Q. What are the Next Steps to do With My Money?
I am a neurologist in my 30s and currently max out a 403(b) and a 457 with my employer. We also have a 529 for our 3 kids and put $5K/yr in there. Our only debts, student loans and a mortgage, have interest rates under 4%. I have read about backdoor Roths, personal and commercial real estate, post-tax investments through Vanguard, etc and all sound great. I receive frequent requests for capital this or that, but have yet to jump at them. Can you give some guidance around a logical approach or order to decide what's the next step?
A.
I've written before about what order to look at your investments, especially if you still have debt, but it has been years and it's definitely a topic worth revisiting multiple times. I also included a slightly different (but better IMHO) list in The White Coat Investor: A Doctor's Guide to Personal Finance and Investing. In this post, I'm going to boil all that down a little bit, and add a few thoughts I've had lately on the subject.
# 1 Clean Up Your Messes
Who knew surfing could be a family sport?
The first thing any new attending should do is to clean up his financial messes. This includes updating his term life, disability, and liability insurance policies. It includes paying off any high-interest debt (say 8%+) or at a minimum refinancing it to a lower rate. It includes boosting that emergency fund to 3-6 months expenses (shouldn't be hard if you're continuing to live like a resident as you should be.) It includes making sure there is a will in place. It also includes time-sensitive activities like converting any tax-deferred savings from residency before you hit a higher tax bracket in your first full year as an attending and getting rid of any traditional or SEP-IRA money to allow future Backdoor Roth IRAs.
# 2 Compare Retirement Savings Figure to Available Retirement Accounts
The next step is to determine how much you're going to save for retirement. To do this properly, use the Excel Future Value function or similar, make a few assumptions, set a few goals, and come up with an annual dollar figure. However, if you don't feel like doing that, well, multiply your gross annual income by 20% and call it good. Now, take that figure and compare it to the amount of tax-protected retirement space available to you. That might take a little research. Include any employer match that may be offered. If the amount you wish to save for retirement is $50K a year, and all you have is a 401(k) with an $18K contribution limit, a $6K a year match, and $5500 each in his and hers Roth IRAs ($35K total), then you're going to have to invest (another $15K a year) in a taxable account for retirement.
If you have a 401(k)/Profit-sharing plan ($53K) available to you, but only wish to save $50K a year, then you may not need to use any other accounts or investments to save for retirement. You may, however, face a choice of WHICH accounts to use. The general rules for an attending in his peak earnings years are:
- Get any available match
- Max out all tax-deferred options
- Max out Roth options
- Invest the rest in a fully taxable account
However, there are lots of exceptions to these general rules, especially when comparing tax-free (Roth) and tax-deferred accounts.
# 3 What About Other Financial Goals?
There are other financial needs and goals out there. The most well-known, of course, is saving for college. Assuming you're saving enough for retirement and can save more, 529 plans are excellent places for college funds. In many states, not only your withdrawals are federal and state tax-free, but you also get a state income tax deduction or credit in the year you make the contributions. Other financial goals may be paying for your healthcare, either now or in retirement. If you have a High Deductible Health Plan, you can open an HSA. This Stealth IRA can even double as another retirement account, and as the only triple-tax-free account, it is actually where my first investment dollars go each year. You might also wish to invest some money for your kids, especially for their 20s. This can be used for autos, a summer in Europe, a wedding, mission work, paternity/maternity leave, or even a house downpayment. While you want to be careful about the kiddie tax rules, if you invest tax-efficiently using a UGMA/UTMA you can reduce the overall tax burden significantly.
You may also wish to become debt-free or at least pay off your student loans. Paying down most non-mortgage loans is the equivalent of a guaranteed after-tax investment with an interest rate equal to, well, the interest rate of the loan. Giving large sums of money to charity may also be a goal. If you do not wish to actually give it this year, but want the tax deduction now, you can use a charitable trust or even just a donor-advised fund at any of the major brokerages or mutual fund companies.
You may also wish to save up for some high-ticket, but relatively short-term goals such as a house downpayment, a new car, an expensive vacation, a vacation home, or an expensive boat or airplane. This savings is generally done in safe investments such as a savings account, CDs, or a short-term municipal bond fund.
# 4 And Beyond That?
Most people, including doctors, don't get to this point, but many doctors who read financial blogs do. They're covering all their expenses, on track to reach their financial goals, and still have more money than they know what to do with. Here are some considerations for what to do with this money.
A- Spend it. Believe it or not, spending money can make you happier as I wrote about last year in my post Loosening the Purse Strings. Try to spend deliberately and with an emphasis on boosting your happiness.
B- Give it away. Find some charities whose goals you support and well, support them. This has the nice benefit of an additional tax deduction most of the time. You may also wish to help friends or family by starting a college fund for a niece or paying off a parent's mortgage.
C- Build wealth. There is no limit on a taxable account. You can always invest more in order to spend more later, give more later, achieve financial independence sooner etc.
# 5 What Investments Should I Use?
Assuming your investments are long-term (i.e. retirement) I'd just follow your written investment plan. The bulk of your portfolio should consist of index funds composed of stocks, bonds, and REITs. However, if you so desire, you can also add some real estate, either syndicated or directly held, investments designed for accredited investors, precious metals and other more exotic asset classes. But the key is to keep your goals straight, understand the difference between investments and accounts, and couple a reasonable plan with an adequate savings rate for the goals.
My Current Dilemma
Yes, all of that came out of that boat.
As I write this, in July of 2015, I'm struggling a bit with where to deploy extra capital. Between my successful emergency medicine practice, the financial success of this website, good health, a little luck, and plenty of good financial decisions, we've been blessed with an income far higher than we ever expected or need and are trying to be good stewards of the money. We've already maxed out our Roth IRAs, HSA, Defined Benefit Plan (well, for 2014 as we contribute this money in March of the following year,) the WCI Individual 401(k), and have just about maxed out the practice 401(k)/Profit-Sharing Plan. We've contributed the tax-deductible amount to our children's 529s, and even kick-started the newborn's 529 with a $10K contribution. We dabbled in several syndicated real estate investments. We've bought a fancy expensive wakeboat, and have more money in our “allowance” funds than we know what to do with.
