Podcast #108 Show Notes: What is Value Averaging and How Does it Work?

insurance score

A listener asked about value averaging. This is separate from dollar cost averaging where you are spreading out a lump sum investment over time. The idea behind value averaging is you decide how much money you want to have in your investing account at a certain age, and if the market does poorly, then you invest more money into the market so you’re on that line, that value averaging line. If the market does really well, you don’t invest as much money or you even take money out of your investments and put it into a side fund, which is a very safe fund, like a money market fund or a high yield savings account or maybe some high-quality short term bonds. Then when the market does poorly, you move it from the side fund into stocks. The idea is that you set up and follow this glide path so no matter what the market does, it’s forcing you to buy low and sell high. There is some good data that shows this works pretty well. Do I do it? No, and I discuss why not in this podcast.

 

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Quote of the Day

Today’s quote the day comes from Benjamin Graham who said,

“the investor’s chief problem and his worst enemy is likely to be himself. In the end how your investments behave is much less important than how you behave.”

Value Averaging

The idea behind value averaging is great in that it forces you to buy low and sell high. There is some good data that shows this works pretty well. Do I do it? No. My problem with value averaging is mainly the side fund and the complexity. I don’t like the opportunity cost of having money sitting in the side fund. I would rather have it fully invested all the time, but this is something that every investor’s going to have to decide on their own.

Value Averaging May Give You an Advantage

value averagingI recommend you read the book Value Averaging. It’s a complex book, lots of math in it. If you can’t get through that book, you have no business doing value averaging. If you don’t enjoy spreadsheeting out your investments, don’t do value averaging. This is a relatively complex technique. If you want to do it, I think it’s fine. I think it may even give you an advantage but realize that you’re going to have to do it the right way. You can’t just do it halfway and mess it up a little bit and think you’re going to come out okay. You either do it right or don’t do it at all.

I Don’t Need Value Averaging to Reach My Goals

I realized early on that I didn’t need to do stuff like this in order to reach my financial goals. There are lots of other things like this that I’ve chosen not to do, and they’re not necessarily stupid, I just don’t need to do them in order to win the game. The truth is, in investing, you only have to win the game once. You don’t have to come up with 20 different ways to do it. One reasonable way to invest, one reasonable way to make money, is perfectly fine.

Reader and Listener Q&A

Total Stock Market Index Fund vs S&P 500 Index

“I just opened my first Vanguard accounts, looking to start doing some investing for the very first time. I’m in my early 40s, debt-free, make around $225,000 a year. I’ve noticed that the total stock market index fund is one of your favorites. I would like to put roughly 50% in that, maybe 25% into S&P 500 index, and the balance of the 25 in Small-Cap and international. Could you offer some thoughts on that and also what Small-Cap and international you could suggest I start looking into?”

It is silly to own both a total stock market index fund and an S&P 500 index fund. The correlation between these two mutual funds is 0.99. They’re basically the same fund. You should expect the same performance out of them. The total stock market fund is a little bit more tax efficient. It includes mid caps and small caps, but the vast majority of its performance is explained by large cap stocks. So a portfolio that’s 50% total stock market and 25% 500 index is basically a portfolio that’s 75% total stock market. I think that’s probably too big of a chunk.

I prefer a little bit more diversification than that. Whether you add some bonds to it, whether you add some international stocks to it, whether you add some real estate to it, I think it’s worthwhile having a little more diversification there than most of your portfolio basically in US large cap stocks. Now I love total stock market fund. It’s 25% of my portfolio. It’s a major part of my stocks, but I think 75% is just a little bit too much. He talks about adding international stocks, which as I mentioned, I think is a good idea at some percentage between 20% and 50% of the stocks in your portfolio.

Now small, once you’re tilting a portfolio towards small, if you just buy a total stock market index, you’re getting small stocks in that, but once you’re adding a separate small fund, you are tilting the portfolio towards small. So in order to do that, you better believe that small stocks really are going to outperform the overall market over your investing horizon. Small is a factor. You’re now factor investing once you add a small fund to the portfolio. And if you’re going to do that, you owe it to yourself to at least look at some of the other factors. For example, one of the more common ones is the value factor and when you actually do the research on how it’s performed in the past, value has been a better diversifier than small.

So if you’re just going to add one factor to a portfolio, I would add value before I added small. But I think what most people that believe in factor investing do is they add a small value fund and that way they’re getting both some value and some small. That’s the way I divide up my US stock exposure. My US stocks total 40% of my portfolio and 25% of the portfolio is in total stock market and 15% is in the Vanguard small value fund.

That enables me to have a tilt to small and value. So if those factors really do show up over my investing horizon, I will be rewarded for it. I have most of the portfolio in just the overall market such that if small and value turn out not to be real factors over the next 30 or 40 or 50 years, at least I’m not penalized too badly. If you’re going to just use one international fund, I think the best one is a total international stock fund. It gets you developed markets in Europe, Japan, and the Pacific and also gets you emerging markets all at one easy stop, at a relatively low price, that is very tax efficient.

Credit Card Debt and Credit Scores

A listener asked should he get a 0% credit card in order to pay off his credit cards? He is a little worried about the hit to his credit score.

This is a question of behavior versus math. Yes, if you transfer your debts that are now at 9% or 15% or 30% onto a 0% card, mathematically you’ll be able to pay off the debt faster. Simply more of your payments are going toward principal rather than interest. But the issue is more of a behavioral issue. As a general rule, you don’t get into debt because you have trouble understanding math. You get into debt because your behavior is bad. Particularly bad debt like credit card debt. You make mistakes, you buy things you shouldn’t have bought, you finance them. Now all of a sudden you’ve have this 19% debt.

So the solution to a behavioral problem is not a mathematical solution. Just reducing your interest rate is a mathematical solution. Too many people who do this, transfer everything onto a 0% card, then go back and charge up the 19% card again. Obviously, that’s not going to help you get out of debt. If your problem is primarily behavioral the solution to that is changing your behavior. You have to spend less, you have to put big chunks of money onto that credit card and pay it off.

Now can you do both? Yes, you can move it to a 0% credit card, you can cut up the old cards, you can close the accounts and then put big chunks onto the 0% credit card and get it paid off over the next year while it’s still at 0% and that will help. But be aware that just refinancing doesn’t do anything for the debt. The debt is all still there and the way you get rid of it is by throwing big chunks of money at it.

In regards to credit scores here is what you need to know.  If you pay your bills as you agreed to pay your bills, you will have a credit score that’s high enough to do anything you want a credit score for. You’ll be able to get the jobs you need. You’ll be able to get the utilities you need, you’ll be able to get a mortgage.  No problem. So pay your bills, your credit score will be fine. The number one factor that goes into your credit score is whether you pay your bills.

After that, utilization of available credit matters. The idea is you want to use less of your available credit. That makes you look more responsible, I suppose. So if you close credit cards, sometimes that can drop your credit score. Of course, applying for new credit also drops your credit score a little bit. So going and applying for a 0% credit card will drop your credit score.

But the truth is, what do you need a credit score for? Unless you’re about to apply for a mortgage or you’re about to refinance your student loans, who cares what your credit score is. Get yourself in a position where you don’t care about your credit score. If you’re in that position where you have to watch your credit score like a hawk, you need to make other changes in your financial life besides just monitoring your credit score.

Which Retirement Accounts to Max Out First

“I’m an emergency physician on a 1099 currently maxing out my individual 401K, backdoor Roth IRAs, and an HSA. My wife works part time and she has the option of investing in a 457B plan, a 401A plan and a 403B plan. Also something called a retirement savings plan. I was wondering if there is any preference on which one of these to max out first and which one I should go to next.”

As a contractor paid on a 1099 his course is pretty straight forward. You get an individual 401K, you do your backdoor Roth IRA, an HSA, if you’re using a high deductible health plan, maybe a personal defined benefit cash balance plan, if you really want to save a lot of money, especially if you’re older, and everything else goes in taxable. It’s really not that complicated.

Her situation is much more complicated. She’s got a 401A, 457B, a 403B and some other plan that none of us even know what is going on with. We would have to read the plan document and know what this Retirement Savings plan is, but let’s talk briefly about these types of accounts because they’re very common in the academic world.

