of principle. You want your money there when you need. You need it liquid and you need it safe.

I don’t think a whole life insurance policy really provides that. If you turn around and you want that money in a year because you need it to buy a car or you’re out of work or something, and all of a sudden, a third of it is gone. That’s not a very good emergency fund. I would stick with putting your emergency fund into CDs or I bonds or probably more frequently, just a high-yield savings account or a money market fund.

 

Tax Deferred Accounts or Roth Accounts

A super saver, with $2 million already in tax-deferred accounts in his forties, wants to know should he keep investing in tax deferred accounts if he expects to be in the top tax bracket now and in retirement? Should he invest in real estate or hard money lending instead?

If you want to have real estate or hard money lending assets in your portfolio that is fine but the bottom line here is the key, if you’re really worried you’re going to have a required minimum distribution problem, is to do Roth conversions. Start doing Roth contributions instead of tax-deferred contributions. Make sure you’re getting your backdoor Roth IRA contributions in every year and maybe even do some Roth conversions each year. That basically allows you to move some of your money out of the taxable account and move it into tax protected accounts. It lowers the size of your future required minimum distributions and if you’re going to be paying at the highest tax bracket anyway later, you might as well do it now.

Another option that you might take on in that situation, of course, is a self-directed IRA or 401K. Particularly, for something that’s pretty tax inefficient, like hard money loans, these are basically investments that pay you 7-12 percent and it’s totally ordinary taxable income. So you’re going to pay taxes on it every single year at your marginal tax bracket. If you do that, inside a self-directed IRA or 401K, you can save on those taxes. That’s a pretty good asset to move into your tax-protected accounts. Of course, that brings on some asset protection benefits too because retirement accounts generally get much better asset protection than a taxable account. You have more of your assets in asset-protected accounts than you had previously.

Ending

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Full Transcription

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.

WCI: This is White Coat Investor podcast number 112. How Do You Treat Dad Loans? Are you tired of the ups and downs of the stock market? Private real estate is known for its stability and high returns, and Origin Investments has a great new fund that delivers both.

WCI: The Origin Income Plus Fund is a diversified private real estate fund targeting a total annual return of 9 to 11%, inclusive of 6% in annual distributions. The principles are investing $10 million of their personal capital alongside investors in the fund. Learn more by visiting www.originincomeplus.com/wci. That’s www.originincomeplus.com/wci. Thanks for what you do. I know you’re probably on your way into work, your way home from work, maybe working out at the gym, whatever. Medicine is stressful. Dentistry is stressful. Law is stressful. I don’t know what you do for a living, but chances are that, in order to become a high-income professional, you had to spend a long time in school, spent a long time training for it, and you put up with a lot of crap. So if nobody’s told you thank you today, let me be the first.

WCI: All right, coming up here in a couple of weeks, we have got The White Coat Investor Con. WCI Con 20, which is March 12-14 of 2020 in Los Vegas at the Paris Hotel. We are going to have an awesome conference. There’s 27 hours of material. You’re not even going to be able to attend it all, but don’t worry. We’re going to record it, and we’re going to give it to you recorded so you can finish watching it at home if you can’t attend it all. But we’ve got some awesome big names coming. We’ve got Harry Sitt, we’ve got Paul Merriman, we’ve got Rick Ferri, we’ve got Morgan Housel, we’ve got Phil DeMuth. We’ve got all the top physician financial bloggers and podcasters and Facebook Group leaders. There’s going to be some awesome people there, some great panels, some great presentations, and lots of wonderful networking for the beginner and the advanced White Coat Investor, alike. So I encourage you to sign up for that.

WCI: What you need to know, however, is that signups are going to open at 7:00 pm Mountain Time on Monday, July 8. I don’t know how long they’re going to be open for. This thing could fill in minutes, maybe it fills in hours. I think more likely, it fills over a couple of days, but no guarantee. Once it’s full, it’s full, and I’m not going to be able to get you in there. So even if it takes a couple of weeks to fill, which I think is about the longest this is going to take, given that our last conference filled in six days. I would encourage you to get on right when it opens up. So I’m going to tell you, just like I’m telling everybody else, 7:00 pm Mountain time, July 8th.

WCI: If you have been following us in the Facebook group, our private Facebook group White Coat Investors, you’ll know that we’ve done some Facebook live events. These are tons of fun. Whether I do them by myself of bring a sponsor in with me and we answer your questions, if you want to interact with us live face-to-face, ask questions, all you got to do is type them in as a comment, we’ll answer your questions. It’s like this podcast, except it’s live. It’s kind of fun. It’s like a real radio show, rather than having to record your speak pipe questions in advance, or waiting a few weeks to get them answered, we answer them in real time. So it’s been a lot of fun and I encourage you to check those out. We try to publicize them at least a day or two in advance. But the best way is just to be in the Facebook group and we’ll let you know about them.

