Podcast #72 Show Notes: Why Invest in Bonds?
So you are in your 30s, just out of training, and you really want to catch your retirement savings up since the pipeline to get here was so long. And you think, why should I put any investment money in bonds? I understand they are lower risk and every book recommends a minimum of 10% of my portfolio be in bonds but since I won't be touching this money for decades I can just add bonds to my portfolio in 10 years or so. I mean I could tolerate any changes in the total stock market over the next 10 years before I make my portfolio more conservative by adding bonds.
Well, truth of the matter is that you don't need to have bonds to be successful.
Probably………
In this episode I caution you that when you decide not to invest in a major asset class like bonds you're making a pretty big bet. And so I think it's probably a good idea for you to at least include a little bit of bonds in your portfolio even when you are after those high returns.
PLUS
More importantly the reason to include bonds in your portfolio is that you don't really know your risk tolerance when you're just starting out as an investor. This period of time when you think you can get away with not owning bonds because you want those high returns. That is also the period of time when you are an unproven investor. You're unproven to yourself. It seems like you could to stay the course in a big bear market but you don't actually know that you can because you've never done it. You're essentially an investing virgin. And I think it's a good idea to set your asset allocation up a little more conservatively than what you think you can handle until you go through your first bear market.
But before we get into what else is in this episode, here is our sponsor. Have you downloaded Adam's free e-book yet?
Podcast # 72 Sponsor
[00:00:20] This episode was sponsored by Adam Grossman of Mayport Wealth Management. Adam is a Boston-based advisor and works with physicians across the country. Unlike most other advisors, Adam offers straightforward flat fees for both standalone financial planning and investment management. Whatever stage you're at in your career, Adam can help you get organized with a personalized financial plan and can help you implement it with a low-cost index fund portfolio.
Adam is a CFA charterholder and received his MBA from MIT, but more importantly, you'll benefit from Adam's own personal experience with many of the same financial obstacles and opportunities that face physicians.
To learn more, visit Adam's website mayport.com/whitecoat to download a free e-book especially for physicians.
Quote of the Day
And of course our Quote of the Day. So many good quotes to share from Morgan Housel.
[00:01:03] “There is a lot of money to be made in the finance industry which despite regulations, has attracted armies of scammers, hucksters, and truth benders promising the moon” -Morgan Housel
Introduction
Three things I cover in the introduction.
1) Read The White Coat Investor book
[00:01:23] Seriously though if you haven't had a chance to read the White Coat Investor. It's a great book. And I'm not just saying that because I wrote it. You should take a look at it. It has had hundreds of reviews, almost all of them are five star reviews, and it is changed a lot of lives. It's a great way to catch up quickly to other listeners of the podcast or readers of the blog. And it contains information that isn't found either on the podcast or on the blog. So if you haven't had a chance to read that, I'd suggest picking up a copy and reading it. If you know somebody else that could benefit from it, get them a copy while you're at it. It could change their financial life.
2) Subscribe to the White Coat Investor Youtube channel.
[00:02:04] Check out the WCI channel. We are putting a lot of effort into it, to reach more people with this financial information. There is both audio and video there covering important topics. Be sure to check it out and subscribe.
3) Speak Your Questions Directly on to the WCI Podcast
Main Topic
Why Invest in Bonds?
[00:02:48] You may do just fine not investing in bonds. Maybe. But since we don't have a crystal ball I recommend you include bonds in your portfolio because:
- There may be a situation in which bonds outperformed stocks over your investment horizon. Is that situation unlikely? Yes that's unlikely. You're more than likely going to do better with stocks then bonds over 30 to 60 years. That said there are significant periods of time in history when bonds have outperformed stocks for periods of 10 and up to almost 20 years. And that could certainly happen again and it has happened in other countries.
- You don't really know your risk tolerance when you're just starting out as an investor. You are an unproven investor. Like I said earlier you're essentially an investing virgin. So set your asset allocation up a little more conservatively than what you think you can handle until you go through your first bear market. It is a little bit like the Price is Right. You want to have as many stocks as you can tolerate but not any more than that. So you're trying to get as close as you can to the right amount of stocks for you without going over.