So what now? Well, being the creative financial mind that I am, I can come up with a baker's dozen of items I'd like to do this year. Unfortunately, we but don't have enough money to do them all. These include:
1) Purchase some more syndicated real estate
I like the asset class. I like the hands-off nature (I've learned that I not only dislike being a landlord, but I'm bad at it.) I dislike the difficulty of exchanging properties and I dislike the expenses that seem monstrous when juxtaposed to my index funds. There is really no limit to how much money I could invest in this each year.
2) Purchase shares in a life settlement fund
This is another asset class I'm really interested in. Not interested enough to meet the $100K minimum as it would knock my portfolio way out of whack, but maybe in a few more years.
3) Buy shares in my hospital
My for-profit hospital offers syndicated shares to the medical staff. Owning some would give us a look into the hospital's finances and make it a little more expensive to cancel our contract. Expenses are higher than I like, but past returns have ranged from not-too-bad to incredible.
4) Build up a taxable index fund portfolio
This serves two functions- first, it gives me the “house payoff fund” I wrote about earlier this year. Second, it allows me to invest very tax-efficiently as I make large charitable contributions each year. I can tax-loss harvest any losses, and flush out any gains through the contributions. These contributions have kept me from really establishing much of a taxable account in the past.
5) Start a UGMA account for the other three kids
We started a UGMA in 2008 for our eldest. The intention is to give them both college money in a 529 and money for their 20s, when they can really use it, in a UGMA. The idea is to use it on a mission, a car, a wedding, or a house downpayment. I did some tax-loss harvesting in the 2008 bear market and it has grown well since. But we've never gotten around to starting one for the other three.
6) Max out 529s
We've never actually maxed out 529 contributions. With a limit of $28K per year per kid ($14K from each of us), we're not even close.
7) Contribute more to family 529s
We've started 529s for some of the nieces and nephews, tiny amounts primarily to stimulate an interest in college and investing in both them and their parents. It would be great to put more money in those too.
8) More windows
My wife still wants to replace the rest of the windows eventually. I'm trying to be supportive but still haven't forgotten that the last, very expensive, windows didn't actually increase my happiness one iota.
9) Pay off the investment property
I'm trying to avoid getting upset that it still hasn't sold at what I feel is a very reasonable price. Perhaps there will be an update by the time this post runs. [Update: It sold! Hallelujah!- more details in a later post.]
10) Saving up for next year's contributions
While it's cool that we've just about filled all the accounts by July, there's really no reason I couldn't fill them all in January if we really wanted to by saving up some money in the last few months of this year. Part of the reason for our financial success is we contribute to retirement accounts as early as possible, rather than as late as possible like many investors. This gives HSA, IRA, and 401(k) contributions 12-16 more months to grow in a tax-protected manner.
My daddy opened my 529 the day my SS card came in the mail
11) Expand our charitable giving
We would especially like to get our kids more involved in this.
12) Boost our automobile fund and vacation fund
The $8K we've got in there now isn't going to go very far toward a new SUV when one or both of our 10-13 year old SUVs (each with 165K miles on them) eventually dies.
13) Work less
I'd really like to drop my night shifts. My group pays a heavy subsidy for night shifts, so that is actually a pretty big expense. But as I look at the above list, I think that would probably make me happier than any of those other uses for our money.
[Update 12/25/15- We ended up mostly doing the mortgage payoff fund (# 4,) but also did quite a few home improvements (# 8), more family 529s ( # 7), sold the property and paid off the mortgage (# 9), saved up for January Roth IRA, HSA, and 529 contributions ( # 10), and expanded charitable giving (# 11). I also put the family on the payroll and now have even more tax-protected accounts to max out.- more on that in a later post.]
What do you think? What do you plan to do with your “extra” money this year? What are you doing to get yourself into a position to have “extra” money? Comment below!
Fix Windows. It isn’t for your happiness.
Then get your 529s fully funded.
Once 529s are on target, reduce working.
Avoid gambling into “other areas” just bc you have extra capital to deploy. It’s why doctors get suckered all the time.
Merry Xmas
It turns out it wasn’t the window leaking. It was the door above it. Good times.
An excellent compilation of options for early wealth builders. Anything else is relatively “small change”, but here goes:
To a high earner; a mortgage is an asset protector and inflation hedge. I am not saying get a huge mortgage, but be in no hurry to pay it off.
Always exploit low tax brackets to take capital gains and/or Roth conversions.
Start a home based based business with your spouse, forces you to learn basic business skills, improves the marriage and diversifies your Human capital.
Read tax books. I like Sandy Botkin myself. He says just recording your expenses has a 10x return. Try getting that return on investments.
Learn to tax loss harvest in your taxable accounts. Turn lemons to lemonade. Feels good to have Uncle Sam share in my losses. Changes your whole outlook on investing. Loss aversion is one of the most powerful human emotions with investors.
Learn the Rule of 72.
“Learn to tax loss harvest in your taxable accounts. Turn lemons to lemonade. Feels good to have Uncle Sam share in
my losses. Changes your whole outlook on investing. Loss aversion is one of the most powerful human emotions with
investors.”
I tax loss harvested for the first time this year. It really makes a bad situation not so bad, and lets me do something positive with a bad event.
Work less play more
Do not get involved in other investments like real estate, shares in your hospital, etc
You need not to take risks as such as you are on target to reach your goals
With your extra funds buy tax free munis, nothing better than tax free income
As said convert your iras to Roths
There is a point of critical mass where extra dollars will not change your lifestyle
Absolutely right that additional money brings very little additional happiness after a certain point.
I tend to agree with Ken. I basically followed the Dave Ramsey 7 baby steps and it worked well for me. I built a strong financial foundation as well as peace of mind. I paid off my mortgage and maxed out 529s. Being completely debt free is an awesome feeling. It also freed up a lot of cash flow. If you want to play with real estate or other investments as a hobby that is fine. But I agree with Ken that you are assuming risk that you do not need. Those who have extra money can take less risk. That is one of the benefits of financial success. One other thought. Once you have reached your “number” you could put that into a truly secure investment (e.g. TIPS ladder) as recommended in Bernstein’s Rational Expectations book and other such sources that worry about a potential 80-90% market collapse.