WCI: Okay, our first question today is really an email exchange I had with a doc that I think is worth talking about. Basically opens up the email with, I’m wondering how you prioritize dad loans, i.e., loans from your parents. Here’s my situation. I live in the super expensive Bay Area. I’ve been in practice two or three years. We initially rented and then bought the house we were renting for $1.3 million, with $200,000 borrowed from dad at 3.5% times 30 years. So this is good. When you borrow money from family, you have to pay a reasonable interest rate and the IRS defines what reasonable is. And it’s also a good idea to have written terms there, even if you’re just borrowing from family.

WCI: He says then two years later, I bought into my practice Ortho Hand Surgery, borrowed another $150,000 from my dad at the same 3.5% and consolidated the loans. Now we’re considering remodeling the house in the next year or so and dad’s graciously offered another $200,000. Man, I need a dad like this. This is a lot of money so far, dad’s loaned you. We’re up to 550, it looks like. On one hand, the dad loan is the cheapest money I can get for these things at 3.5%. But at the same time, the dad loan is the most expensive money I borrow, since the mortgage is deductible. My mortgage of one million at 3.85% and a factor rate at 2.22%, so there’s no additional mortgage deduction allowable. And our auto loan of $40,000 is at 2%, but we don’t have any other debt.

WCI: The dad loan poses internal conflict for me. On one hand, I hate owing money and would like to aggressively pay it off. On the other hand, my dad doesn’t need or want me to pay it back early. A little background on him, he’s first generation immigrant. Conservative with money. How to be frugal. Divorced and lives alone. Owns his condo. Expenses are minimal. Loves loaning money to his children, because he likes to help us and it’d otherwise sit in a bank account earning less than 1%. So by loaning out the money, he is effectively purchasing his own annuity. Another way to think of this is basically borrowing our inheritance in advance. God willing, my dad will live forever. Unfortunately, that’s unlikely to happen. So in reality, at 3.5% interest I’m paying to him will come back one third to me as an inheritance. Or another way to think is if he dies within 30 years, then the loan would be covered by any inheritance and I would be off the hook.

WCI: The value of his homes still exceeds his total loans to my sisters and I. But after that, I don’t want to wait 30 years to be debt free. Admittedly, we’d rather pay off our house and loans within the next 10 to 15 years with aggressive savings and payments.

WCI: All right. So what do I say to this guy? Well, I’d hate to owe money to my dad. So that would be a major priority for me to pay it off. I once owed my dad $3,000 for a car he gave me as a college senior. I paid it off about three months into my internship year. This doc seems a little bit dead numb to me. That’s not unusual for a doctor because you borrow so much money in med school and let it ride through residency. It’s particularly not unusual for a doctor in the Bay Area, where mortgages tend to be huge because house prices tend to be so insanely high. But even so, this doc seems a little too debt numb for me. Yeah, the interest rates are low but you got a lot of it. I think you can stand to deleverage quite a bit. I think I’d pay off some debt before embarking on a renovation, for example.

WCI: We’re doing a renovation this year. We’re going to pay cash for it. You say you hate owing money? But your actions say you love it. I mean, a $40,000 car loan as a hand surgeon? That’s not someone who hates debt. If you hated debt, you’d be driving a $5,000 paid-for beater and sending big checks every month to your dad. If you hated debt, you wouldn’t be considering renovation paid for with borrowed money. I think a quote from Dave Ramsey’s appropriate here, where he says Thanksgiving dinner doesn’t taste the same when you owe money to the person across the table.

WCI: So because I don’t like owing money to my family, I’d make a plan to get your dad paid off in the next couple of years, if I were you. So he responded back. He says thanks for the honest advice. Debt numb? Perhaps. Although admittedly, I’ve never thought of it that way. Yes, we have a lot of debt but what are options in our area? We like the area. We’re not willing to move. My practice is great. We don’t regret buying the house. It’s the cheapest of our friends. Maybe you need a new set of friends, right? If all your friends have multi-million dollar houses, but … Buying the practice was a fantastic opportunity to double my income. Okay, that’s a good sign. Maybe this doc can actually afford all this debt. Obviously, I left out income information. Between my wife and I, we bring in about 1.3 million.

WCI: Okay, new story here. We’re making $1.3 million a year. You can obviously afford a lot more on $1.3 million a year than you can on an income of two or three thousand. Of course, in California, that puts our effective tax rate around 45% overall. Your point about a $40,000 car loan is well taken. I could write a check for that loan right now. Maybe I should if it runs at 2%. Why? I believe the housing market will cool off. Construction will be a little less expensive and we like that we’re aggressively funding both our taxable and tax-deferred accounts right now.  How much he’s putting in those, which isn’t all that much. It’s about $175,000 a year. So for all those reasons, I’d like to keep cash on hand or invest it in anything greater than 2%. I mean, I could put it in a money market account now and get 2.4%, right?

WCI: The interpersonal relationship dynamic of family loans is different. Perhaps my family dynamic is different. I must admit that owing my dad money doesn’t feel that way. He views it as a gift, thinks nothing of it. Payments are automatic and currently, I’m actually overpaying him by double, simply because I have the cash and I can. If we took an additional loan from him, I would leave the payments at the same amount so we’d just cover the minimum payments.