- Specialized kinds of bonds can be important to your portfolio. Municipal bonds for instance kick out tax free income when you hold those in your taxable account. Treasury Inflation Protected Securities or TIPS can also help protect you against inflation. So don't ignore this asset class.
Q&A from Readers and Listeners
Enough about investing in bonds. Let's get to some listener questions.
Q) [00:06:56] “I'd love to hear your thoughts on target date retirement funds.”
A) A target date retirement fund is a fund of funds. It's a mutual fund that buys a bunch of other mutual funds. And at Vanguard they're basically invested entirely in the Vanguard Total Stock Market Index, the Vanguard Total International Stock Market Index, the Vanguard Total Bond Market Index Fund, and the Vanguard International Bond Market Index Fund. I think as you get into the later stages, toward the less aggressive ones, they even throw their Treasury Inflation Protected Securities Fund in there. And so it's a good mix of funds. It's not like you're going to go wrong picking a target retirement fund. There are no bad funds in there at Vanguard anyway. Now some of the other companies have some higher expense funds you may want to avoid. But the problem with target retirement funds is not only that you get the higher expense ratios, you can't get the lower ones you would get with Admiral shares or the ETF share classes of Vanguard, but also it's probably not available to you in all of your accounts. For instance my 401k at my partnership doesn't offer target retirement funds so if this is supposed to be a one stop shopping solution, use one fund and forget about it. Well that doesn't work if it's not available in your 401k.
The other problem with it is if you are investing in a taxable account you're going to have some assets in there that you probably don't want in your taxable account. For example most docs are in a high tax bracket and if you are going to hold bonds in taxable you want to be holding muni bonds or tax exempt bonds. The bonds in the target retirement funds are not tax exempt bonds. And so in that respect you may not want to hold it in a taxable account if you're looking for the most tax efficient solution possible.
Most people using target retirement funds are looking for a simple solution, a one stop shop, something they can set and forget. They're not usually the people who are listening to financial podcasts and reading financial blogs and that worry about things like a 10 basis point difference in expense ratios. If you are the type of person who worries about those things you probably don't belong in target retirement funds. You might as well set your own asset allocation. But are they perfectly fine? Sure they are. It just doesn't work for most docs because they have all kinds of different investing accounts they're trying to manage. But certainly when you're starting out in residency, in a Roth IRA, and that's your only investment account, throw it into a retirement fund, that's a great choice.
Q) [00:10:38] “I have a loan for disadvantaged students where 5% interest is paid for during my training. Should I continue with this loan as is or consolidate all my loans and and go for REPAY or PAY and presumably eventually public service loan forgiveness?”
A) The reader has 150,000 dollars in student loans at 6% with Great Lakes and 80,000 at 5% with heartland. The smaller loan is a loan for disadvantaged students. He was not considering loan forgiveness at the time he deferred the loan for disadvantaged students since 5% interest would be paid for during his training (6 years). He could still make four years of qualified payments. after that. But is unsure whether he will be in a nonprofit after training though is not opposed to the idea. If he consolidates the loan for disadvantaged students he loses the 5 percent benefit.
The most difficult part of this is deciding whether you are going for public service loan forgiveness or not. If you're going for a public service loan forgiveness you want to get as many of your loans as eligible for public service loan forgiveness as you can. And if consolidating helps you do that. You want to do that. You also want to make as many tiny payments during your training as you can. And so it's hard to answer this question without knowing the future, whether you're going to be working for a qualifying institution for Public Service Loan Forgiveness.
If you're not, there's no reason to consolidate that loan for disadvantaged students. This is a subsidized loan and they're covering the interest for you during residency. That is a great deal. However you're not making payments toward public service loan forgiveness. So which one's a better deal? Well the Public Service Loan Forgiveness is probably the better deal. But if you end up working in private practice you will have paid a lot of interest that you didn't have to pay by taking that loan out of that program and putting it into a typical loan program. So the first thing to decide is whether or not you're going for public service loan forgiveness. If you are then go ahead and consolidate that LDS loan. If you are not, leave it where it is right now and let the government cover the interest on it.