Paying off your mortgage isn’t always the best thing, financially. If you want peace of mind becaus you are debt free, that’s one thing. If you have a low interest rate and are in a high tax bracket, your after tax interest rate may be below 2%. The opportunity cost may be huge here, if you can put that money to work over the long term in equities, or even a fixed investment greater than 2%
Yes, paying off the mortgage is a status symbol in some ways. Those who can afford to do it sometimes just do it because they can while the masses are forced to use every ounce of cheap leverage they can get.
You have some math errors with simple arithmetic here.
18k 401k + 6k match + (IRA*2 ) is not 33k.
In that same paragraph, you misspelled the word “multiply”… must have been tired or something.
Merry Christmas! Did you actually save this “Christmas in July” post for today?
Your daughter is beautiful.
Still no “extra” money for us as we see it, but at least we are in a better place than last year. Thank you.
I’ve had “extra” money since we were in medical school/grad school living on $1500 a month. Extra money doesn’t come from the offensive side of the ball. It comes from playing great defense.
I’m about 4 months ahead on all my posts, so this sort of thing reflects what I was thinking about months ago, about the time we maxed out all the tax-protected accounts for the year.
Thanks for the corrections. I should hire you as an editor.
Why not stick with the “basics?” They have served you well, the data supports them…No need to get involved in anything “exotic.”
I put more money into “the basics” every year. I’m currently putting in 3-4 times what my original financial plan called for. More details on “exotic” investments here:
https://www.whitecoatinvestor.com/10-things-to-know-prior-to-purchasing-an-accredited-investor-investment/
But mostly, I look at them for several reasons:
1) Interest- It’s fun and gives me something to research and write about
2) Potential for higher returns
3) Lower correlation with my more traditional portfolio
4) Possibly the future ability to give even more than I currently do to causes I support
Many docs think they are smarter than wall st and get burned
As said STICK TO THE BASICS
Joel Greenblatt:
“Those who can’t value companies or securities have no business investing and limited prospects (other than luck) for investing successfully.”
When it comes to syndicated real estate, precious metals, investments for accredited investors, life settlement funds and buying shares in the hospital you work at, you’re engaging in security selection. Security selection is predicated on the assumption that you can value those securities. Can you do that?
The expected return from security selection is zero. In order for your to win, someone else has to lose. In a market dominated by professional investors who have stronger backgrounds in valuing securities, that won’t be easy. Just as learning to practice medicine takes a considerable amount of time, so does learning to value securities. And when you look at the track record of professional investors, their record isn’t good.
My assumption of zero return ignores costs. As compared to an index approach, security selection (active management) will result in greater costs, so expected return will be negative.
There are two other issues. When it comes to security selection, you’re preferring privately traded securities. IMO, valuation skills are more important with such securities than publicly traded securities. With publicly traded securities, you can ride the coattails of institutional investors, who have stronger valuation skills. That’s much less likely with privately traded securities. Also, investing in the hospital where you work is a bad idea IMO. A recurring piece of advice is don’t invest in the company you work at. If there are problems at that company (think Enron), your human capital and financial capital are at risk. In other words, diversify.
I understand where you’re coming from, WCI. The US stock market may provide not provide a significantly greater risk adjusted return over cash in the next decade. But think carefully about the alternatives.
To summarize, security selection is about valuation. To win at the game of security selection, your valuation skills have to be better than average. Are your valuation skills better than average?
I totally disagree with Greenblatt. # 1 Everyone needs to invest and “has business” investing. # 2 It is entirely possible to invest successfully without ever valuing an individual company.
Whether I can successfully value these non-accredited securities appropriately is irrelevant to my success at reaching my financial goals given the amount I pour into index funds every year.
I think you’re misinterpreting Greenblatt’s comments. I’ve read all his books. For the retail investor, he advocates index funds. He also thinks the mechanical value investing, either with a fund or DIY level, is good; he’s written a book on DIY mechanical value investing and also had mechanical value funds he sold. I assume that he is in favor of actively managed funds, as he runs several. But in his books, he mentions that index funds outperform actively managed funds on average. For a sophisticated investor, he would consider special situations investing appropriate; he wrote a book giving advice on that.
What I think he is saying is that unless you can value securities, you shouldn’t be investing, unless you’re using the options in the above paragraph.
Some of investments mentioned in the original post are not on that list of options.
You mean there is someone who disagrees with me on the subject of what I should do with my money? Weird. 🙂
A couple of huge flaws in your comment.
A hospital is a business not a security. These are entirely different but related.
The stock market is not a zero sum game, just look at total market cap from some year in the past to today. When you buy a stock, the other person did not necessarily lose, just think about it for more than two seconds and it should be blindingly obvious that is not the case. It may be sometimes, or youre the loser, or neither. Options/futures are different.
For example, if you buy Exxon stock next week, the person you bought it from may have held it for decades and be way in the green, or last year and in the red, etc…No matter what they wanted to get out enough to sell.
If the expected return on security selection is zero no one would do it, this is an odd statement. Even index funds are securities. Its actually not that terribly difficult as a small time investor to get an above zero return. Buy stocks/funds, dont churn, dont overpay and let time do the heavy lifting.
I think he’s saying your expected alpha is zero on picking stocks, not your expected return.
He also has his own circle of competence and its impossible to be successful at every style/type of investing situation, its simply too large a universe. Im sure someone from a different regime style would say something similar. Not all of the types of investments have been around for a long time or as easily accessible when Greenblatt wrote those things.
There are successful investors of all types, traders, value, momentum, volatility, options, futures, currency, commodities, etc…I wouldnt expect one type to feel confident about a different style. There are even hedge fund guys that seem to consistently do well (still not outside statistical chance probability for serial success). Dont confuse personal preference with the law. Expand your reading and dont necessarily take it 100% to heart, these are people and they arent perfect. Test it out, compare it, etc…
WCI mentions that he’s considering buying shares in his hospital. I would consider such shares privately traded securities.