A 401A in general is all employer money. It’s tax deferred money. The employer puts in however much they’re going to put in. Maybe it’s eight or 10% of your income and that’s that. Until you close it or leave the employer, you can’t really do much about it. You may be able to select investments, but that’s about it. Eventually, when you leave or separate or retire, you can roll it into an IRA or another 401K.

A 403B is basically the academic equivalent of a 401k. In non-profits, you tend to see 403Bs instead. There are some very minor differences in the rules between a 403B and a 401K but in essence, it’s the same thing. They’re both defined contribution plans. You can put an employee contribution of up to $19,000 per year if you’re under 50, plus a catch-up contribution if you’re 50 plus, maybe the employer puts matching money in it. In my experience, when you also have a 401A, they don’t tend to put matching money into the 403B. They basically look at that as all going into the 401A.

The other account we’re talking about here is a 457B. Now a governmental 457B, like a lot of academic docs have, is a pretty good account. The risk of your employer going under is pretty low. Remember that the 457B is technically employer money until you take it out of the account. The options when you take it out of a governmental 457 are pretty good. You can just put it into an IRA or a 401K if nothing else. When you’re looking at those non-governmental 457, that’s when you need to worry about how strong the employer is, whether that money could become subject to your employer’s creditors and what the distribution options are.

But if you have a governmental 457B and you don’t think your state hospital is going out of business anytime soon and the investment options are reasonable then go ahead and max that out. The contribution amount is 19,000 per year. It’s totally separate from the contribution amount for a 403B or a 401K. Now in this situation, it sounds like she is not working full time so she may be limited in how much money she can put into all these accounts. But certainly, they can live off his money and defer her entire income into these accounts up to the amounts that she’s allowed to defer. So that’s a great opportunity for them to save even more money. But honestly, if they’re maxing out his individual 401K, both their backdoor Roth IRAs, the 401A, 457B, and 403B, they’re well up over $100,000 a year in retirement savings. That is going to be enough to get most doctors where they want to go.

Due Diligence in Real Estate Investing

“I’m interested in increasing my allocation to real estate and I’ve looked at some of the companies that you’ve used for your real estate portfolio such as 37th Parallel and Origin Investments. I was wondering what you do for your due diligence beyond simply reading the offering. Do you have any specific resources that you use?”

If you’re going to branch out from REIT Index Funds with your real estate investing, keep in mind, first of all, Bill Bernstein’s advice last week, on the podcast. What did he say? Basically, “no, I think the risks here are more than the rewards.” So don’t feel like you have to do this. It’s totally an optional asset class.

If you want to get into it, you can, but if you’re going to get into it, you do need to do due diligence. What can you do? Here is where I would start:

  1. Read Peter Kim’s blog, Passive Income MD. He focuses a lot more on these sorts of syndications and other sources of passive income and real estate investing than I do.
  2. Read Crowd Due Diligence, CrowdDD. This is a group of accredited investors that try to crowdsource the due diligence on these investments.  I think getting 30 or 40 different opinions on an investment rather than just your own and what you can dig out of the paper is very helpful. You can also learn from people who have done this on dozens of other investments in the past.
  3. Another great site is Ian Ippolito’s site, realestatecrowdfundingreview.com. He does something similar to Crowd Due Diligence. He does do some grouping of investor money into some of these investments though, so keep the conflicts of interest in mind, but it’s a great place to get more information.
  4. Keep in mind that diversification protects you from what you don’t know. If you don’t feel like you can do really good due diligence, be sure to spread your bets around so you don’t get burned if one goes bad.  If you’re only going to put $100,000 into these sorts of investments, you don’t want to put it all into one fund or into one apartment building. You want to spread this around, look for things with lower minimum investments like two thousand, five thousand, ten thousand dollar investments to spread your bets out a little bit. If you’re putting $1 million into this, then sure a $100,000 investment into one particular fund is probably a reasonable thing to do. My first dozen syndications that I did were two to $10,000 a piece. I wanted to watch them, I wanted to see them go round trip and I literally watched for two, three, four years to see what happened with these things. I was pretty happy with what I saw and so I’ve gradually up the amounts that I invest.
  5. Google the names of the principals in the firm and the firm itself in connection with scam or fraud or jail time or arrest and see if anything pops up. You might be surprised what pops up with some of these people.
  6. You can talk to them on the phone and maybe even fly out there and see them in person. You can walk around the property for a lot of these syndications and look at it yourself. You can talk to current and, if possible, even previous investors. You can even do a background check on the principals if you like. Bear in mind for small investment, that might not make financial sense.
  7. You can also run it by your own team of professionals. If you have an accountant, a financial adviser, or an attorney you can run these investments by them.

But here’s the deal. There’s no reason you should feel like you have to do this solo. You can find other investors, you can find other professionals. If you feel really solo, maybe you ought to just avoid it altogether. And of course there is no rush. Most of these investments do have closing dates. It’s going to close in a month or two months or six months, but there is going to be another investment down the road. Most of these people do private funds, they open a second fund, third fund, fourth fund, fifth fund. There’s going to be another one in a year. So there is no big rush and there are dozens of companies out there doing it. So if there’s anything that makes you feel uncomfortable about a particular deal, just skip it and move on to the next one.

When Can you Buy a Ferrari?

“Let’s say you’ve been a really frugal guy all your life and been reasonable with money. You have all your ducks in a row, but ever since you were a little kid, you wanted to buy a really nice car. You’re a car person. I know you addressed this sometimes in the past talking about buying a Tesla. But I’m not talking about a Tesla. I’m talking about like a brand new Ferrari F8 Tributo. Something that’s going to depreciate like a mother, and it’s going to cost $350,000. I know probably most readers would never say that this is ever wise, but assuming you really wanted to do this your entire life, at what point would you say it is not entirely unreasonable to do that?  What cross roads between income and net worth?”

When is buying a $350,000 car no longer insane? Clearly, this is insane for a resident to do. Clearly, this is insane for someone who owes $400,000 in student loans. But when does it not become insane? I think there is a lot to think about here. When this question came across our desk, Katie and I were laughing a bit about it, and she says, “Well, when you have adequate retirement savings and cash set aside to do it, you can buy it. You just can’t buy it on credit.” I agree with that. If you’re going to buy something like this, it needs to be cash. This is not something you go and borrow for. But let’s distinguish here between basic transportation and what this really is, which is one of your financial goals.

Basic transportation is available for $5,000 or less. You can go out today and buy an economy car with 100,000 miles on it, that’s less than 10 years old. That is going to get you from point A to point B reliably for the next two-five years and do just fine. Yes, you’re going to have to do some repairs every now and then. Maybe it doesn’t start once or twice in those five years and you’ve have to get a jump and buy a new battery or something, but it’s essentially reliable transportation. That’s what reliable transportation costs.

Anytime you’re spending more than that on a car, you are buying some amount of luxury. Maybe it’s a nicer car, maybe it’s a newer car, maybe it has some other features, four-wheel drive or a TV, a navigational system, more safety features.  When you’re talking about a car that costs $350,000, we’re way beyond the Teslas I like to make fun of.  There are people listening to this podcast who live in homes that are not worth $350,000. But if this truly is something that’s important to you in your life, this is something you value a great deal, this is an important financial goal for you, then you treat it like your other important financial goals. Like retirement, like saving up for college, like saving up a down payment or paying off a mortgage. You just put it on your list and you dedicate some of your income towards reaching that goal and when you have enough money, you buy the goal. That’s how you do it.

Now, bear in mind when you’re going to blow $350,000 on a car that there are some real consequences to doing that. You’re probably going to have to work later, maybe 25 years instead of 20 years.  It really could make that big of a difference in your finances if you buy this in the first half of your career. So don’t underestimate how much of an impact something like this can have on your future financial life. But if it’s truly worth it to you, if you run the numbers, and this is something where you go, “Hey, I really want this and it’s worth working longer to me.” If that’s worth it to you, then go ahead, knock yourself out.

It is not like we’ve never done something like this. We have a boat. We bought brand new, it was more expensive than a lot of people’s Teslas. We walked into the dealership and we paid cash for it.  We really wanted it and we saved up for it and we’re glad we bought. Maybe you’ll feel the same way about a $350,000 Ferrari, but do it the right way. So it’s a blessing in your life and not a curse.