Q) [00:13:19] “I've been saving money in a taxable account just in case something happens with the Public Service Loan Forgiveness program. If I plan to potentially use that money for loan payoff in five years what is the best allocation strategy?”
A) So he's asking what should you do with your public service loan forgiveness side fund. I've got a blog post coming up on this. It really gets into the details of it. But here are a few principles you should consider when looking at this.
- The first is how likely are you to use this to actually pay off the loan? And in my view you're pretty unlikely to use it. This money is almost surely going to be used for something else because I don't think public service loan forgiveness is going away. And even if it does in the next five years I think this doc is going to be grandfathered in. So the most likely thing is that this money is just going to be added to the retirement portfolio in which case it ought to be invested aggressively like the rest of the retirement portfolio.
- If you think for some reason that you're very unlikely to stay in a job that's going to qualify for public service loan forgiveness and you really are going to use this money to pay off your loans then I would invest it much less aggressively perhaps just in a money market fund or a short term bond fund or a high yield savings account.
Q) [00:15:13] “We have 401k retirement accounts through are current jobs that we max out each year, Roth IRAs and a separate investment account with T.D. Ameritrade. Should we invest in the same low cost index fund for all accounts, the Vanguard Index S&P 500, or is it better to diversify somewhat?”
A) This is one of those questions I get all the time and the answer to it is — you need a written investment plan! If you can draw one up yourself. That's fine. I've got a post about how to do an investing plan. If you're not ready to do that but you want to learn how to do it yourself you might consider taking my online course, Fire your Financial Adviser . It teaches you how to not only interact with a financial adviser but also to draw up your own financial plan if you should want to.
There are basically lots of reasonable asset allocations out there. You need to pick one that you can stick with through thick and thin and then when you go to choose investments you choose them according to that asset allocation, according to your written investing plan.
Q) [00:17:54] After we pay off our loans where should we direct funds? Emergency fund, pay off the mortgage, or invest in funds or property?
A) If you don't have an emergency fund, you need to get an emergency fund. It is probably okay to have a small one while you're trying to knock out your student loans but should get a bigger one, three to six months of what you spend, after you pay those loans off. So that's priority number one. Should you invest or pay off the mortgage? Both are reasonable things to do. As long as you have additional tax protected space I think you should invest. But once you're looking at your taxable money I think it's reasonable to consider paying off your mortgage with all or part of that savings above and beyond your retirement accounts. This assumes you're putting at least 20% of your gross toward retirement even if that's being invested in a taxable account.
Q) “We have a long term goal to move to New Zealand. We realize this would lead to much lower salaries. Is there a better time to do this? Would you recommend working 10 years in the U.S. to save as much as possible in retirement before going? Any certain amount we should save up before going or other tips?”
A) [00:20:12] I don't know if there is a right answer here as far as when is the best time to go to New Zealand. Obviously the more you save first the better off you're going to be financially. But life isn't always about money. It might be tough to do that New Zealand thing once kids are in high school. So if you're going to go temporarily I think I'd go before that. If you're going to go permanently, I'd probably do it before then as well. So maybe they can work for five years and then go. There is not really a certain dollar amount you should save in the U.S. before going to New Zealand, it's just too personal of a question for me to answer. But I suggested they send in a guest post about what they decide to do!
Ending
[00:21:46] That is all for this week. Be sure to check out the White Coat Investor book if you haven't yet. Also check out our Youtube channel. And thank you for supporting our sponsors.
Full Transcription
[00:00:00] 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.
[00:00:20] Welcomed to the White Coat Investor podcast number 72, Why Bonds. This episode is sponsored by Adam Grossman of Mayport Wealth Management. Adam is a Boston based adviser and works with physicians across the country. Unlike most other advisers Adam offers straightforward flat fees for both standalone financial planning and investment management. Whatever stage you're at in your career Adam can help you get organized with a personalized financial plan. He can help you implement it with a low cost index fund portfolio. Adam is a CFA Charter holder and received his MBA from MIT but more importantly you'll benefit from Adam's own personal experience with many of the same financial obstacles and opportunities that face physicians. To learn more visit Adam's website Mayport dot com slash white coat to download a free eBook especially for physicians.