WCI: So does that additional income information change your mind at all? Is it so bad to take out $40,000 at 2% when the money can be used elsewhere?
WCI: All right. So my response. Would you borrow a hundred million dollars at 2% to invest? If not, why not? If so, then what you’re doing’s probably fine. But it’s really the same thing. I don’t deny that the math works out. But if you borrow at a low rate and you earn at a high rate, you’re going to come out ahead. Overdoing so, ignores risk and ignores behavior and sometimes it even ignores taxes.

WCI: So let’s start with the taxes. Yeah, you could make 2.4% in prime money market fund right now. But borrowing at 2% and earning at 2.4%, you come out ahead, right? Well, not so much. After tax, you’re borrowing at 2% and earning at 1.3%, thanks to your high California tax brackets. That’s a dumb idea. So instead, you ratchet up the risk a bit and expect to earn 5% after tax. So you’re borrowing at 2% and earning at 5%.

WCI: The problem is that to get 5%, you’re going to have to take risk. There’s no risk involved in paying off a 2% loan. Pay it off, it’s exactly the same as making 2% risk-free. 5% risky is not necessarily better than 2% risk-free. You have to adjust for the risk. You have a very high likelihood of making 10%, then sure, I’d borrow the 2% for that. If I had a slight chance at making 3%, then I probably wouldn’t borrow at 2% to do that.

WCI: And finally, the most important component, which is behavior. The truth that very few of us actually invest the difference. Instead of borrowing at 2% and investing at 5%, we simply borrow at 2% and spend and obviously, that comes out behind. Think of it this way, everything you’re buying right now, you’re essentially borrowing at 2% to purchase because money is fungible. Your groceries, your car, your vacations, your last dinner out, your iPhone, whatever. So ask yourself if you’re comfortable with that. And if not, the only way to stop doing it is to pay off your debt.

WCI: In my experience, very few people borrow their way to wealth like this. The same drive that causes someone to accumulate wealth, quickly at least, also seems to drive people to pay off their debts quickly. That’s just an observation I made. Obviously, it’s possible to borrow at 2% and truly invest at 5% or 10% or whatever and come out ahead. But chances are if you would have paid cash for that car, you would’ve only bought a $20,000 car or a $30,000 car or a $5,000. Instead, you spent more than you otherwise would have. You’re justifying consuming more than you otherwise would by the fact that you can borrow at a low rate. Just you’re justifying an optional home renovation because you can borrow at a low rate. If you had to save up and pay cash for that renovation, chances are you’d wait longer and spend less on it.

WCI: So I told him good luck with your decision. Obviously, it isn’t the same as ignoring a 15% credit card debt but debt numbness holds lots of docs back. I paid off my last debt a couple of years ago. That was a 2.75% mortgage and I haven’t regretted it yet. Since then, my net worth has doubled. Coincidence? Maybe. But I think there’s actually something to it. Go look around for people who paid off their student loans or mortgage quickly and regretted it. There just aren’t very many of them. Maybe they could’ve theoretically come out ahead mathematically by doing so. You can always go get another mortgage if you do regret paying it off early. And of course, to me, it seems silly to have any debt at all with an income of $1.3 million a year.

WCI: All right. Let’s take another email question here. This one a little bit shorter. I’m grateful for your podcast and book. It’s saved me, in just a short time. That said, after reading your book and blogs and after listening to your podcasts, I’m overwhelmed with doom and gloom about starting so late. Honestly, I’m so discouraged, because all of your messages imply that we must start in residency or shortly thereafter or else. I’m starting to think that there’s no point for me to even try at this point.

WCI: I’m a single 47 year old, couple of kids that I’m just now starting with my retirement planning. I live in a $700,000 house. I’m just starting 529s now. I make 300 to $350,000 a year but I only have $5,000 left after bills are paid and I’m starting to save it all now. I began listening to your podcast to learn how to manage extra funds but I’m starting to get depressed about how much money I wasted over the past 15 years since getting out of residency. Should I just surrender to the fact that I’ll never be affluent?

WCI: Well, here’s the truth of the matter. No doc is ever really more than about ten years away from financial independence. And the reason why is that, if you become a super saver, you can start saving 60, 70, 80% of your net income, you can become financially independent in a very short period of time. Look at the physician on fire, right? Ten years out of residency, financially independent. Doing nothing more than practicing medicine and saving a big chunk of it.

WCI: So do you actually have to make some changes? Yeah. Your life’s going to have to change, if your first 10 or 15 years out of residency, you haven’t put anything away, give that another 10 or 15 years of doing the same thing, and you’re going to get what you’ve always gotten.

WCI: But if you are willing to change your behavior, maybe even downsize your house, maybe move, maybe work a little bit more or ask for a raise. Work on all these aspects of it, saving more, earning more and making sure your investments are working as hard as you do, you can certainly make a huge difference in your life. So I would not feel like 47 is old or you’re past it. All these same principles that I talk to 32-year-old residents about can be applied just as readily with a 47-year-old doc. Now if you’re 67, maybe we got to start talking about how you missed out on a lot of chances but at 47? I mean, you still got 20 years of your career ahead of you. Lots of docs become financially independent in less than 20 years. So I would not feel discouraged if you’re just picking up this podcast and you’re 45 or 50 or 55 or even 60. You still got a lot of time, not enough that you can waste any, but a lot of time that you can use to build wealth. That physician income can overcome a lot of financial mistakes, including screwing around for 10 or 15 years in the beginning of your career.