Dave Ramsey’s guideline on vehicles is that you should not own more that is going down in value, things with motors like cars and boats and airplanes, than 50% of your income. So if you’re going to own a $350,000 Ferrari, and no other vehicles, Dave would say you need an income of at least $700,000 to do that. Is that a little too strict? It seems completely reasonable to me. If you have a lower income and also have five or $10 million in the bank, then obviously this is going to be a relatively small part of your financial life and you can probably also afford it even if you don’t meet that guideline.

Probably the closest thing to this in our life is a home renovation we are very seriously embarking on this year. It’s going to cost us a ton of money. It’s going to cost more than we paid for the house initially. But how are we doing it? Well, we’ve got our financial ducks in a row. We’ve met our retirement savings goals, we’ve met our college savings goals, we have paid off all our debt and we’re saving up the money in cash to cash flow it as we go along. Now, if you can do that for your Ferrari, then I think you’re in a similar position. You can’t take the money with you when you go and if this is what you want to spend your money on, if you’re truly a car guy, then go for it, enjoy it.

A Single Mutual Fund for all Investment Accounts

“Could it be reasonable to use a single mutual fund for all of my different investment accounts. I would prefer not to hire a financial advisor. I plan to basically stick to your advice and save a lot, continue to live like a resident for a while, pay off my debt quickly, max out 401K, health savings account, backdoor Roth and put the rest in a taxable account and probably a 529 as well. My question is, would it be reasonable to just use a single mutual fund such as a Vanguard Target Retirement-Date Fund for every single one of these different accounts? It’s basically a mix of stock and bond index funds, has a 0.15% fee, rebalances for you yearly, decreases the ratio of stocks to bonds each year. I feel like this would be really easy and simple and hands off and could eliminate the need for an advisor. But I just worry it’s too overly simplistic and that I could be missing something. What are your thoughts?”

Is it reasonable to use a single mutual funds such as a target retirement fund? Of course it’s reasonable. Mike Piper does this. His only investment is a Vanguard Life Strategy Moderate Growth Fund. It’s about 60% stocks and 40% bonds and holds some international stocks and bonds in it. Some TIPS I think are in it as well. It’s basically a fund of funds, having five different low cost index mutual funds in it with no additional charge on top of it. That is a reasonable thing to do. It certainly is a way to keep things simple and to keep you from having to hire a financial advisor if you don’t want to delve into this a little bit more.

However, I’m not a big fan of it. The reason why is I think you’re giving up a fair amount of return and it’s probably enough of a return that with the additional return you could hire a financial advisor to handle all this for you. Let me explain what I mean. You’re losing return in two places when you do this. Assuming you have a taxable account, when you’re using a target retirement fund, in that taxable account, you are placing taxable bonds into your taxable account. And for most doctors and other high income professionals, that’s the wrong kind of bond to have in that account. That is assuming it’s right for you to have bonds in that account in the first place. But if you’re going to buy bonds in a taxable account, you probably want to use Muni bonds and that’s not what they have in a target retirement fund.

So not only are you buying bonds there, but as the years go by, the fund will be more and more bonds and that will become more and more tax inefficient in your taxable account. So just getting the asset location right probably adds a little bit of return to your portfolio. Some people have estimated as much as 0.4 or 0.5% a year to get your asset location right. I’m not sure it’s quite that much money, but certainly it’s something.

The other thing is you are not getting any sort of factor investing when you do that. You’re not tilting towards small or value or momentum or any of these other factors, so if you don’t believe in factor investing, that’s fine. If you do believe that small and value stocks are going to outperform the market over your investment horizon, then you’re essentially giving up that extra return in order for simplicity’s sake. I think that probably you’re going to make money tilting your portfolio towards small and value and if you’re giving that up too in addition to the asset location issue, I think there’s probably enough return there to justify hiring an advisor that can probably get you the same or better return for less hassle in your life than doing this all on your own with just a target retirement fund, but to each their own.

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If you believe that just total market investing is the way to go, keeping it as simple as possible is best. This is certainly a reasonable way to invest. You’re investing better than 95% of the investors out there who are doing stupid stuff. It also helps you probably to stay the course behavior wise, to just have a simple investing strategy like this, and that’s worth something, too.

Retirement Savings % When You Will Get a Pension

“Does the general recommendation to save 15 to 20% of your gross income for retirement still apply if there’s a pension that will kick in once one is retired? How do you figure out how much to save for a safe and comfortable retirement as salaries at the VA are lower than the private sector with no opportunity for any business expense deductions, saving 20% is more difficult than other situations.”

Yes, pensions are worth something. The further away you are from the pension, the less it’s worth because you might leave and not get it or the rules change or the employer goes out of business. Pensions from private employers go under all the time. So I don’t think relying wholly on a pension is a good idea. Does the fact that you’re going to have a pension allow you to save a little bit less than you otherwise would? It probably does. Instead of having to save 20%, maybe you only have to save 10 or 15% assuming you have a very sure looking pension and you’re not that far away from it. But what’s the big harm if you put a little bit extra in there early in your career?

So now you have more options. You can leave the employer sooner. You don’t have to stay until you get the pension. I would still continue to save even if you qualify for a pension. It probably gives you permission to save a little bit less, but not dramatically less.

 

Paying off Your Debts as a Guaranteed Return

“I got a medical residency relocation loan with Sallie Mae of about $20,000, six months before residency while I studied for my steps. My interest rate is about 10.5%. I don’t have to make any payments until after residency. I am currently contributing to my match on my employer’s 403B and I’m also able to contribute around $400 monthly to a Roth IRA with a Vanguard Target Retirement-Date Fund, but during this time I have not paid $1 towards my loan. I thought about refinancing, but most major companies don’t see this loan as your average student loan and will not refinance with the best rates. Do you think it is better to continue with my investment strategy and then pay my loan off when I finished residency or should I decrease my contributions to Roth IRA and redirect that towards the loan?”

10.5%. I wish I had a guaranteed investment that paid 10.5%. If I did, I’d be throwing all the money I could at it. 10.5% is an awesome investment and he has 10.5% guaranteed investment available to him. I would not be investing in a Roth IRA. I probably would put enough into the 403B to get the match, but even not doing that wouldn’t be insane at 10.5%. This needs to be a major priority. This is a true debt emergency. This is something I would be throwing a lot of money at. I wouldn’t be eating out. I’d be riding my bike to work. I’d really be doing all I could to get rid of this loan. This stinks. 10.5% that’s going to double in seven years.

Save for Retirement or Medical School

“I was recently accepted into medical school. I’m in my second gap year working at the NIH in Bethesda and trying to decide if I should open and max out a Roth IRA or keep this money to use during medical school. I’ll be taken out loans for tuition and other expenses, I will also likely take loans from my parents, interest free, but will still have to pay that back. Is it worth starting retirement savings early or keeping that money to lower loans?”

I think there are a few things you can do if you have any sort of career before medical school. One great thing to do with it is put it in tax deferred accounts because you get that tax break while you’re working and then during those four years of medical school, you can convert it all to a Roth Ira totally tax free because you have the 0% tax bracket.

It is also great to just invest in yourself. This is one of the best investments you can make. Pay for your schooling and avoid those six, seven, 8% loans or 10.5% loans.  I think it’s perfectly fine to just save that money up and use it to reduce how much you take out in student loans your first year of medical school.

 

Waving Taxes on Interest for EE Savings Bonds

“You mentioned waving taxes due on interest for EE Savings Bonds, if the money was used for education. Would medical school debt count as education? If so, this may save me thousands.”

You can certainly pay for grad school or med school with those bonds, but you cannot pay off the student loans with them. The savings bond education tax exclusion permits qualified taxpayers to exclude from their gross all or part of the interest paid upon redemption of eligible series EE and I bonds issued after 1989 when the bond owner pays qualified higher education expenses at an eligible institution. Lots of fine print there. Make sure you understand it all. So qualified educational expenses include tuition, fees, expenses that benefit you, your spouse or dependent from whom you can claim an exemption, expenses paid for any course required as part of a degree or certificate granting program or expenses paid for sports, games or hobbies if part of a degree or certificate program.

It’s interesting that books and room and board don’t qualify and certainly, it doesn’t say anything about paying back student loans. So I would not expect you to be able to do that. Of course, the amount of qualified expenses is also reduced by the amount of any scholarships or fellowships or employer provided educational assistance. Now, I don’t know what the current income limits are, but I think they’re similar, just slightly higher. But in 2017 there was also an income exclusion on this benefit. If you made more than an Adjusted Gross Income of 93,000 or 147,000 married, you could not get this benefit.