What drives investor returns are asset allocation, security selection and market timing. Asset allocation is usually the decision between stocks and bonds. Both stocks and bonds have positive expected returns. When it comes to security selection, I mean activities such as stock picking; expected return is zero. As for market timing, expected return is negative the vast majority of the time, when it comes to deciding between stocks and bonds.
Index investors focus on asset allocation, and ignore security selection and market timing. By focusing on asset allocation, expected return is positive. Any other form of investing involves more than just asset allocation, and all other things being equal, will not increase your return (security selection) or most likely will decrease it (market timing stocks/bonds) on average. All other things are not equal. The increased costs associated with active management (security selection, market timing) will mean return from security selection will be negative and that from market timing more negative on average. Since a retail investor will most likely lose against the competition when it comes to active management, this means returns from security selection and market timing will be more negative yet.
My point is that once a retail investor decides to invest in any other way than indexing, s/he faces a headwind of significance. It’s certainly possible to overcome that headwind, but I would not want to minimize the effort or the probability of failure.
The shares of the hospital provide a significant benefit to my day job- I get the financials for my primary business partner. Well worth a small investment, even if returns are poor.
Small business tends to generate about 12%/y over the long run (obviously survivorship bias here). There are also a lot of side benefits here. If you consider the macro factors that are huge tailwinds to this industry that would pile on to the making it safer side, as well as WCI personal knowledge about his community, the systems, that make it more/less a good target, etc…This could put your foot in the door to management, committees, steering, etc…all where you start to exert influence over your investments future. Its like shares in a surgery center, etc…you’re more a true business owner than a shareholder. Its not all upside, but people, and seemingly doctors tend to overweight the tail probabilities as opposed to the likely outcome. Level of risk is also highly dependent on amount of exposure and options in case things go against you. Just saying I would not brush off these small type investments so easily, as they can be excellent builders of wealth, diversification, non correlated, and give one a stronger position in whatever area of your community you’re interested in.
Indexing isnt any less of an active style, you’re still choosing to index and given the number of indexes and how you allocate capital to them you are again adding in another layer of active investing. Its all active, lets not fool ourselves. To ignore the security selections within your indexes isnt that great, and as I’ve mentioned several times before most indexers dont understand the degree that they are concentrated in the top 10-25 stocks, or even how the index functions (and why youre unlikely to replicate the market). Or how many stocks in what sector diversification it takes to replicate the function of an index (very few). What increased costs are there associated with buying stocks? Its cheaper than funds on a cost basis as there is no ongoing cost after purchase, and its not difficult to get free trades so theres no commision involved either (I get 100/month). The benefit of funds over individual stocks is not cost but risk diversification, and you pay for that.
Asset allocation doesnt necessarily generate alpha, the point of allocation is diversification and increasing your risk adjusted return and decreasing volatility. Only having a specific tilt (sector, value, momentum, growth, size, etc..) in your allocation can increase your return, but with that will of course come increased risk. It does not generate alpha. If its long term out performance you want go 100% stocks, as we know historically thats the case. Every bit of diversification you do that decreases your stock exposure will decrease returns on an absolute level, while increasing them on a risk adjusted one. The goal in investing is to maximize your risk adjusted return. You want the return of equities with the safety of treasuries.
I dont get what you’re trying to say in regards to market timing with the stocks/bonds part, do you mean with respect to a tactical asset allocation momentum style? Market timing can be tough and is wrought with downsides for sure, just unclear what specifically you’re saying. This has been a good year for timing, as most trading range years are, all the “buy the dip” crowd has done really well.
You again state the return on security selection is zero, whereas you most certainly mean alpha as WCI clarifies, which makes much more sense.
Funds also provide convenience and liquidity over holding dozens of individual stock positions. Plus, the fund likely enjoys a smaller bid/ask spread.
I disagree that a total stock market index is an active approach.
However, stock market indexing is not without significant weaknesses. As you mention, the largest stocks dominate the index. If you market cap the largest 1000 US stocks, the top 30 are 40% of the index. So a market cap portfolio consisting of those 1000 is less diversified than one would initially think.
http://www.forbes.com/sites/rickferri/2012/12/20/any-monkey-can-beat-the-market/
Also, market cap indexing results in overpriced stocks having a disproportionate share of the index, and the opposite hold true for underpriced stocks.
An example would be late 1989. The Japanese stock market was 41% of the total world stock market, and had a PE10 greater than 90.
So stock market indexing is not without its flaws. But compared to the alternatives, one can make a good case that it’s the best option for retail investors.
I’ve invested in local medical and nonmedical partnerships. As far as valuing them goes, it wasn’t too difficult. We had 3rd party appraisers provide a value or we looked at prior distributions, recent growth, assets/liabilities, and future projections to determine if the price to buy in was appropriate. I’m not saying that all such deals are sure things, but mine have paid off well so far.
I would note, though, that partnerships are like a marriage, and you need to feel comfortable with and trust your partners. You also need to ensure that the right legal documents are in place to reduce the risk of conflicts or arguments in the future.
My comment that the precost expected return of security selection is zero is an understatement for the vast majority of investors. IMO, more than 95% of investors can’t value securities. For them, the precost expected return of security selection is negative.
Charlie Munger:
What about people who want to pick stocks?
“You’re back to basic Ben Graham, with a few modifications. You really have to know a lot about business. You have to know a lot about competitive advantage. You have to know a lot about the maintainability of competitive advantage. You have to have a mind that quantifies things in terms of value. And you have to be able to compare those values with other values available in the stock market. So you’re talking about a pretty complex body of knowledge.”
What do you think of the efficient market theory, which holds that at any one time all knowledge by everyone about a stock is reflected in the price?
“It’s efficient enough, so it’s hard to have a great investment record. But it’s by no means impossible. Nor is it something that only a very few people can do. The top three or four percent of the investment management world will do fine.”
That’s 3-4% of professional investors; he’s not including retail investors
I have to admit that I’ve thought about security selection. I am considering my own DIY small cap value fund. And I’ve engaged in country/sector investing. For example, I am invested in Greece, Russia and gold miners. In my opinion, there is data to support a retail investor investing in undervalued countries and creating their own SCV fund. But even there, I wonder whether it’s just a manifestation of overconfidence on my part.