WCI: All right, let’s take some questions from the speed pipe. Our first one comes from Steve.

Steve: Hi, Dr. Dahle. I was just wondering if you could give your opinion on Dave Ramsey’s portfolio recommendation, which from what I understand, is 100% stocks for everyone, made up of 25% growth, 25% growth and income, 25% aggressive growth and 25% international. Thank you.

WCI: Steve wants my opinion on Dave Ramsey’s portfolio recommendation. Well, if you listen to Dave Ramsey for any period of time, you’ve heard him give this. He basically says put 25% in growth and income, 25% in growth, 25% in aggressive growth, and 25% in international and then of course, he’s got some big chunk of his income in real estate. So he’s just talking about the mutual funds here.

WCI: So there’s a few issues with this portfolio recommendation. The first one is nobody actually knows what it is, right? Growth and income is this category that’s used by mutual fund companies to mean all kinds of different things. Sometimes it means large growth stocks, sometimes it means large value stocks, sometimes it means large blend stocks. Sometimes it means a balanced fund, with 25% bonds or maybe 75% bonds. So depending on what mutual fund company you go to, their growth and income fund may be dramatically different so this isn’t really like recommending an asset class, it’s like recommending a type of mutual fund that people used as a description back in the ’90s. Nobody really uses this anymore and so I think in general, what he’s referring to when he talks about this is a large blend, large caps stocks.

WCI: We’re talking an S&P 500 index fund type fund. His next category is growth and if you pin him down on this, it seems like what he’s talking about is mid cap and large cap growth stocks so he’s talking about putting that first 25% into growth and income into a large blend or a large value, the second 25% into mid cap or large cap growth stocks, the third category’s aggressive growth and this is really hard to pin him down on. Sometimes this means mid caps stocks, sometimes this means small cap stocks. Sometimes this can mean emerging market stocks and so it’s really unclear exactly what asset allocation he’s recommending here but I think most of the time when I’ve heard him talk about it, he’s talking about small cap stocks so now we’ve got a quarter of your portfolio in large value, a quarter in mid to large cap growth stocks and a quarter in small cap growth stocks.

WCI: Then the last quarter’s international. Okay, that’s a little more straight forward. At least, it’s a broad category, but at least you know what it means. The problems with this asset allocation, well, number one, it’s a hundred percent stocks. Yes, that has the highest long-term expected return but that’s assuming you can tolerate the volatility of this portfolio and the vast majority of investors cannot. You don’t really know what your risk tolerance is until you’ve been through a big, nasty bear market and that is a terrible time to find out that your tolerance is not as high as you thought it was. I’ve got three partners who basically sold all their stocks low in 2008 and it had a dramatic effect on the size of their nest eggs. It’s really held them back in their financial lives.

WCI: You are far better off having a less aggressive portfolio than you are having one that’s just a little too aggressive for you. So I’d encourage you to dial back the risk a little bit by adding some bonds to the portfolio, at least until you’ve been through a bear market and know how you behave in that bear market.

WCI: The other problem with David Ramsey’s recommendation here is that he’s generally recommending actively managed mutual funds and the data’s pretty clear on this, over the long run, you’ve only got about a 10% chance of choosing an actively managed mutual fund that beats an index fund, a low-cost index fund in that category, in that asset class. And if you multiply that by multiple asset classes in your portfolio, the likelihood of choosing winners is even lower.

WCI: The worst part about it is that when these funds beat the index funds, they usually don’t beat them by very much. When they fail to beat the index funds, they often fail by a lot. And so there’s a lot of risk trying to pick active mutual fund managers that are going to beat an index fund. And frankly, I don’t even think it’s worth the risk. I just buy index funds. Yes, I know that in a long time period, five or ten or fifteen percent of the funds are going to beat my index fund. But I don’t have to try to guess which funds those are in advance. I don’t have to monitor those funds over the years and I can basically ensure that I get the market return, so that’s what I’ve chosen to do.

WCI: All right, our next question comes from Alexander.

Alexander: Hi, Jim. Thank you for the work that you do and I’m a big fan of yours. I was wondering if you could give me a hand regarding Vanguard’s funds? I’ve noticed many of the most common funds can be closed at times and there’s no good equivalent fund. Do you have any suggestions for how to manage this problem? Thanks for your help.

WCI: He’s basically asking what do you do about Vanguard closed funds. If you go to Vanguard, you go through their list of mutual funds, you will see that some of them are closed. This is for the most part, funds have been around for a long time and have done pretty well. They’ve got pretty good records and so what has happened there is the mutual fund managers have gone, this fund’s just getting too big. We cannot deploy these funds into our best ideas any quicker than we already are so we’re not taking new money so as I looked the other day, the funds that this applies to a Vanguard, include their dividend growth fund, their prime cap fund, their prime cap core fund and the capital opportunity fund.