So if you’re planning on saving this up as an attending physician to pay for your kids’ schooling, you may want to think again. Although one thing you can do is to put the bonds in the kid’s name. Then, of course, you have to file tax returns for them each year because the bonds are kicking out interest. But that may work out quite well if they don’t end up having to pay any taxes on it anyway and they can get the exclusion from taxes when they spend them on true educational expenses.

 

Any Riders that are Worth it for Term Life Insurance?

“I recently purchased disability insurance and the riders were very important. Is that the same for term life?”

Riders include the ability to convert it to a whole life policy, temporary waving the premiums if you get disabled, receive part of the death benefit early, accidental death and dismemberment, etc. I think for most of the people who are following my advice and accumulating wealth rapidly early in their career by living like a resident will not need these riders. These are all bells and whistles to make these policies more expensive and make the commissions higher. As a general rule, I wouldn’t necessarily buy any riders on a term life insurance policy.

Inherited IRAs

“Do inherited IRAs count for the prorata rule for the backdoor Roth IRAs? Must they be rolled into your individual 401K to bypass the prorata rule?”

You can’t roll them into a 401K. An inherited IRA stays an inherited IRA. It’s not your IRA. You can’t just stick it into your own IRA or 401K unless you got it from your spouse. Then you have the choice between which of those two you want to do. So the good news is it doesn’t count for the prorata rule, only your IRA, SEP IRA, and simple IRAs count. The bad news, of course, is that you have to take out the required minimum distributions each year and you can’t roll it into your own retirement accounts.

Ending

Keeping the questions coming! I know many readers have similar questions and find these Q&As helpful. Tune in next week for an interview with Rick Ferri. 

Full Transcription

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.

Welcome to The White Coat Investor Podcast number 108 target retirement funds, value averaging, and a Ferrari.

Hello White Coat Investor readers, Cindy, back again to introduce this episode’s sponsors Origin Investments. Are you tired of the ups and downs of the stock market? Private real estate could be your answer and Origin Investments has a great solution. The company recently launched income plus fund, a diversified private real estate fund designed to deliver a 6% stable annual dividend yield and a total return of nine to 11%. The principals are investing 10 million of their personal capital alongside investors into the fund. Learn more about the fund at www.originincomeplus.com/wci. That’s www.originincomeplus.com/wci.

Thanks for what you do. I had a young lady, I should say a girl, really, she was four years old in the ER the other day came in with belly pain. Had been signed out to me when I came in for my shift at 6:00 AM. I’d just come in about 20 minutes before with abdominal pain. The doc who saw her was a little bit worried about appendicitis, but when I got in there and asked a few more questions, it didn’t sound quite like appendicitis. She’d been having pain for sure, only about 24 hours with some vomiting. But she’d been having distension for a week before then.

Once we ended up proceeding down the path we do with some labs and an ultrasound and eventually a CT. What it turned out, she had was a 13 centimeter mass in her abdomen. Now we couldn’t quite tell from the imaging whether it was a benign cyst or whether it was a more serious neuroblastoma, but by the time all was said and done, she had interacted with at least three emergency docs, a radiologist or two and an entire surgical team at the children’s hospital and I’m sure depending on what the results of that biopsy were, an oncology team.

That’s a lot of doctors that spend a lot of time training and working hard and educating themselves to take care of one patient with a very serious need. Now that is your daily life. So I thank you for it. It is not an easy life sometimes, but it is worthwhile and you really are making a difference. Today’s of quote the day comes from Benjamin Graham who said the investor’s chief problem and his worst enemy is likely to be himself. In the end, how your investments behave is much less important than how you behave.

I want to take a minute as well to plug our social media feeds. We’ve put a lot of effort in the last year into social media, both on Twitter, where I’m probably the most active as well as Facebook. We have a page on Facebook and we appreciate it if you like or follow that. That helps spread this message of physician financial literacy to your colleagues and family members and everybody. It’s an easy way to share the message without being overly kind of shoving it down their throats is just to share and like things on social media. We also have a Pinterest page and an Instagram page.

So if you enjoy those mediums, if you like those methods of social media, please like what we do there and share it around with your peers. As well, we have a group, a Facebook group if you like interacting in this relatively new way to interact on Facebook, we have over 18,000 high income professionals there in the Facebook group asking and answering questions and taking polls and all kinds of stuff. So please check that out on social media if you like interacting that way. If you just have a few minutes while you’re waiting for a bus or whatever you do, between cases, it’s a good chance to get a little bit of continuing financial education in along the way.

It’s interesting doing these podcasts. We are actually recording four podcasts today. This is my third of the four. We recorded the one you listened to two weeks ago and then the interview you listened to last week with William Bernstein. And then in about an hour, I’m going to be interviewing Rick Ferri for next week’s podcast. I’m really looking forward to that interview. I think it’s going to be great, so be sure you tune in to that. But I think it’s a little bit interesting that all this seems very all packed together for me, but I know you’re listening to it over the course of a month.

Let’s get into some of our questions off the SpeakPipe. If you have not left us a SpeakPipe question before, this is a great way to do it. You go to speakpipe.com/whitecoatinvestor and you just talk into your computer, for 30 seconds, 45 seconds up to a minute and a half. We record it, we play it on the podcast and then I answer your question. The only way we could get it even more live is to have this as a call-in show. I’m not sure we have quite the audience to do it as a live call-in show, but we may experiment with that in the future. Maybe with a Webinar that we turn into a podcast or something like that. But for now, this is the best way to get your voice on the podcast is to leave us a SpeakPipe question. Our first question comes from Jay.

Just opened my first vanguard accounts, looking to start doing some investing for the very first time. I’m in my early 40s, debt-free, make around $225,000 a year. I’ve noticed that the total stock index fund is one of your favorites. I would like to put roughly 50% in that maybe 25% into S&P 500 index and the balance of the 25 in Small-Cap and international. Could you offer some thoughts on that and also what Small-Cap and international you could suggest I start looking into? Thank you for what you do. We appreciate everything.

Okay. Jay’s essentially proposing a portfolio that’s 50% total stock market, 25% S&P 500 index and then some Small-Cap and international. What do I think of that? Well, I think it’s absolutely silly to own both a total stock market fund and a 500 index fund. The correlation between these two mutual funds is 0.99. They’re basically the same fund. You should expect the same performance out of them. Yes. The total stock market fund is a little bit more tax efficient. Yes, it includes mid caps and small caps, but the vast majority of its performance is explained by large cap stocks. And so a portfolio that’s 50% total stock market and 25%, 500 index is basically a portfolio that’s 75% total stock market. And I think that’s probably too big of a chunk.

I prefer a little bit more diversification than that. Whether you add some bonds to it, whether you and some international stocks to it, whether you add some real estate to it, I think it’s worthwhile having a little more diversification there than most of your portfolio basically in US large cap stocks. Now I love total stock market fund. It’s 25% of my portfolio. It’s a major part of my stocks, but I think 75% just a little bit too much. So he talks about adding international stocks, which as I mentioned, I think is a good idea at some percentage between 20% and 50% of the stocks in your portfolio. I think it’s good to have them be international stocks but also small.

Now small, once you’re tilting a portfolio towards small, if you just buy a total stock market index, you’re getting small stocks in that, but once you’re adding a separate small fund, you are tilting the portfolio towards small. So in order to do that, you better believe that small stocks really are going to outperform the overall market over your investing horizon. Small is a factor. You’re now factor investing once you add a small fund to the portfolio. And if you’re going to do that, you owe it to yourself to at least look at some of the other factors. For example, one of the more common ones is the value factor and when you actually do the research on how it’s performed in the past, value has been a better diversifier than small.

So if you’re just going to add one factor to a portfolio, I would add value before I added small. But I think what most people that believe in factor investing do is they add a small value fund and that way they’re getting both some value and some small. That’s the way I divide up my us stock exposure. My us stocks total, 40% of my portfolio and 25% of the portfolios in total stock market and 15% is in the vanguard small value fund.