[00:01:03] Our quote of the day today comes from Morgan Housel. There's a lot of money to be made in the finance industry which despite regulations has attracted armies of scammers, hucksters, and truth benders promising the moon. I guess that's just what happens when you have a lot of money sloshing around in one industry. You're going to get people who are just in it for the money going after it rather than people who really want to help you.
[00:01:23] If you haven't had a chance to read the White Coat Investor, the book. It's a great book. You should take a look at it. It's had hundreds of reviews almost all of them are five star reviews and it's changed a lot of lives. It's a great way to catch up quickly to other listeners of the podcast or readers of the blog. And it contains information that isn't found either on the podcast or on the blog. And I'm surprised that I continue to not only sell lots of copies of it each month because it continues to help people but also the feedback I get on it and just how many lives is changed. So if you haven't had a chance to read that I'd suggest picking that up and reading it. And if you know somebody else that could benefit from them get them a copy while you're at it.
[00:02:04] Be sure to also check out our youtube channel. This is something where you can not only get some audio and video, covering these important financial topics but also another way in which we can put some really great content together. It really only works in that format so we're trying to use that more and more. Be sure to check it out and subscribe.
[00:02:27] The first topic we're going to hit today was sent in by a reader who asked us to cover this important question of why Bonds? And by the way, you are able to leave your own questions, in your own voice soon, that we'll be able to put on to this podcast. More info on that to come but we think that's going to be a great addition to the podcast.
[00:02:48] But this doc wants to know why he should have bonds in his portfolio? “Specifically for a 30 something M.D like me. Only one year out of training. Why should I put any of my 401k and other investment money in bonds as opposed investing only in equities and a smaller amount in real estate. I understand that bonds are much lower risk and every book I've read recommends a minimum of 10 percent bonds for anyone. But since I don't plan on touching any of these funds until retirement it could be reasonable to invest no money in bonds for now and then add that to my portfolio maybe 10 years in the future. Well this would be a relatively aggressive investment strategy. It seems that I could tolerate any changes in the total stock market over the next 10 years before I made my portfolio more conservative by adding bonds.”.
[00:03:29] Well you know this is an interesting question. Lots of people have this. There is no right answer to it which makes it worth a discussion really. The truth of the matter is that you don't have to have bonds to be successful, probably. You know there may be a situation in which bonds outperformed stocks over your investment horizon. Is that situation unlikely? Yes that's unlikely. You're more than likely going to do better with stocks then bonds over 30 to 60 years. That said there are significant periods of time in history when bonds have outperformed stocks for periods of 10 up to almost 20 years. And that could certainly happen again and it has certainly happened in other countries. And so bear in mind that when you decide not to invest in a major asset class like bonds you're making a pretty big bet. And so I think it's probably a good idea for you to at least include a little bit of bonds in your portfolio for that reason.
[00:04:28] But a more important reason to include bonds in your portfolio is that you don't really know your risk tolerance when you're just starting out as an investor. This period of time when you think you can get away with not owning bonds because you want those high returns. That's also the period of time when you are an unproven investor. You're unproven to yourself. It seems like you would be able to stay the course in a big bear market but you don't actually know that you can because you've never done it. You're essentially an investing virgin. And I think it's a good idea to set your asset allocation up a little more conservatively than what you think you can handle until you go through your first bear market.
[00:05:08] My first bear market was the 2008 bear market and I'll tell you what, By the end of that I was pretty darn glad that I had 25 percent of my portfolio in bonds because it felt like stocks were going to keep going down and down and down forever. But by having those bonds in my portfolio it made it easier for me to tolerate the losses I had had in stocks. And so you may find that you're in the same situation but if you decided not to own any bonds you may have exceeded your risk tolerance and end up doing the worst possible thing you can do in a bear market which is cashing out and basically selling low. And so you're far better off holding 10 20 30 40 percent bonds than you are selling low in a bear market. It's a little bit like the price right. You want to have as many stocks as you can tolerate but not any more than that.