WCI: I don’t actually invest in any of those closed funds. They’re basically all actively-managed funds or sector funds sometimes get closed temporarily so I don’t invest in those so it’s not really an issue. I just buy the index funds and they don’t seem to have a problem. They don’t seem to ever close. So that’s option number one that you have, you can just use index funds.

WCI: Option two is you can watch for future openings. After the funds start performing badly, people start pulling their money out and all of a sudden, you can put more money in there. Or after a market drop, a lot of times, they will take new money, as well. So if you have a bear market, you might check again and see if those funds are open if you really want to invest in them.

WCI: You might also find an exception in a 401K. Sometimes a different type of account still has access to that find, maybe it’s a 529, maybe it’s your 401K at work, maybe it’s an individual 401K. If you already have some funds in there, you can probably reinvest your dividends or maybe you can still invest more money. It just depends on the rules of the closure, but if you really want to get into a fund, it might be worth looking into that.

WCI: And then lastly, you can use an alternative actively managed fund from other companies that use a similar strategy. If you really like that strategy and that’s how you want that portion of your money to be managed, well, chances are good somebody at Fidelity or somewhere else is doing something similar, so you can do that.

WCI: But remember there are no called strikes in investments. There are no magic investments. There are no must-have investments. Avoid the fear of missing out that causes you to do dumb things with your money and so just because a fund is closed and had good past performance doesn’t mean you have to get in there to be financially successful. Far more of your financial success is about getting the high income, saving a big chunk of it and investing it in some reasonable way, rather than picking the exact perfect mutual fund that’s going to eke out another point three percent per year in return.

WCI: Okay, next question comes from Nick.
Nick: Hi, Dr. Dahle. I have a question about my retired parents in their early 60s, having a hundred percent of their 401Ks in stock equities, low-cost index funds. Both of them have pensions through their work and social security, as well, which will cover the bulk of their living expenses in retirement and I think that these guaranteed payments can act like the bonds in their portfolio, allowing the rest of that principle to grow at a higher rate by being invested a hundred percent in equities. What do you think about that?

WCI: Nick asks, my parents want to put a hundred percent of their retirement funds in low-cost index mutual funds because they have pensions. Is this okay? So I think what he’s asking is should my parents be a hundred percent stock because they have a pension? Well, I don’t think it’s a question for Nick. This is a question for Nick’s parents. I mean, what do your parents think? What was their behavior like during bear markets? Were they able to tolerate those losses? I remember in 2008, I was helping my parents manage their portfolio. Their portfolio was 50% stocks, 50% bonds. They lost about 18% of their money in 2008. I think I lost 30 something percent in a more aggressive portfolio. Mine was about 75% stocks.

WCI: And so realized that going a hundred percent stocks, you could lose, quite easily, in a nasty bear market, 50, 55% of your money and I think for a retiree, that’s very difficult to do and stay the course, even if you have pensions. Yes, if you can somehow do the mental manipulation to say, I’ve got a pension. I’m okay. I don’t need to sell. Then maybe you can pull it off, but I think for the most part, it’s a good idea for any investor and especially a retiree, to have at least some of their money in bonds.

WCI: Now if that money is truly not money that they’re going to be spending, truly it’s money for their heirs, it’s money for their charitable desires and they really don’t need it, they’re living one hundred percent off that pension, then sure, you can invest it more aggressively. But I’d be pretty careful going a hundred percent stocks for a retiree.

WCI: Next question comes from Justin.

Justin: Hi, Jim. First, I just want to say thank you so much for everything that you do. I’ve been listening to the White Coat Investor since I first started medical school about five years ago and you’ve been extremely helpful for me. My question for you is about target retirement funds, specifically cost basis. So if a target retirement fund holds other mutual funds, is the cost base listed, for instance, I’m on Vanguard and they have a cost basis of .18%. Is that the total cost basis that I’m paying or is the cost basis of the additional mutual funds kind of hidden in there somewhere?

Justin: I’m not sure if I’m clear with my question but I’m not quite sure how else to ask, thanks.

WCI: What’s the expense ratio of target retirement funds, is basically what he’s asking. Is there an additional expense ratio above and beyond the expenses of the underlying funds?

WCI: Now first thing we need to do is clarify something Justin asked. He was talking about cost basis when I think he meant to say expense ratios. Remember the cost basis is what you paid for an investment and matters when you’re investing in a taxable account and you’re trying to figure out how much of the sale is exempt from capital gains taxes but that is not the same thing as an expense ratio.

WCI: So what’s a target retirement fund? A target retirement fund is a fund of funds. Basically, it’s a mutual fund that goes and buys other mutual funds to make a mix, a diversified portfolio all in one mutual fund. So Vanguard has a series of these, they’re called target retirement funds. You can buy them at other places, as well. Schwab has some. Fidelity has a set of nice ones and a set of kind of more expensive, crummier ones they sell through advisors and of course, the TSP, the federal 401K, has life cycle funds.

WCI: At Vanguard, the expense ratios for these target retirement funds range from 12 to 15 basis points, so that’s .12 to .15 percent per year so that’s a pretty cheap mutual fund. It’s not absolutely the cheapest you can get. At Fidelity, you can now buy an index fund with a zero percent expense ratio. But most of the cheap funds are .03 to .1 percent per year.