Hedge your bet on your own ability. Very hard to tell the difference between skill, luck, and overconfidence. And don’t forget to include the value of your time.
The truth is, as wci said…you dont need to know how to value securities. The market over time tends to go up. Companies that are successful today and not in some crazy environment with headwinds will probably be larger in ten years than today….lets see off the top of my head starbucks, amazon, visa, etc…Its even easier if you just index.
Even Greenblatt admits as much with his magic formula for value investing and every other decile based system. What about momentum, trend following, etc…Its a bit easier even to understand the market is made up of people, and understanding their behavior is exceedingly important to long term successful investing.
Theres lots of data, and some recent posts by Meb Faber on what happens when countries go down 50-90% what happens in the next 5 years (excellent returns unless you think they are going to disappear), sector cycles, etc…and again you need to know nothing about security analysis as mean reversion, history, etc…all make obvious points.
Benjamin Graham:
“To achieve satisfactory investment results is easier than most people realise; to achieve superior results is harder than it looks”
It’s not that difficult to obtain market level results via index investing. But once you decide your goal is to beat the market (active management) , the level of difficulty increases dramatically.
If it was easy to beat the market, why is it difficult to identify those who have that ability? The track record of professional investors, when it comes to beating the market, is poor. Exceptions, such as Warren Buffett and David Swensen, can be found. But interestingly enough, both Buffett and Swensen recommend that retail investors index. And Buffett says that Graham was making a similar recommendation near the end of his life.
You’re making a good case that you don’t need to value securities to beat the market. That’s only one way to beat the market. But regardless of which way you chose to beat the market, it’s not easy.
Beating the market isn’t easy. Regardless of which method(s) you use to do it, expected return is negative for the clear majority, and that group would have better returns indexing.
If you are going to try to beat the market, it’s going to take time, and very likely lots of it.
The following is an example. Assume you decide to beat the market by valuing companies. Although I don’t have data, my impression is that among those who are successful at beating the market, this a common way to do it.
Aswath Damodaran has an online course on valuation on his website.
http://pages.stern.nyu.edu/~adamodar/
It’s 25 webcasts of 12-20 minutes each. So in less than 500 minutes, you can become an expert on valuation :-).
What he’s done is replace the 26 sessions of 80 minute each that he gives to his MBA students with 12-20 minute sessions.
https://www.quora.com/How-much-time-do-successful-students-at-top-MBA-programs-spend-on-school-work-each-week
The above link states that a business student will spend 2 hours preparing for an 80 minute session.
And that doesn’t include time spent on presentations, exam preparation etc.
I doubt that someone who graduates from an MBA program would be considered an expert on valuation. I certainly wasn’t an expert in medicine, when I got my degree. As there are people who devote their entire working lives to valuation, my guess would be that similar to residency, it would take a few years of full time experience to be considered good at valuation.
And even after all that time spent, you most likely will either fail to beat the market or beat it by a small extent. I have read that 90% of all stock trading is done by institutions. Valuation experts are competing with each other, with predictable results.
I never said to “beat the market”. I said non-zero. You clearly mean alpha, so itd be more precise to state as much going forward. Valuation of companies is not how you beat the market anymore. Grahams style no longer works at all, it was a function of poor accounting rules that no longer exist. Further, valuation blew up in the 70s, 80s and thats not a secret to anyone, and you dont even have to do it. At my brokerage I have access to Merrill Lynch, S&P IQ, and Morningstar full length analysis reports on every company. At others I have even more access. There is no alpha in value, only in assuming risk that some company will come back and thats really just banking on behavioral economics and that the crowd over and under shoots reality.
You sound early into your investing self education and are focused where we all do at that time, value, etc…Just remember that all those things are backward looking and benefit from regulations, policy, and secular changes that will not be reflected in their self reflective assessments. There are lots of examples of methods that worked until they suddenly dont. Regime change can wipe out very profitable strategies.
Institutions arent trading to obtain value or buy at a great price and hold to appreciation. They are generating fees, closing hedges, buying/selling for pensions/funds/retail at times against their personal opinions. You cant look at institutions as if they have similar motivations as retail investors and are looking to retire in 20 years, they are simply looking to make money every day and thats very different.
You should branch out your reading now that youre super value read. It will only make you a more well rounded and better consumer of finance even if you dont partake in any other strategies (which most should not).
The main tool the average person has is time, this should not be downplayed. The other main tool physicians have is a very high income, and when you put those things together its hard not to do well.
I’m interested in what suggestions you have, when it comes to my reading.
Thanks
Its good to force yourself to see other sides and views even if you dont do them. For instance, I think technicals are mostly bs, but enough people/institutions use and believe in them that it can become a self fulfilling prohecy so its good to be aware of them and read about those just because. Interesting. Even if total bs (it is of course) with enough momentum it happens.
Theres lots of stuff out there, and WCI has good stuff on his suggested pages as well. Currently reading Misbehaving by Richard Thaler which is behavioral economics and excellent. Pragmatic Capitalism by Cullen Roche which is about modern monetary theory and macro stuff, very cool, and he has a wonderful blog of the same name as well. Joy of Game Theory is a quick interesting read (not finance directly). Meb Faber has a blog where you can find links to his research papers as well and those go over lots of things you mentioned like sector rotation, timing….a great paper is “where the black swans hide” myth of the ten best days. I read a bunch of other stuff but its mostly now blogs and papers I come across from the web and FinTwitter as dumb as that sounds there are some very smart people on there.
I think the hardest part about being younger is the desire to catch up and do well, when we really need to just plug along using time and our income to give us what we need. Dont get me wrong I have a tilt toward sectors I think are going to/have performed better than the greater economy but Im getting more confident it doesnt matter as long as I stick to the basic plan of just saving a lot. Ive also done momentum and some trading, and I dont think theres anything inherently wrong with it if you can devote the time and have a safe set of rules (usually a very small amount)…but at some point you may just value your time instead when you realize the returns are not necessarily much different but the time involved is. Check less make more.
I have discussed that I see the role of active management as being that of beating the market. I sense that you feel that improving risk adjusted returns is the more important role of active management.