[00:05:59] So you're trying to get as close as you can to the right amount of stocks for you without going over. So be very careful in that respect. There's also some other benefits of bonds for example some specialized kinds of bonds. Municipal bonds for instance kick out tax free income. You know when you hold those in your taxable account. Treasury Inflation Protected Securities or TIPS can also help protect you against inflation. And so that's also another great case for why you might want to own some bonds in your portfolio. But those are my main thoughts on whether you should own bonds in your portfolio or not. I certainly do and have throughout my entire career and I haven't regretted it. But the truth of the matter is if I went back and had held 100 percent stocks instead of bonds I would have more money today assuming I was able to tolerate the ups and downs than I do now. And whether that continues in the future or not of course is anybody's guess.
[00:06:56] All right. Second question from the same listener. “I'd love to hear thoughts or even entire episode on target date retirement funds. For example I have Roth IRA funds and Vanguard target date fund with an expense ratio of zero point one five percent. I can instead put that money directly into the component individual index funds with an expense ratio of about point 04 percent if I use the ETF. I don't have enough funds to purchase Admiral shares in all categories. So is this difference in fees large enough to justify the time needed to rebalance the account and adjust the asset allocation through retirement? I understand I could choose a different asset allocation and different glide path in retirement but I don't have any evidence based reason to think that my choices would be better than Vanguard settings for its target date funds.”.
[00:07:40] Well what a target date fund is, it is a fund of funds. It's a mutual fund that buys a bunch of other mutual funds. And at vanguard they're basically invested entirely in the vanguard total stock market index, the Vanguard Total International Stock Market Index, the Vanguard Total Bond Market Index Fund. I think they also now have the Vanguard international bond index fund in there as well. And I think even as you get into the later stages toward the less aggressive ones they even throw their Treasury Inflation Protected Securities Fund in there. And so it's a good mix of funds. It's not like you're going to go wrong picking a target retirement fund. There are no bad funds in there at Vanguard anyway. Now some of the other companies have some higher expense funds you may want to avoid.
[00:08:32] But the problem with target retirement funds is not only that you get the higher expense ratios, that you can't don't get the lower ones you would get with Admiral shares or the ETF share classes of Vanguard but also it's probably not available to you in all of your accounts. For instance my 401k and my partnership doesn't offer target retirement funds so this is supposed to be a one stop shopping solution ,buy one fund and forget about it. Well that doesn't work if it's not available in your 401k.
[00:09:03] The other problem with it is if you are investing in a taxable account you're going to have some assets in there that you probably don't want in your taxable account. For example most docs are in a high tax bracket and if they're going to hold bonds in taxable they want to be holding muni bonds there or tax exempt bonds and the bonds and the target retirement funds are not tax exempt bonds their taxable bonds. And so in that respect you may not want to hold it in a taxable account if you're looking for the most tax efficient solution possible.
[00:09:35] Now the truth is most people are using target retirement funds are looking for a simple solution, a one stop shop, something they can set and forget. They're not usually the people who are listening to financial podcasts and reading financial blogs and that worry about things like a 10 basis point difference in expense ratios. If you are the type of person who worries about those things you probably don't belong in target retirement funds. You might as well roll your own asset allocation in that respect. But are they perfectly fine? Sure they are. Even some very sophisticated investors use those types of funds. For example Mike Piper who blogs at The Oblivious Investor his entire portfolio is in a vanguard life strategy fund which is basically a target retirement fund that doesn't change its asset allocation as you move toward retirement and so it's a very simple but elegant solution. It just doesn't work for most docs because they have all kinds of different investing accounts they're trying to manage. But certainly when you're starting out in residency, in a Roth IRA, and that's your only investment account sure throw it in a retirement fund, that's a great choice.