WCI: So this 12 to 15 basis points in the target retirement funds is slightly higher than what you could build those portfolios for yourself. In exchange, what do you get? Well, you get automatic rebalancing. You get a lower minimum then you would have into all those funds and you get a professional recommendation on asset allocation, so I think that’s worth something. A few basis points doesn’t seem unreasonable to pay for that.

WCI: What you need to know, though, is that every fund family answers this question differently, as to whether you pay an additional expense ratio in addition to the expense ratios of the underlying funds. Unlike many fund families, the Vanguard ones don’t have any additional fees. You’re not paying both the underlying expense ratios and the target retirement fund expense ratio. That’s not the case with all companies. A TSP and T. Rowe Price, they do it similarly to Vanguard and the TSP fees are so low anyway, it really doesn’t matter. I think Fidelity and American Century in the last year or two, have also adopted this approach, which is a change from the way it was before. I think Schwab’s also now doing it this way but it’s a good idea to know how your fund of funds addresses this issue and the only way to do it is to look at their prospectus and see or even call them up and ask them.

WCI: But the big fund companies, the ones where most of the money is in these target retirement funds, it looks like they’re moving toward doing it the right way for the investors.

WCI: Okay, next question comes from Tim.

Tim: Hi, Jim. This is Tim calling from San Francisco. I was walking through Golden Gate Park with my toddler when I heard you mention that you were saving with future generations in mind. You said you hoped to help your children and even grandchildren achieve financial security through your savings and investment. Do you worry that you will debilitate or otherwise spoil your children through giving, especially now that you are a super saver? What do you think about leaving your children nothing?

WCI: Okay, Tim is basically asking, do you worry you’ll spoil or debilitate your children by leaving a large inheritance? What do you think about leaving them nothing?
WCI: Well, I’m not really sure what Tim’s referring to here. I mean, I have a plan to give my kids a fair amount of money in their 20s but I haven’t really decided what to do after that. In fact, all they may get by way of an inheritance is the opportunity to manage charitable foundation that we leave behind. But what they are going to get for sure, is financial literacy. I’m going to teach them not only how to make money but what to do with it once they’ve made it. And so that’s probably the most valuable inheritance I’m going to give them.

WCI: But we’ve also been funding Roth IRAs for them with any earned income they earn. We give them a daddy match on that. They get to spend the money they earn or an equivalent amount to the money they earn that I give them and the money they earn actually goes into the Roth IRA. They also have 529 accounts that we’ve funded to help pay for their college and then they have a 20s fund that we invest in a UGMA or a UTMA account. This is basically a taxable account for a minor, that at age 18 or age 21, becomes their money to spend on whatever they want. They can spend it on hookers and cocaine if they want. It’s up to them, really, when they reach that age. But that’s their 20s fund and our hope is that they’ll spend that on something good. A car, a home down payment, summer in Europe, missionary work, those sorts of things. At this time in life, when you don’t have a lot of earning capacity, but you have a lot of need for cash, that that money will help fill some of the need.

WCI: Now, do we plan to leave them millions? Well, probably going to come down to how well they can show us they can manage money throughout their lives. If not, it may all just go to charity. But can you spoil your children? Absolutely. And so I think that’s something we all struggle with and a lot of it comes down to teaching them as you go along. You got to teach them how to use money effectively. You got to teach them what money means. You got to teach them where money comes from. You ask any of my kids where money comes from and they’ll answer that it comes from work and so I think it really comes down to how you’re teaching them as to whether you can get away with leaving them a large inheritance or not. I think you probably can with the right people. And I think there’s some people that you absolutely can’t leave them anything or they’ll go spend it on heroin. So you really have to know your kids.

WCI: This doc says I worry a little bit about giving them so little because they could be really far behind in an era when many people are inheriting substantial sums. Does that mean my grandkids are going to in crummy schools, et cetera?

WCI: Well, I think in moderation, all things. I think you’re absolutely right. That a lot of people these days, especially as the baby boomers pass on, are going to be starting life a few steps ahead than people that don’t have these sorts of inheritances and so if you want your grandkids in the nice schools, you may have to help them with the down payment on their house but try to find moderation in all things and focus on what the kids are learning.

WCI: Man, seems like we got all guys asking questions today. Ladies, send in your questions on the podcast. Very easy to leave a speak pipe question. You just go to www.speakpipe.com/whitecoatinvestor and leave your questions. We’ll get them on the podcast.

WCI: All right, Jonathan asks a question here. Let’s listen to this.

Jonathan: Hi, Dr. Dahle. This is Jonathan. I’m a dentist in California and I love the White Coat, appreciate all the work you do there. It’s been a tremendous blessing in my life and the life of my family. Keep up the great work. Couple quick questions for you. One, there’s a total stock market ETF called RSP. It’s an equally weighted ETF. I wanted to hear your thoughts on that versus something like VTI. It’s posted better returns over the last ten years or so and it is a total stock market index fund. It does have a greater expense ratio. Just wanted to see your thoughts about it.