That enables me to have a tilt to small and value. So if those factors really do show up over my investing horizon, I will be rewarded for it. And I have most of the portfolio in just the overall market such that if small and value turn out not to be real factors over the next 30 or 40 or 50 years, at least I’m not penalized too badly. If you’re going to just use one international fund, I think the best one is a total international stock fund. It gets you developed markets in Europe and in Japan and the Pacific and also gets you emerging markets all at one easy stop at a relatively low price that is very tax efficient.

So Total International Stock Market Fund, Vanguard’s got one. Fidelity’s got one, Schwab’s got one, Ishares has one. I own the Vanguard one but it’s not like the other ones are bad. All right. Our next question comes from Matt.

Hi, my name is Matt. I’m going to start as a internal medicine resident in July. Fortunately, I was able to get through medical school without any student loans, but I have accumulated about $7,000 of credit card debt during that time. The plan is to aggressively pay this off as soon as I start getting a paycheck in July. However, I was wondering in the next few months, would it be worth getting a 0% longterm credit card, the kind that you could basically transfer your funds over and pay off throughout the year and the cost benefit analysis of that would be … Would it be worth doing that to save the six, eight, nine months worth of interest that I’m accumulating on my credit card each month versus the hit of potentially opening and then closing a credit card and what that will do to my credit score. So any advice you could give would be great. Really appreciate it. Thank you. Have a great day everybody.

Okay, so Matt is asking, should you get a 0% credit card in order to pay off your credit cards? And then he’s a little bit worried about the hit on his credit score. Well, let’s talk a little bit about behavior versus math. Yes. If you transfer your debts that are now at 9% or 15% or 30% onto a 0% card, mathematically you’ll be able to pay off the debt faster. You’re simply more of your money, more of your payments are going toward principal rather than interest. The issue is more of a behavioral issue. As a general rule, you don’t get into debt because you have trouble understanding math. You get into debt because your behavior’s bad. You know, particularly bad debt like credit card debt, right? You make mistakes, you buy things you shouldn’t have bought, you finance them. Now all of a sudden you’ve got this 19% debt.
So the solution to a behavioral problem is not a mathematical solution. Just reducing your interest rate is a mathematical, it’s not a behavioral solution. And too many people who do this, transfer everything onto a 0% card, then go back and charge up the 19% card again. Obviously, that’s not going to help you get out of debt and so in that respect, if your problem is primarily behavioral and admit that to yourself, if it is, the solution to that is changing your behavior. You got to spend less, you got to put big chunks of money onto that credit card and pay it off.

Now can you do both? Yes, you can move it to a 0% credit card, you can cut up the old ones, you can throw them away, you can close the accounts and then put big chunks onto the 0% credit card and get it paid off over the next year while it’s still a 0% and that will help, but just be aware that just refinancing doesn’t do anything for the debt. The debt is all still there and the way you get rid of it is by throwing big chunks of money at it.

Okay, so let’s talk about credit scores for a minute. There’s a lot of things that go into a credit score and honestly, they don’t actually reveal everything that goes into it. But here’s what you need to know about credit scores. If you pay your bills as you agreed to pay your bills, you will have a credit score that’s high enough to do anything you want a credit score for. You’ll be able to get the jobs you need. You’ll be able to get the utilities you need, you’ll be able to get a mortgage, you’ll be able to get those debts that you need to take on. No problem.

So pay your bills, your credit score will be fine. Don’t worship at the altar of the FICO score. But one of the most important factors that goes into that is, whether you pay your bills, that’s number one. And after that, utilization of available credit matters. The idea is you want to use less of your available credit. That makes you look more responsible, I suppose. And so if you close credit cards, sometimes that can drop your utilization ratio or increase your utilization ratio and drop your credit score. So you got to be a little bit careful about that. And of course, applying for new credit also drops your credit score a little bit. So going and applying for a 0% credit card will drop your credit score. But the truth is what do you need a credit score for? Unless you’re about to apply for a mortgage or you’re about to refinance your student loans, who cares what your credit score is.

I don’t care what mine is. The last time I borrowed money for anything significant was at least months ago. And if so that was merely a credit card or something that I was applying for. I just don’t have a big need for a credit score, right? If I got turned down for that credit card and no big deal, I’ve got credit cards, but I don’t need to get a new mortgage or anything like that. So I really don’t care. But if I looked at my credit score, it’d be 800 plus because I’m a great credit risk. I’ve got a great debt to income ratio. I have hardly any debt at all. You know, is basically whatever is rotating on my credit cards this month. So get yourself in a position where you don’t care about your credit score either.

If you’re in that position where you have to watch that like a hawk and sign up for a subscription service so you know when it drops five points, you need to make other changes in your financial life besides just monitoring your credit score. Our next question comes from anonymous ER doc.

I’m an emergency physician on a 1099 currently maxing out individual 401K backdoor Roth IRAs and an HSA. My wife works part time and she has the option of investing in a 457B plan, a 401A plan and a 403B plan. Also, something called a retirement savings plan. I was wondering if there is any preference on which one of these to max out first in which one I should go to next. Thanks for all of your help.

Okay. He’s on a 1099 so his course is pretty straight forward. You get an individual 401K, you do your backdoor Roth IRA, an HSA, if you’re using a high deductible health plan, maybe a personal defined benefit cash balance plan, if you really want to save a lot of money, especially if you’re older and everything else goes in taxable. It’s really not that complicated. Her situation is much more complicated, right? She’s got a 401A, 457B, a 403B and some plan that none of us even know what’s going on. We’d have to read the plan document and know what this Retirement Savings plan is, but let’s talk briefly about these types of accounts because they’re very common in the academic world. The docs at the local university here, they all have these accounts. A 401A in general is all employer money.

It’s tax deferred money. The employer puts in however much they’re going to put in. Maybe it’s eight or 10% of your income and that’s that. Until you close it or leave the employer, you can’t really do much about it. You may be able to select investments, but that’s about it. Eventually, when you leave or separate or retire, you can roll it into an IRA or another 401K. A 403B is basically the academic equivalent of a 401k. In not for profits you tend to see 403Bs instead. There are some very minor differences in the rules between a 403B and a 401K but in essence it’s the same thing. They’re both defined contribution plans. You can put an employee contribution of up to $19,000 per year if you’re under 50 plus a catch up contribution if you’re 50 plus, maybe the employer puts matching money in it.

In my experience, when you also have a 401A, they don’t tend to put matching money into the 403B. They basically look at that as all going into the 401A. The other account we’re talking about here is a 457B. Now a governmental 457B like a lot of academic docs have is a pretty good account. The risk of your employer going under is pretty low because you remember that 457B is technically employer money until you take it out of the account, that’s when it becomes your money. And of course the options when you take it out of a governmental 457 are pretty good. You can just take it into an IRA or a 401K if nothing else. When you’re looking at those non-governmental 457, that’s when you need to worry about how strong the employer is, whether that money could become subject to your employer’s creditors and what the distribution the options are.

But if you have a governmental 457B and you don’t think your state hospitals going out of business anytime soon and the investment options are reasonable then sure. Go ahead and max that out. The contribution amount is 19,000 per year. It’s totally separate from the contribution amount for a 403B or a 401K and so yeah, if you can, I would try to use that as well. Now in this situation, it sounds like she is not working full time. She’s only part time, so she may be limited in how much money she can put into all these accounts. But certainly, they can live off his money and defer her entire income into these accounts up to the amounts that she’s allowed to differ. So that’s a great opportunity for them to save even more money.

But honestly, if they’re maxing out his individual 401K both their backdoor Roth IRAs, there is 401A, 457B, there is 403B, they’re well up over $100,000 a year in retirement savings and that’s going to be enough to get most doctors where they want to go. Our next question comes from Richard.

Hi. I want to say thank you for everything that you’ve done. I had a question about due diligence in real estate investing. I’m interested in increasing my allocation to real estate and I’ve looked at some of the companies that you’ve used for your real estate portfolio such as 37th Parallel and Origin. I was wondering what you do for your due diligence beyond simply reading the offering. Do you have any specific resources that you use? Thanks for your help.