What if an indexer just adds the desired amount of bonds to an indexed stock portfolio? From the data I’ve seen, as long as stocks are at least 30% of the portfolio, that will improve risk adjusted return.
I’ve seen the argument made for other alternatives to bonds. An example would be market neutral strategies, such as arbitrage or long short. But I haven’t seen research that such alternatives to bonds improve risk adjusted returns better than bonds.
From what I see, the role of active management is to beat the market. If you want to improve risk adjusted returns, add bonds, but that doesn’t mean you have to abandon your stock indexing strategy.
But if there is research that I’m wrong, I’d be happy to see it.
However, if
Since Im young, and I understand the long term nature, reasons for allocations, aggressive, maybe dumb, etc…im 100% stocks (funds) as that has the highest long term return and thats my timeline. I do have muni bonds in my taxable as something of my savings/emergency account. I have been in bonds only when I trialed a momentum system and it was the proper allocation at that time period. This is not necessarily a great time to be a long term bondholder (it has been a great hand for decades though) as we are now (possibly) in a raising rate environment. When we reach the top of the raising cycle my opinion on that will likely turn 180 and I will go long on bonds for some portion of my portfolio. There is validity in the risk parity model, but comfort with and access to cheap leverage are much different in practice than in academic research.
There are lots of ways to reduce risk, diversify, etc…and it of course depends on your definition of risk, volatility vs. permanent loss of capital and your time horizon. I think if you could reliably get market beating performance from active management that would be awesome and is the point, it just rarely happens and the amount of managers who have done so has collapsed by a factor of 10 in the last decade compared to prior ones. That ability is getting tougher and tougher net of fees.
When I was speaking of risk adjusted returns I meant yourself as the active manager. Even indexing is active as you must make conscious choices,etc…Theres no such thing as bond alternatives and at some point the reach for yield crushes those who do, witness the MLP and high yield credit market this year.
I wouldnt abandon stock indexing as a strategy, on the contrary I would hold fast to that for the most part and just accumulate.
I’m in an almost identical situation to the OP who started WCI’s post above — newish attending, maxing out 401k/Profit Sharing plan (53k). My medium sized group also offers a relatively new Cash Balance Plan, into which we can elect to contribute differing amounts based on age. I believe the interest credit is around 3%. Anyone have any opinions re: how much to put into the CBP versus maxing out backdoor Roths? Where in the priority ranking should a CBP fall? My understanding is that the amount contributed decreases compensation dollar for dollar, thereby resulting in a pretty substantial tax benefit for the contribution year.
Thanks!
I’d put my backdoor Roths ahead of a CBP most of the time because of increased control and probably increased return despite the bigger tax benefit with the CBP. However, I max out both. So if you want to do as I do and not as I say, try to do that.
You are deferring taxes and not eliminating them with all defined benefit plans. That has value but don’t get suckered into focusing on the contribution. For defined benefit plans you would actually prefer the lowest contribution for the same benefit.
WCI. Congrats on your invest prop sale! Are you going to pay the taxes or have you considered a 1031 exchange to defer the 23.9, recapture, state etc (assuming you made a profit and even if you didn’t). Wondering if you know of some private placements or other way to invest 1031 exchange money outside of buying another property outright?
I love that you think I owe taxes on the sale of my investment property purchased in 2006. I’ll be using the losses for years to reduce my tax bill. Lots of lessons learned for an upcoming post.
I have not found a great way to 1031 exchange reliably without buying a property outright. It’s fairly tricky with syndicated properties which is what I prefer using. Maybe I’ll buy another investment property outright in the future, but it’ll be local to me and it will be purchased for that purpose from the beginning. This property is one I lived in for four years and then became an accidental landlord with. Luckily for us, it was an inexpensive townhome and not a huge “doctor house.”
Whitecoatinvestor, if you lost money on your real estate deal, you’re probably not going to take years to burn off your losses. First, any of the suspended passive losses connected to the property will appear on your 2015 tax return because you’ve disposed of the activity. Second, note that a real estate loss isn’t a capital loss that gets limited… it’s s Sec. 1231 loss which you can use to erase basically any type of income.
That would be awesome news as I could really use the entire loss this year. You’re right I haven’t started researching this for my 2015 taxes, but expected it to be a capital loss.
As I kept reading your options as to what to do with your extra money I kept wondering (or hoping, to be honest) that “work less” was on your list. Obviously, that’s a very personal choice that may or may not be right for you, but I do think the ability to have greater control over your time is a very precious thing to have.
I’ve already given notice about dropping from 15 shifts to 12. But we’ve got to hire someone in order to let me (and another doc) drop some shifts. That’s a 9 month process.
I guess I could start working less on WCI at any time….
Working less on WCI??!?!?? Hey, let’s not get crazy here–I mean I don’t want you to have too much time on your hands. 😉
We chose work less and have never regretted the decision.
Also, WCI, your posts occasionally now come up on my Flipboard app without going to your site. Was that intentional? It’s a nice touch.
Happy Holidays to all!
I’m not sure what Flipboard is, but I probably ought to find out.
This post is why I and others will continue to read your blog:
1) You always restate the basics but in sufficient details.
2) You then delve into a complexity that intrigues all.
3) Then, most importantly, you let us in to your own financial life and thinking.
I’m so glad you still personally blog, because I learn from you even when my opinions differ. Thanks and Merry Christmas!
You’re welcome. Sometimes writing a post helps me to think through the related issues. Then I usually have to rewrite it when I realize my initial plan/assumptions were wrong.
I completely agree. I have written quite a few posts for the bogleheads community to help me answer a question,. Just by writing it out, I am forced to really think about it and usually answer my own question.
For an emotional choice and not necessarily math point of view…. How is paying off that home mortgage coming ?
The mortgage was originally $370K or so. Between the mortgage payoff fund and amortization I think I’m at something like $150K left. There’ll be a post about it.
From one ED doc to another, I don’t know how dropping nights isn’t #1,2,3 on your list.
There is nothing more toxic to your health, family life, career longevity than nights.
The returns on that investment would far exceed and surpass any theoretical or actual return from all the other investments combined.