Jonathan: Also, I know you’re not a huge fan of the simple IRA, but it is an extra tax account that is available to small employers such as myself that isn’t terribly expensive to administer. Your biggest critique of the simple IRA has been that it prevents you from doing back door Roth IRAs. Is there anything wrong with contributing to a simple IRA and then rolling it over into a 401K? Is there a specified period of time that the funds need to be in the simple IRA account and as long as you get to a zero balance by the end of the calendar year, you avoid the pro rata rule implications? Appreciate your thoughts. Keep up the good work.

WCI: So Jonathan is talking about RSP. This is an equally weighted exchange traded fund. So if you look this up, you see the returns over the last 15 years are 9.52% versus the Vanguard total stock market index fund of 9.12%. So a little bit higher past returns over the last 15 years.

WCI: Well, here’s what you need to know about a fund like this. First, the higher expenses are guaranteed. You’re also going to have higher transaction costs in the fund because they are going to be buying and selling things a lot more frequently in order to keep the equal weighting among the different stocks. So it’s not going to be nearly as good in a taxable account because it’s going to be distributing a lot more capital gains and particularly short-term capital gains.

WCI: And the other thing to keep in mind with an equal weighting strategy, where rather than taking a capitalization weighted, where you own a lot more Google than you do some tiny company you’ve never heard of, is when you own an equally weighted strategy, you actually have a lot more of your money in small stocks and value stocks then you otherwise would. Now if you paid any attention to the literature on factor investing, you’ll know that small stocks and value stocks are considered riskier and thus, over the long-term, have had higher returns than large cap and growth stocks and so you would expect a fund that has more of your money invested in smaller and value stocks to have a higher long-term return than a total stock market fund. And so it shouldn’t be any surprise at all to you, that over a 15 year time period, you see a little higher return out of this.

WCI: Personally, I think you’re probably better off just buying a total stock market fund and if you want to tilt towards small and value stocks, adding a small value index fund on top of that. But it’s not crazy to do this sort of an equally weighted ETF in a tax-protected account if you really want to give it a try. It’s not an insane way to invest and still fairly passive. Just realize there’s some additional costs there and realize where your extra return is likely to come from. It’s not the magic equal weighting. It’s just a small and value tilt.

WCI: Another question he’s asking here is what do you think about simple IRAs? Well, simple IRAs have their issues. One, they have low contribution limits. Two, you can’t do rollovers for two years and three, they get counted in that pro rata calculation for your backdoor Roth IRA, so if you’re using a simple IRA, that’s one your employer offers or if you’ve stupidly chosen that for your self-employed work, you kind of hosed yourself on the backdoor Roth IRAs. And so not a big fan of simple IRAs. Sometimes it makes sense for a small practice with a few employees, but in general, this is one of my least favorite self-employed retirement accounts.

WCI: Okay, next question comes from an anonymous asker.

Anonymous: Thank you for all your help and guidance over the years, really appreciate what you do. My question. I’m currently a gastroenterologist, first year out. I was able to refinance my student loans at a favorable 2.5% and expect repayment in about seven years, if not sooner. However, the real question is for my wife, who is a psychologist and starting her private practice. Very low overhead, however, we don’t expect there to be a real full income for the first couple years.

Anonymous: Her student loans are above 300,000, more than mine and on paper, she doesn’t look very good for refinancing, even with me as a co-signer. Again, her loans are over 300,000. Her sequences pretty much range from 5% to 8%, which are terrible and we’ve looked into refinancing with other companies, however, terms are 15 plus years and refinancing rates of about six, maybe seven percent. So not good. Ultimately, my question was whether we should mess around with a home equity loan. We currently are renting, trying to cut down costs. However, if we can get a low home equity loan, pay off our student loans and deal with a lower interest rate through the home equity loan, I was wondering if that might be another way to pursue things for the next couple years until her practice picks up.

WCI: Okay, this is a psychologist wife, has $300,000 in student loans at 5 to 8%, and he’s a gastroenterologist. They might be able to refinance these loans to 6 to 7% for 15 year terms. Should we use a home equity loan?

WCI: Well, there’s a lot of issues here. First of all, if you’re renting, where’s that home equity going to come from? It doesn’t magically appear when you buy the home. Home equity either comes from a down payment you put in there, from mortgage principle that you’ve paid down or from appreciation on the home. There’s no instant equity as soon as you buy it, unless you bought it for a price much less than what it’s worth. And so I wouldn’t necessarily go first to that. I think I might look into refinancing first, if you can get a lower rate, or paying them down and then refinancing or maybe even putting off the purchase for a while to pay down some of these loans, rather than going to a home equity loan.

WCI: That said, if you’re in a position where you’ve got a bunch of home equity, a home equity loan is a pretty good way to lower your interest rate. Regulations have changed a little bit recently. It used to be you could deduct a certain amount of a home equity loan that wasn’t necessarily being used to buy or improve the property. They’re tightening that up quite a bit. However, money is still fungible. The truth is, you can probably still slosh it around a little bit and make it somewhat deductible but you’d have to look into the details there.