Okay, this is a great question. If you’re going to branch out from Reit Index Funds essentially with your real estate investing, keep in mind, first of all, Bill Bernstein’s advice last week, right on the podcast. What did he say? He said basically, no, I think the risks here are more than the rewards. So don’t feel like you have to do this. It’s totally an optional asset class. If you want to get into it, you can, but if you’re going to get into it, you do need to do due diligence and so what can you do? Well, I think a good first place to start is Peter Kim’s blog, passive income MD. He focuses a lot more on these sorts of syndications and other sources of passive income and real estate investing than I do. So I’ll be sure to check that out. Other things you can look into I think are some other sources like Crowd Due Diligence, crowdDD.

This is a group of accredited investors that try to kind of crowdsource the due diligence on these investments. And I think getting 30 or 40 different opinions on an investment rather than just your own and what you can dig out of the paper is very helpful. You can also learn from people who have done this on dozens of other investments in the past. Another great site is Ian Ippolito’s site. This is realestatecrowdfundingreview.com. He does something similar to Crowd Due Diligence. He does do some grouping of investor money into some of these investments and so keep the conflicts of interest in mind, but it’s a great place to get more information.
Also, keep in mind that diversification protects you from what you don’t know. If you don’t feel like you can do really good due diligence, be sure to be spreading your bets around so you don’t get burned if one goes bad, right? If you’re only going to put $100,000 into these sorts of investments, you don’t want to put it all into one fund or into one apartment building. You want to spread this around and say you’re going to be looking for things with lower minimum investments like two thousand five thousand ten thousand dollar investments to spread your bets out a little bit.

If you’re putting $1 million into this, then sure a $100,000 investment into one particular fund is probably a reasonable thing to do. My first dozen syndications that I did were two to $10,000 a piece. I wanted to watch them, I wanted to see them go round trip and I literally watched for two, three, four years to see what happened with these things. I was pretty happy with what I saw and so I’ve gradually kind of up the amounts that I invest. That’s not only because I’m more comfortable with it now, but I just have more money to invest and that’s why my amounts have gone up and then make some other investments available to me that weren’t available when I was only investing $5,000 into a deal.

What else can you do? Well, you can start with Google. It’s very easy, take the names of all the principals in the firm and the firm itself and Google it in connection with scam or fraud or jail time or arrest and see if anything pops up. You might be surprised what pops up with some of these people. You can talk to them on the phone and maybe even fly out there and see them in person. You can walk around the property for a lot of these syndications and look at it yourself. You can talk to current and if possible, even previous investors. You can even do a background check on the principals if you like. Bear in mind for small investment, that might not make financial sense. If you’re spending a couple of grand on a background check for a $5,000 investment, that’s obviously not a very smart move.

You can also run it by your own team of professionals. If you have an accountant, a financial adviser, an attorney, et Cetera, you can run these investments by them. But here’s the deal. There’s no reason you should feel like you have to do this solo out there. You can find other investors, you can find other professionals. If you feel really solo, maybe you ought to just avoid it altogether. And of course there is no rush. Most of these investments do have closing dates, right? It’s going to close in a month or two months or six months, but there is going to be another investment down the road.

Most of these people to do private funds, they open a second fund, third fund, fourth fund, fifth fund. There’s going to be another one in a year. These people that do a real estate syndications, you know, buy apartment buildings and put the deal together. There’s going to be another one in six months. So there’s no big rush and there’s dozens of companies out there doing it. So if there’s anything that makes you feel uncomfortable about a particular deal, just skip it, right? There’s no called strikes and investing and move on to the next one.

One of the companies that I invest with, is Origin Investments that’s sponsoring this podcast and I think that’s a pretty good company, but even if you go to a company that I use or that I’ve recommended or that has paid me advertising dollars, you should still do your due diligence. Whether that’s going skiing with them in Park City like I did or whether that is getting them on the phone and talking to their previous investors. I think due diligence is pretty important when you’re branching out from these more traditional investments where you have pretty significant SEC protections, through the 1940 Investment Company Act and, and other similar Acts. You’re really on your own when you get out into these accredited investor investments and you ought to keep that in mind. Okay. Our next question is about value averaging.

Okay. My problem with value averaging is mainly the side fund and the complexity. The idea behind value averaging and remember to distinguish this from dollar cost averaging, but value averaging is when you decide how much money you want to have in your investing account at a certain age and if the market does poorly, then you invest more money into the market so you’re on that line, that value averaging line. If the market does really well, you don’t invest as much money or you even take money out of your investments and put it into a side fund, which is a very safe fund, like a money market fund or a high yield savings account or maybe some high quality short term bonds, et cetera. And then when the market does poorly, you move it from the side fund into stocks. The idea is that you have this glide path you have set up and you follow it.

So no matter what the market does, it’s forcing you to buy high and sell low. And there’s some good data that shows this works pretty well. I don’t like the complexity, I don’t like the opportunity cost of having money sitting in the side fund. I would rather have it fully invested all the time, but this is something that every investor’s going to have to decide on their own. I recommend you read the book Value Averaging. It’s a complex book, lots of math in it. If you can’t get through that book, you have no business doing value averaging. If you don’t enjoy spreadsheeting out, your investments don’t do value averaging, right? This is a relatively complex technique. If you want to do it, I think it’s fine. I don’t think it’s stupid. I think it may even give you an advantage but realize that you’re going to have to do it the right way.

You can’t just do it halfway and mess it up a little bit and think you’re going to come out okay. You can either do it right or don’t do it at all. I realized early on that I didn’t need to do stuff like that in order to reach my financial goals. There’s lots of other things like that that I’ve chosen not to do and they’re not necessarily stupid, I just don’t need to do in order to win the game. The truth is in investing, you only have to win the game once. You only have to get rich ones. So you don’t have to come up with 20 different ways to do it. One reasonable way to invest, one reasonable way to make money is perfectly fine.

Let’s get into my next question, which may be one of my favorite questions I’ve ever had on the SpeakPipe. This one comes from the crazy Ferrari guy.
Let’s say you’ve been a really frugal guy or your life drive you to really be reasonable with money. You have all your ducks in a row, but ever since you’ve been a little kid, you wanted to buy a really nice car. You’re a car person. I know you addressed this sometimes in the past talking about, hey, you know, once things stable, then you can go ahead and buy that Tesla. But I’m not talking about a Tesla. I’m talking about like a brand new Ferrari F8 Tributo. Something that’s going to depreciate like a mother, as it’s going to cost $350,000.

I know probably most readers would never would say that this is never wise, but assuming you really wanted to do this your entire life, at what point would you say it is not entirely unreasonable to do that? And I can see my wife, you’re looking at me like I’m crazy. What cross roads between income and net worth, let’s say, okay, once I have an income of 200 grand a year, about a net worth of $3 million, and I would think it’s reasonable to do it or an income of 500,000 with a net worth of one and a half million then it might not be unreasonable. What do you think? I’m really curious to hear your thoughts. Thanks.

Okay, so when can you buy a really, really nice car? Like a Ferrari F8 that cost $350,000. Well, I guess the question is when is this no longer insane? Clearly, this is insane for a resident to do. Clearly, this is insane for somebody owes $400,000 in student loans to do, but when does it not become insane? Well, I think there’s a lot to think about here. You know, when this came across, Katie and I were laughing a bit about it and she says, “Well, when you have adequate retirement savings and cash set aside to do it, you can buy it. You just can’t buy it on credit.” And I agree with that. If you’re going to buy something like this, it needs to be cash. This is not something you go and borrow for. But let’s distinguish here between basic transportation and what this really is, which is one of your financial goals.

Okay. Basic transportation is available for $5,000 or less. You can go out today and buy an economy car with 100,000 miles on it, that’s less than 10 years old. That is going to get you from point a to point B reliably for the next two, three, four, five years and do just fine. Yes, you’re going to have to do some repairs every now and then. Maybe doesn’t start once or twice in those five years and you’ve got to get a jump and buy a new battery or something, but it’s essentially reliable transportation. That’s what reliable transportation costs.

Anytime you’re spending more than that on a car, you are buying some amount of luxury. Maybe it’s a nicer car, maybe it’s a newer car, maybe it has some other features, four wheel drive or a a TV in it or whatever, a navigational system, more safety features. You’re buying some luxury features. When you’re talking about a car that costs $350,000, we’re way beyond the Teslas I like to make fun of. I’ve got a blog post coming up on those. I’m sure you Tesla owners are going to love, but we’re way beyond that, right? We’re talking about $350,000. There are people listening to this podcast who live in homes that are not worth $350,000. I mean, I joke in some of my presentations about a question I once got from a med student about whether you can buy a Lamborghini as an emergency doc, and I told him, yes, if you live in it, you can do that.