Ari,
As an ED doc as well, my goal is to reach a wealth number that if allowed to grow without further contributions will reach my goal on its own. At that point I will do everything in my power to never do another overnight shift and minimize weekends. By doing this, and going part time I hope to be able to work into my 60s because the job is fun, not because I need the money.
My health and free time is worth a lot more than a boat, sports cars, or even paying for my kids future college.
The plan was to drop both shifts and nights in April. Well, can’t drop the shifts until July but I could probably still drop the overnights in April I suppose.
Yeah. It’s interesting that you haven’t really talked at all about the marginal utility of wealth in your situation. It’s mentioned here and there, but not nearly as much as new investments/opportunities. When in reality, each incremental dollar now is pretty meaningless since you have enough. I’d stop wasting mental energy (looking at alternative investments) or physical energy (working extra shifts) and use that time LIVING.
I’ve got enough income, but not enough assets yet to have “enough.” But I’ve spent more and more time thinking about marginal utility of wealth over the last year or two, especially as I start looking at my upcoming tax bill.
Haven’t you reached a wealth level that will grow to enough without a single extra contribution?
It is definitely much harder to pick up an extra shift when you get to keep only half the money thanks to taxes.
On another note. Cutting your income by $50K only cuts your take home by $25K. Makes cutting a shift or two not that big of a deal. It is why I think it is so important to pay off debt and build that nest egg as early as possible in a career.
Yes.
I agree with your last paragraph and that was how I justified dropping shifts…I just have to wait a few more months before I can actually do it.
Maybe it is time to really think about your personal definition of enough. It really comes down to how you weight time and money personally. What was it you were thinking about so much on that run you referred to a few points back? Seems I recall it was more time related. I look forward to your future posts now that you have reached this point in your financial journey.
I spent a lot of time thinking about that this year. I’ve had several “personal” posts in the last few weeks, but they were all written months apart.
I’m already cutting back on shifts and dropping night shifts in the next 6 months.
curious question to night differential from a fellow ER doc. What premium does your group pay for nights? Hourly? Per shift?
We pay by the shift and we let the market determine the rate. It works out to a night shift paying about 25% more than an evening shift and 50% more than a day shift.
If I had to do it over again I would make my taxable account half munis and the other half stock index funds
Spent the last three hours on this site. First, I am a homemaker and my husband makes well over 220k a year. He is not a doctor. But I often feel alone in all of this because I’m not surrounded by people who understands our situation. I googled investments and high income earners and found this site. I’m so glad to be here! After reading for a few hours, I finally found a home. People who I can chat with about investments and ungodly tax income and giggled (some blog post had me laughing out loud!). Thank you for creating this community for doctors as well as others.
Welcome Jellybean!
Just you wait when the forums open up on this site next month…it will be great. This is a wonderful place.
Welcome to the site. As is probably obvious, most of the stuff discussed here is far more income-specific than doctor-specific.
Welcome. You can make a huge impact on your family by taking up finance as a hobby. Kudos for taking the interest!
I suspect that you are wanting to try alternative investments partially as a way to learn about them and then share the experience with your reader. At least that’s what I would be thinking if I ran the site. Glad you making a lot of money and having a lot of fun! It’s been a good year for me as well. Savings rate has been over 60% the last 6 months and deciding what to do with next years income. I’m thinking 50k in Roth and 20k against loans.
$50K in Roth? Must be mega-backdoor Roth, no?
No mega backdoor needed for a couple. 18K 401k +18k 403b +5.5K IRA +5.5K IRA + at least 3K employer match. I’m sure our tax bill will be pretty high for not taking advantage of Traditional space (probably higher than yours as an army Doctor), but our income will only go up when my wife finishes residency.
The employer match is always tax-deferred. But you’re right that you could get $47K into Roth when you include your spouse and your IRAs.
I pay taxes on their contribution and it goes into my Roth 401k. I do not have anything in my traditional 401k.
So your plan must allow in-plan conversions. Nice feature to have. Any reason you’re going all Roth?
It just makes sense to me that when you are in residency/fellowship (or have a spouse that is) that you would invest all in Roth. Our top tax rate is probably 30% if you include state tax. I suspect that our lowest 401k dollar will go in at 30+% once my wife is an attending plus we will probably have close to 100k in traditional space per year. This is against the advice of FIRE people like Mad Fientist who say go all Traditional, but that assumes you have less than 2.5 million (100k at 4% withdrawal rate) in traditional when you retire.
TLDR: Not diversifying now to be diversified later. Cheaper taxes overall.
Yes, Roth is usually the right move in residency. I had forgotten you were a resident.
I wouldn’t have time to post here if I were a resident. My wife is in residency. Don’t want anyone else to start thinking I am smarter than I am 😉
A)How did you put your young family on payroll?
B. I have managed to save 40% of my income this year, i really want to save before buying my model X and thinking of cutting down work in 15 years so i can work longer
C. I really don’t want to spend too much time or know too much about alternate investments. I guess why take risk if i have enough money
A. Put them to work. Then paid them for it.
B. Good job.
C. Totally optional.
Put them to work and pay them for it was not the answer I was looking for. What do they do for you? How do you value their work? Do you have to pay any SS tax for them?
I guess I could just cut and paste the post and put it in the comment section of this post. 🙂
Brief version- They’re models. $100 an hour is the going rate for child models. No you don’t pay SS tax. Nor income tax.
How much modeling can a child do in a year to really make this worthwhile? I have a few friends who have asked me about putting their kids on payroll. I said when young modeling is a decent option for business cards and holiday cards. But that is maybe 4-5 hours. Is it worth $500? When older they can assist with some business management and maybe rack up enough to max out Roth.
Also, can you please explain why there is no Soc security or Medicare tax?
I’m paying $1500 each to have their pics splashed all over this website. Heck, that’s what I’d charge someone else who wanted to use pictures of my kids on their website. They’ve easily spent 15 hours a year, especially when you include travel to the site of the pictures. So that’s $6K that would be taxed at 48% that now isn’t. Sure, it’s only $3K off my taxes, but it’s also $6K into Roth IRAs never to be taxed again and able to compound for 8+ decades.