WCI: Obviously, borrowing $300,000 to become a psychologist, was a bad business decision. However, marrying a GI doc was a good one so you put the two together and you’re probably doing okay. But assuming she’s not going for public service loan forgiveness, I’d probably just put every available dollar toward her loans and let the 2.5% ones that he’s got ride. The attitude to take when you get married is this is our money. It’s our loans. They’re our assets. They’re our income. Combine it all. Assuming this marriage is stable and looks like it’s going to be long-term, and work on it together. Working together matters a lot more than what each person brought into the marriage.

WCI: Next question is from Jason.

Jason: I am a physician in my mid-forties who is considering buying a whole life insurance policy. My thought was to take my emergency fund dollars and invest it over the next five to ten years in this whole life policy that could be borrowed against, should an emergency or crisis situation arise, my thought was that I would get a return that was better than my options in a liquid bond portfolio or a savings account at the bank, while also having the advantage of a death benefit should something unexpected happen. I know that in general, life insurance policies have a lower return but I wanted to hear your thoughts, betting this against other vehicles for holding an emergency fund. Thank you.

WCI: Okay, Jason is asking should I put my emergency fund money into a whole life policy? Well, I don’t think you should buy a whole life policy in the first place, for any purpose. So I certainly wouldn’t put your emergency fund money in there. One of the big downsides of a whole life policy is that your returns are negative for the first few years. Even on a good policy, your returns are negative for five years. On a bad policy, they might be negative for 15 or 20 years. And so one of the nice things about an emergency fund, what it’s supposed to have, is its supposed to have stability of principle. You want your money there when you need. You need it liquid and you need it safe.

WCI: And I don’t think a whole life insurance policy really provides that. If you turn around and you want that money in a year because you need it to buy a car or you’re out of work or something, and all of a sudden, a third of it’s gone. That’s not a very good emergency fund. So I don’t think that’s a really great idea there. I would stick with putting your emergency fund into CDs or I bonds or probably more frequently, just a high-yield savings account or a money market fund.

WCI: Okay, next question, also from Jason.

Jason: My question today regards to qualified retirement accounts. I’m a physician in my mid-forties and have been heavily contributing through the years to both a defined benefit and a defined contribution plan and currently have about $2 million between those accounts. My question today specifically focuses on what the best path is for somebody who expects to have a significant portion of their income be at the highest marginal tax rate both before and after retirement. I’ve been very fortunate in both my practice income, as well as investments through the years, that unless something drastic changes, that will hopefully hold true.

Jason: I’m beginning to question whether or not I should continue to heavily contribute to these qualified retirement accounts, given the limited investment vehicles that are available that mostly produce single-digit returns as opposed to simply taking that money as taxable income and investing through the years in vehicles that can produce low double-digit returns, such as hard money lending in the real estate space or other things like that. Wanted to hear your thoughts given that specific set of parameters when one expects to be in the highest tax bracket both before and after retirement. Thank you.

WCI: Okay, this is a doc with $2 million in tax-deferred accounts in his forties. Okay, so we’re a super saver. That’s what we’re saying here. We got $2 million already in tax-deferred accounts in my forties. What should I do now if I expect to be in the top tax bracket now and in retirement? Well, he’s asking should I invest in real estate or hard money lending instead? Well, that’s fine, if you want to have those assets in your portfolio. But the bottom line here is the key, if you’re really worried you’re going to have a required minimum distribution problem, is to do Roth conversions. Start doing Roth contributions instead of tax-deferred contributions. Make sure you’re getting your backdoor Roth IRA contributions in every year and maybe even do some Roth conversions each year. That basically allows you to move some of your money out of the taxable account, moving it into tax protected accounts. It lowers the size of your future required minimum distributions and if you’re going to be paying at the highest tax bracket anyway later, you might as well do it now.

WCI: Another option that you might take on in that situation, of course, is a self-directed IRA or 401K. Particularly, for something that’s pretty tax inefficient, like hard money loans, these are basically investments that pay you 7, 8, 10, 12 percent and it’s totally, ordinary, taxable income. So you’re going to pay taxes on it every single year at your marginal tax bracket. If you do that, inside a self-directed IRA or 401K, you can save on those taxes. So that’s a pretty good asset to move into your tax-protected accounts. Of course, that brings on some asset protection benefits, too, right? Because retirement accounts generally get much better asset protection than a taxable account. So you have more of your assets in asset-protected accounts than you had previously.

WCI: All right. I think that’s all the questions we’re going to do today. Are you tired of the ups and downs of the stock market? Private real estate is known for its stability and high returns and Origin Investments has a great new fund that delivers both. The Origin Income Plus Fund is a diversified, private real estate fund targeting a total annual return of nine to eleven percent, inclusive of six percent in annual distributions. The principles are investing ten million of their personal capital alongside investors in the fund.
WCI: Learn more by visiting www.originincomeplus.com/wci. That’s www.originincomeplus.com/wci. Head up, shoulders back. You’ve got this. 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 is not a licensed accountant, attorney or financial advisor so this podcast is for your entertainment and information only and should not be considered as official, personalized financial advice.