Obviously, this doc is not wanting to live in it, but if this truly is something that’s important to you in your life, this is something you value a great deal. This is an important financial goal for you, then you treat it like your other important financial goals. Like retirement, like saving up for college, like saving up a down payment or paying off a mortgage. You just put it on your list and you dedicate some of your income towards reaching that goal and when you have enough money, you buy the goal. That’s how you do it. Now, bear in mind when you’re going to blow $350,000 on a car that there are some real consequences to doing this, right?

You’re probably going to have to work later. You know you’re going to work instead of 20 years. Maybe you’re working 25 years. He really could make that big of a difference in your finances if you buy this in the first half of your career. And so don’t underestimate how much of an impact something like this can have on your future financial life. But if it’s truly worth it to you, if you look at the numbers, you run the numbers, and this is something where you go, “Hey, I really want this and it’s worth working longer to me.”

It’s worth essentially, for an average physician, this is probably two years of income. If that’s worth it to you, then go ahead, knock yourself out. It’s not like we’ve never done something like this, right? We have a boat. We bought brand new, it was more expensive than a lot of people’s Teslas. We walked into the dealership and we paid cash for it and we bought it. We have something we saved up for that we really wanted and that we truly use and that we’re glad we bought. And maybe you’ll feel the same way about a $350,000 Ferrari, but do it the right way. So it’s a blessing in your life and not a curse. Speaking of blessings and curses, that kind of reminds me of Dave Ramsey’s guideline. His guideline on vehicles is that you should not own more that’s going down in value.

You know, things with motors like cars and boats and airplanes, et Cetera, than 50% of your income. So if you’re going to own a $350,000 Ferrari, and no other vehicles, Dave would say you need an income of at least $700,000 to do that. Is that a little too strict? Well, I don’t know. It seems completely reasonable to me. If you have a lower income and also have five or $10 million in the bank, then obviously this is going to be a relatively small part of your financial life and you can probably also afford it even if you don’t meet that guideline.

Probably the closest thing to this in our life is a home renovation. We’re very seriously embarking on this year. It’s going to cost us a ton of money. It’s going to cost more than we paid for the house initially. But how are we doing it? Well, we’ve got our financial ducks in a row. We’ve met her retirement savings goals, we’ve met our college savings goals, we have paid off all our debt and we’re saving up the money in cash to cash flow it as we go along. Now, if you can do that for your Ferrari, then I think you’re in a similar position. Go for it, enjoy it. You can’t take the money with you when you go and if this is what you want to spend your money on. If you’re truly a car guy, then go for it. All right. Our next question comes from Chris from Sandy. He’s apparently local to me. Maybe I should just drive over to his house and answer his question, but here it is.

My name is Chris. I graduated from residency last year and I’m now working at down the road from you actually in Sandy, Utah as a dermatologist. My question is whether it could be reasonable to use a single mutual fund for all of my different investment accounts. I’ve read in your book and a couple other investment books. I plan to keep reading and I would prefer not to hire a financial advisor. I plan to basically stick to your advice and save a lot, continue to live like a resident for a while, pay off my debt quickly, max out 401K, health savings account backdoor Roth and put the rest in a taxable account and probably a 529 as well.

My question is, would it be reasonable to just use a single mutual fund such as a Vanguard Target Retirement-Date Fund for every single one of these different accounts? It’s basically a mix of stock and bond index funds, has a 0.15% fee, rebalances for you yearly, decreases the ratio of stocks to bonds each year. I feel like this would be really easy and simple and hands off and could eliminate the need for an advisor. But I just worry it’s too overly simplistic and that I could be missing something. What are your thoughts? Thanks.

Okay. So if you don’t want to use an advisor, is it reasonable to use a single mutual funds such as a target retirement fund? Well, of course it’s reasonable. Mike Piper does this. His only investment is a Vanguard Life Strategy, Moderate Growth Fund. It’s about 60% stocks and 40% bonds and hold some international stocks and bonds in it. And some tips I think are in it as well. It’s basically a fund of funds, have five different low cost index mutual funds in it with no additional charge on top of it. Yeah, that’s a reasonable thing to do. It certainly is a way to keep things simple and to keep you from having to hire a financial advisor if you don’t want to delve into this a little bit more.
However, I’m not a big fan of it. And the reason why is I think you’re giving up a fair amount of return and it’s probably enough of a return that with the additional return you could hire a financial advisor to handle all this for you. Let me explain what I mean. You’re losing return in two places when you do this. Assuming you have a taxable account, when you’re using a target retirement fund, in that taxable account, you are placing taxable bonds into your taxable account. And for most doctors and other high income professionals, that’s the wrong kind of bond to have in that account. And that’s assuming it’s right for you to have bonds in that account in the first place. But if you’re going to buy bonds in a taxable account, you probably want to use Muni bonds and that’s not what they have in a target retirement fund.

So not only are you buying bonds there, but as the years go by, the fund will be more and more bonds and that will become more and more tax inefficient in your taxable account. So just getting the asset location right probably adds a little bit of return to your portfolio. Some people have estimated as much as 0.4 or 0.5% a year to get your asset location right. I’m not sure it’s quite that much money, but certainly it’s something.

The other thing is you are not getting any sort of factor investing when you do that. You’re not tilting towards small or value or momentum or any of these other factors, so if you don’t believe in factor investing, that’s fine. If you do believe that small and value stocks are going to outperform the market over your investment horizon, then you’re essentially giving up that extra return in order for simplicity’s sake, in order to use a target retirement fund. And so I think that probably you’re going to make money tilting your portfolio towards small and value and if you’re giving that up too in addition to the asset location issue, I think there’s probably enough return there to justify hiring an advisor that can probably get you the same or better return for less hassle in your life than doing this all on your own with just a target retirement fund, but to each their own.

If you believe that just total market investing is the way to go, keep it as simple as the way to go. This is certainly a reasonable way to invest. You’re investing better than 95% of the investors out there who are doing stupid stuff. It also helps you probably to stay the course behavior wise, to just have a simple investing strategy like this and that’s worth something too. Okay. Let’s take a few questions off my email box.

This one says, I’ve listened to almost all the episodes of the podcast and I don’t think you’ve ever addressed, this might be an interesting topic. For the physicians who work for the federal government other than the armed forces, how do you affect in the availability of an FER pension on the amount they should be saving for retirement? Does the general recommendation to save 15 to 20% of your gross income for retirement still apply if there’s a pension that will kick in once one is retired? How do you figure out how much to save for safe and comfortable retirement as salaries at the VA are lower than the private sector with no opportunity for any business expense deductions, saving 20% is more difficult than other situations.

Okay. Here’s the deal. Yes, pensions are worth something. The further away you are from the pension, the less it’s worth, right? Because you might leave and not get it or something might change, and the rules change or the employer goes out of business. I mean, pensions from private employers go under all the time. So I don’t think relying wholly on a pension is a good idea. Does the fact that you’re going to have a pension allow you to save a little bit less than you otherwise would? It probably does, right? Instead of having to save 20%, maybe you only have to save 10 or 15% assuming you have a very sure looking pension, you’re not that far away from it. But what’s the big harm if you put a little bit extra in there early in your career, right?

So now you have more options. You can leave the employer sooner, right? You don’t have to stay until you get the pension. It just gives you a lot more options. I would still continue to save. Even if you qualify for a pension. Yes. It probably gives you permission to save a little bit less, but not dramatically less.

Okay. This question comes from a family medicine resident in LA. He says, as you know, life here is pretty expensive. You can say that again. And a large portion of my income goes to rent about 50%. Wow. Got to love California. Thankfully I don’t have a crazy student loan like most of my coworkers, but I did get a medical residency relocation loan with Sallie Mae of about $20,000, six months before residency while I studied for my steps.