[00:10:38] All right next question is about student loans, specifically a loan for disadvantaged students. This doc writes in, “I have about 150000 dollars in student loans at 6 percent with great lakes and 80 thousand dollars at five percent with heartland. The smaller loan is a loan for disadvantaged students. I was not considering loan forgiveness at the time I deferred the loan for disadvantaged students since 5 percent interest would be paid for during my training including fellowships and put the rest in forbearance. I have been making payments on the Great Lakes loans to get the tax deduction over the last two years. I plan on finishing two fellowships that will put me at six years of training. I could still make four years of qualified payments. I'm not sure whether I will be in a nonprofit after training but I'm not opposed to the idea. If I consolidate the loan for disadvantaged students I lose the 5 percent benefit. Should I continue with these loans as is, put the Great Lakes portion into repay or pay and leave the loan for disadvantaged students out? Or consolidate them all and go for repay and pay and presumably eventually public service loan forgiveness?”
[00:11:43] Well here's the deal. The most difficult part of this is deciding whether you going for public service loan forgiveness or not. If you're going for a public service loan forgiveness you want to get as many of your loans as eligible for public service loan forgiveness as you can. And if consolidating helps you do that. You want to do that. You also want to make as many tiny payments during your training as you can because the amount that's left to be forgiven after ten years of payments in the Public Service Loan Forgiveness program is the difference between a full payment that you'll make as an attending and the tiny little payments you make as a resident and a fellow. And so it's hard to answer this question without knowing the future, whether you're going to be working for a qualifying institution for Public Service Loan Forgiveness.
[00:12:29] If you're not. Well certainly there's no reason to consolidate that loan for disadvantaged students. This is a subsidized loan and they're covering the interest for you during residency. That is a great deal. However you're not making payments toward public service loan forgiveness. So which one's a better deal? Well the Public Service Loan Forgiveness is probably the better deal. But if you end up working in private practice you will have paid a lot of interest that you didn't have to pay by taking that loan out of that program and putting it into a typical loan program. And the first thing to decide is whether or not you're going for public service loan forgiveness. If you are then go ahead and consolidate that LDS loan. If you are not then you know leave it where it is right now and let the government cover the interest on it.
[00:13:19] Next question comes from an anesthesiologist. “I am finishing my first year in practice as pain management anesthesiologist at a county hospital. I have about five years left to plan Public Service Loan Forgiveness based on my payments from residency and fellowship. I've been saving money in a taxable account just in case something happens with the Public Service Loan Forgiveness program.” Good. That's what you should be doing. “That being said we've saved about 100000 so far and planned to have 150000 by the end of the year which is what I expect the remaining balance to be after five years should the public service loan forgiveness program be abolished. If I plan to potentially use that money for loan payoff in five years what is the best allocation strategy?”.
[00:13:58] So he's asking what should you do with your public service loan forgiveness side fund. And I've got a blog post coming up on this. It really gets into the nitty gritty in the details of it. But here's a few principles you should consider when looking at this. The first is how likely are you to use this to actually pay off the loan. And in my view you're pretty unlikely to use it. This money is almost surely going to be used for something else, probably retirement, because I don't think public service loan forgiveness is going away. And even if it does in the next five years I think this doc is going to be grandfathered in. So the most likely thing is that this money is just going to be added to the retirement portfolio in which case it ought to be invested aggressively like the rest of the retirement portfolio. However if you think for some reason that you're very unlikely to stay in a job that's going to qualify for public service loan forgiveness and you really are going to use this money to pay off your loans. Then I would invest it much less aggressively perhaps even just in a money market fund or a short term bond fund something like that, a high yield savings account. But if it were my money I'd be investing it pretty aggressively. Just because I think it's unlikely that you'll actually use it for that purpose.