Kids working for their parents don’t pay payroll taxes. Cool huh.
Now I know why you have so many pictures of your family on every post. Very nice.
Just building a case for the audit. 🙂
Always great to have extra money. Since you wrote the post 4 months ago you have probably already deployed the money. I would recommend against an investment in your hospital. I have done this 3 times. I made a decent return. What I did not like was the illiquidity of the investment. My last investment like this just bought me out. I took this “windfall” money and bought 50% Vanguard Intermediate municipal bond fund and 50% vanguard total international stock fund. This is in a taxable account and fills some holes in my asset allocation. I just did some tax loss selling and bought a new position in a Vanguard midcap fund to fill another hole.
I don’t mind having part of my portfolio illiquid as long as I’m paid for it.
Could you post on life settlement funds?
https://www.whitecoatinvestor.com/investing-in-life-settlements-viaticals/
If I had more info, I would post it.
Its funny, you hate whole life insurance, but wouldnt mind buying one through a settlement fund.
If it wasn’t for the ethical dilemma, I would rather sell it than buy it. Those who sell it have great returns!
At any rate, the reason I’m not big on buying whole life insurance as an investment is that it has terrible returns. That’s not the case with a well-run settlement fund. The investors end up with a great return (assuming they buy at the right price), at the expense of the person who bought the policy in the first place and paid all those commissions.
I’ve been wrestling with this question as well as I look toward our budget for 2016. We will max out 401ks, an HSA and backdoor Roths. We also plan to pay of a $20K car loan even though the interest rate is only 2% simply because we have the excess cash.
Beyond that, the plan was to pay extra on our mortgage according to an 8 year repayment schedule, but now we are debating a real estate private equity type deal that would require $50K in January as well as a similar private investment that would require another $25K or $50K in the first quarter. If we don’t do that I could pay off a rental mortgage that’s around $90K at 5% instead of throw it at our home…but the benefit to doing that is that we know we could easily access the home equity with a cheap HELOC if we want to move or start a business or something in the next few years. That’s just theoretical so I hate to have well over 6 figures just sitting in cash in the meantime…
It’s a first world problem to be sure, but sort of a paralyzing one – as silly as I’m sure that sounds to most people.
I know it’s a good problem to have, but
That 5% rental property mortgage looks awfully tempting to me.
With extra money each year I build up my taxable account. I max out my 401k (over 50 years old so can add more) and get my employers 50% match on the whole thing. I’m not a doctor. Don’t have much in Roth or IRA because always exceeded the limits. Bought a second home on a lake in a Boston suburb for cash, and sold primary large 5 bedroom home in Florida to downsize to a maintenance free townhouse. 4 kids are all done with college and on their own. Live great but way below our means, which is a big step in building assets. Cars are paid off, and purposely have a 300k mortgage on the townhouse at 2.6% interest. Put that money into the market 3 years ago and has increased about $70k, so it worked out well. That’s long term money anyway. Will put off social security until age 70 to get the max for inflation protected income stream, and will live off tax deferred withdrawals until then. If possible, tax wise, will convert qualified money to Roths at that time as well. That way I can spend down my qualified money to keep RMD’s as low as possible at age 70 1/2. This will allow me to control taxes on social security as much as possible. That’s why it’s good to have other assets besides all tax deferred.
Also meant to say having taxable and/or tax free accounts allows you to control taxable income when retired to stay in lowest tax brackets possible. Not just for social security. Large RMD’s and taxable interest from investments, along with social security, can easily push you into top tax brackets.
Tax diversification is useful, but your fears of being pushed into the top tax bracket are probably overblown. You’ll be lucky to get $30K from Social Security. At a 2% yield, a $1M portfolio gives you $20K in taxable interest a year. A $200K RMD at 70 requires an IRA larger than $5M. That’s $250K, still $217K below the top tax bracket, and that assumes $0 in deductions. Unless you consider 25-28% a top tax bracket, it’s really quite the exceptional doc with that issue.
Would it be worth taking my wife off of my group’s insurance policy so that she can open a HDHP and HSA? I’d love to have an HSA too but the group has no plans to move to a HDHP.
I max out my 401k/PSP, she maxes out her solo 401K and we fund the backdoor Roths every year.
As a general rule, no. If someone else is going to pay your insurance premiums, that’s usually a better deal than paying your own premiums and getting an HSA. An HSA account is great, but it’s not that great. Here’s a related post:
https://www.whitecoatinvestor.com/should-i-get-an-hdhp-just-to-use-an-hsa/
[From your photo caption above] We didn’t actually wait for our children’s SS card to come in the mail to open their 529 plans – I opened one up under my name when my wife got pregnant. Once the SS card came, I rolled my account money into our daughter’s account and started contributions to both her account and mine in anticipation of the next child. When the second baby came, I rolled my account balance over to the next daughter’s account and started the process over again. I kept doing this until my urologist made sure there would be no more kids 🙂 The few thousand dollars head start on each child will hopefully be a nice bonus with 20+ years of growth.
Interesting strategy. 9 extra months never hurts. You could even front load the first 5 years of contributions like that I suppose. Then when they’re born, you can contribute another 5 years of contributions. That gets you 10 years of contributions in the first year. I’d have to double check the details on that, but I think that would work.
Yes, we have about 24 months between each of our four kids, so the last three have 24 extra months of contributions. It’s not much, but it helps.
I bet you are right, as the five year front load rules of form 709 follow the beneficiary. If that’s the case, parents more affluent than me could give $28,000 in December, $140,000 in January, and then roll the plan over and put in another $140,000. College savings complete; with lots of compounding. Hey, I can dream, right?
Complete? Where are your kids going to school? The moon? If that doesn’t grow to a million bucks by college time I’d be very surprised. But 529s really are a tax break for the rich.
It really comes down to how much you want your kids to have in a 529 for college. I mean, if you put in $5K a year for 18 years and it grows at 5% real, that’s $150K. If you combine that with reasonable school selection, maybe a little merit scholarship and some summer work, and a little cash flow from your pay, there won’t be any student loans for the next generation, at least for undergraduate.