$20,000 seems like a lot for a medical residency relocation. I know when Katie and I moved, we rented the smallest you could get put all our stuff in it and drove it to Arizona. I mean, there’s no way you can spend $20,000 on that. It sounds like this was used to pay for living expenses for a while as well. He goes on, my interest rate is about 10.5%. Wow. I don’t have to make any payments until after residency. I’m not sure. That’s such a benefit, at 10.5%. I am currently contributing to my match on my employer’s 403B and I’m also able to contribute around $400 monthly to a Roth IRA with a Vanguard Target Retirement-Date Fund, but during this time I have not paid $1 towards my loan. I thought about refinancing, but most major companies don’t see this loan as your average student loan and will not refinance with the best rates, do you think is better to continue with my investment strategy and then pay my loan off when I finished residency or should I decrease my contributions to Roth IRA and redirect that towards the loan?

10.5%. I wish I had a guaranteed investment that paid 10.5%. If I did, I’d be throwing all the money I could add it and getting all the money I can for my family and can borrow and would throw that at it. 10.5% is an awesome investment and you sir, have a 10.5% guaranteed investment available to you. I would not be investing in a Roth IRA. I probably would put enough into the 403B to get the match, but even not doing that wouldn’t be insane at 10.5%. This needs to be a major priority. This is a true debt emergency. This is something I would be throwing a lot of money at. I wouldn’t be eating out. I’d be riding my bike to work. I’d really be doing what I could to get rid of this loan. This stinks. 10.5% that’s going to double in seven years.

All right, next question. I was recently accepted into McGovern Medical School, the University of Texas. Cool. I’m very excited to get the Texas in-state tuition. I’m in my second gap year working at the NIH in Bethesda and trying to decide if I should open a max out of a Roth IRA or keep this money to use during medical school. I’ll be taken out loans for tuition and other expenses, I will likely take loans from my parents’ interest free, but we’ll still have to pay that back. Is it worth starting retirement savings early or keeping that money to lower loans?

Well, I think there’s a few things you can do if you have any sort of career before medical school. One, if you can save money before medical school, one great thing to do with it is put it in tax deferred accounts because you get that tax break while you’re working and then during those four years of medical school, you can convert it all to a Roth Ira totally tax free because you have the 0% tax bracket.

Essentially the standard deduction of 12,200 single or 24,400 married to do conversions with, since you’re not going to have any or much earned income during medical school. So that’s one great thing you can do, but if you’ve got taxable money, you got money sitting in a savings account, it’s a great use to just invest in yourself. This is one of the best investments you can make is to pay for your schooling and avoid those six, seven, 8% loans or 10.5% loans. Like the last questioner. I think it’s perfectly fine to just save that money up and use it to reduce how much you take out in student loans your first year of medical school. That’s perfectly reasonable although you may want to consider if you have a retirement account to do some Roth conversions during medical school as well.

Next question is, you mentioned waving taxes due on interest for EE Savings Bonds, if the money was used for education. Graduate student loans, Med school debt count as education. If so, this may save me thousands. Well, you can certainly pay for Grad school or med school with those bonds, but you cannot pay off the student loans with them. The savings bond education tax exclusion permits qualified taxpayers to exclude from their gross all or part of the interest paid upon redemption of eligible series EE and I bonds issued after 1989. When the bond owner pays qualified higher education expenses at an eligible institution, right? Lots of fine print there. Make sure you understand it all. So qualified educational expenses include tuition fees, expenses that benefit you, your spouse or dependent from whom you can claim an exemption, expenses paid for any course required as part of a degree or certificate granting program or expenses paid for sports, games or hobbies if part of a degree or certificate program.

It’s interesting that books and room and board don’t qualify and certainly, it doesn’t say anything about paying back student loans. So I would not expect you to be able to do that. Of course the amount of qualified expenses is also reduced by the amount of any scholarships or fellowships or employer provided educational assistance. Now, I don’t know what the current income limits are, but I think they’re similar, just slightly higher. But in 2017 there was also an income exclusion on this benefit. If you made more than an AGI, Adjusted Gross Income of 93,000 or 147,000 married, you could not get this benefit.

So if you’re planning on saving this up as an attending physician to pay for your kids’ schooling, you may want to think again. That may not be such a hot idea, although one thing you can do is to put the bonds in the kid’s name, right? Then, of course, you have to file tax returns for them each year because the bonds are kicking out interest. But that may work out quite well if they don’t end up having to pay any taxes on it anyway and they can get the exclusion from taxes when they spend them on true educational expenses.

All right. The next question is about a youtube video. So as I was watching a youtube video with a lecture from you about early career financial management while discussing the Public Service Loan Forgiveness program, you had a bullet point stating that many doctors working in non-profit hospitals are not employees of 501c3s. I would appreciate more info on why they aren’t qualified as it seems like working for a non-profit would qualify you. Well, the truth is lots of doctors who are practicing inside a 501c3 hospital are not employees of the hospital.

They’re employees of the separate physician group or they’re employees have a private partnership or they’re sole proprietors, they’re 1099 and so they’re not employees. In order to qualify for Public Service Loan Forgiveness, you have to be a full time employee of a non-profit. Whether that’s the VA or the military or whether that’s a 501c3, you have to be their employee. You can’t just contract with them, your employer can’t just contract with them or those payments do not count toward Public Service Loan Forgiveness.

Next question. I’ve seen quite a bit of posts on tax loss harvesting lately. My question is about doing this with individual stocks. I’m glancing at my parents’ portfolio and one of the big losers was bank of America where they can harvest $3,000 off that one stock. My dilemmas is that mostly, I’ve seen examples with index funds. Would you recommend harvesting this and if so, what would you recommend buying? Should they trade it in for an index fund or a similar stock?

Well, here’s the truth of the matter. If you’re in individual stocks, you probably want to get out of that and buy index funds. It’s just taken on uncompensated risk you shouldn’t be running. That is way easier if you’ve got a loss in the stocks, right? Because now you sell them and you get to use that loss to reduce future capital gains, to reduce current capital gains or possibly up to $3,000 a year reducing your ordinary income. So that’s a no brainer. Sell Bank of America and by total stock market, very easy. Now if you for some reason want to keep investing in individual stocks, then maybe you trade bank of America for Wells Fargo or something, I don’t know. But I don’t do that. I invest in index funds and so when I’m tax loss harvesting an index fund, I swap it for another index fund. But this is a great opportunity to get out of individual stocks and get into index funds and have Uncle Sam help share your loss with you.

Okay. The next question, are there any Riders that are worth it for term life insurance? I recently purchased disability insurance and the Riders were very important. Is that the same for term life? Well, these include things like the ability to convert it to a whole life policy, which I don’t think is very worthwhile. Temporary waving the premiums if you get disabled. I don’t think that’s worth very much, right? The premiums on term life are pretty darn loan. You should be able to pay them out of your disability insurance. Another one allows you to receive part of the death benefit early.

There’s accelerated benefit. If he gets sick, you can access the death benefit. Well honestly that’s probably not worth paying a lot for, I suppose if it were free, that’s great. If you didn’t have to pay much for it, maybe you want to get that. Obviously you can think of a situation where that would be useful, but I think for most of the people who are following my advice and accumulating wealth rapidly early in their career by living like a resident, I don’t think that’s something you’re going to need for very long. They also have accidental death and dismemberment Riders.

Again, that pays you a little bit more if you die accidentally instead from cancer or something. I don’t think that’s worth buying. I’d just buy more regular term life insurance if you need more insurance. You can also get Riders on your family where it covers your kids from dying, that sort of a thing. These are all bells and whistles to make these policies more expensive, make to commissions higher. As a general rule, I wouldn’t necessarily buy any Riders on a term life insurance policy.
Okay. Our last question today is do inherited IRAs count for the prorata rule for the backdoor Roth IRAs? Must they be rolled into your individual 401K to bypass the prorata rule? Well, you can’t roll them into a 401K. An inherited IRA stays an inherited IRA. It’s not your IRA. You can’t just stick it into your own IRA or 401K unless you got it from your spouse. Then you have the choice between which of those two you want to do. So the good news is it doesn’t count for the prorata rule, only your IRA, SEP IRA, and simple IRAs count. The bad news, of course, is that you have to take out the required minimum distributions each year and you can’t roll it into your own retirement accounts.

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Be sure to follow us and share stuff on social media. As I discussed at the top of the podcast, there are really some people who can only be reached with this important message in that way. Be sure to turn in next week for our podcast with Rick Ferri. This is going to be really awesome. I’m going to record it in about five minutes here, but you’ll hear it next week. Keep your head up, your shoulders back. You’ve got this and we can help. We’ll see you next time on the White Coat Investor Podcast.

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