[00:15:13] All right. Next letter this comes from somebody who has three separate questions we'll go through them one by one. “My husband and I found your podcast and website a year ago and have implemented several suggestions. We feel we have improved our financial situation substantially.” That's great. “When we finished medical training we had about eight hundred fifty thousand dollars in combined medical school debt.” Ouch. “We had high interest rates 7 to 9 percent.” Ouch. “So refinanced with Sofi and Laurel Road for interest rates in the 3 to 4 percent range.” That's great. My husband is four years out of anesthesia residency. I'm two out of allergy fellowship and we're on track to pay off all our debt by early next year.” That's awesome. Eight hundred fifty thousand dollars in debt by early next year. “We have achieved this by paying about twenty thousand dollars per month toward the loan since I've been in fellowship.” That's awesome. “I now make about 200000 a year supposed to increase substantially but my group sold the private equity and now pretty much stuck with that salary long term. My husband is in private practice anesthesia makes about 800000 thousand a year but with a pretty grueling schedule. We have four kids and live in the Midwest.” All right. So here are the questions, “we have 401k retirement accounts through are current jobs that we maxed out each year, Roth IRAs and a separate investment account with T.D. Ameritrade. Should we invest in the same low cost index fund for all accounts, the Vanguard Index S&P 500, or is it better to diversify somewhat?”
[00:16:39] Well. That's one of those questions I get all the time and the answer to it is you need a written investment plan. If you can draw one up yourself. That's fine. I've got a post about how to do an investing plan. If you're not ready to do that but you want to learn how to do it yourself you might consider taking my online course. I call it fire your financial adviser which got all my advertisers that are financial adviser kind of riled up when I titled it that but it's useful in that it teaches you how to not only interact with a financial adviser but also to draw up your own financial plan if you should want to.
[00:17:15] But there are basically lots of reasonable asset allocations out there. You need to pick one that you can stick with through thick and thin and then when you go to choose investments you choose them according to that asset allocation. According to that written investing plan. And so you know if you can't just call me up and ask me what funds should I invest in? My answer is what's your plan say you should invest in? If you don't have a plan, go get a plan. But I get lots of questions like that that people just want to know what I should invest in my 529 or what I should invest into my HSA? And the answer is you need a plan. So go get one.
[00:17:54] All right next question, “after we pay off the loans where should we direct funds? Option 1 is an emergency fund. Is that supposed to be six months of what we usually spend?” Yes, three to six months of what you spend is an emergency fund. “Option two, pay off the mortgage. We currently owe Four hundred Fifty thousand dollars at three point five percent. Option number three investments if so which ones? Option number four investment properties.”.
[00:18:19] OK. Well yes if you don't have an emergency fund you got to get an emergency fund which is probably OK to have a small one while you're trying to knock out your student loans but probably ought to get a little bit bigger one, a real one, three to six months of what you spend, after you pay those off. So that's priority number one and the next question is should we invest or should we pay off the mortgage. Well I think both are reasonable things to do. As long as you have additional tax protected space I think you should invest. But once you're looking at your taxable money I think it's reasonable to consider paying off your mortgage with all or part of that savings above and beyond your retirement accounts. This also assumes you're putting at least 20 percent of your gross toward retirement even if that's being invested in a taxable account.
[00:19:06] But what investments should they go into? Again it comes down to what is your return investment plan? That might be more index funds very similar to the ones in their retirement accounts. It might be investment properties. If your plan calls for you to invest in real estate in that manner. So of course there's no right or wrong answer to that question, what should be done with your money. But they do want to make sure they're putting 20 percent toward retirement.
[00:19:33] In this case given that her husband is burning the candle at both ends making a eight hundred thousand dollars as an anesthesiologist. I think one of the things they ought to invest in is letting him cut back a little bit. His longevity is pretty critical to their long term financial plan it sounds like, given that he's bringing in about 80 percent of their income right now. So I think cutting back on that would make it more sustainable long term and give him some career longevity. But all of that's good to do. Paying down a mortgage. Boosting the emergency fund. Saving for college. And of course getting a written investing plan in place.
[00:20:12] Next question, “we have another long term goal to move to New Zealand perhaps permanently. We realize this would lead to much lower salaries and are considering this for various reasons such as a better work life balance, simpler lifestyle, less stress, safer environment for our children et cetera. Is there a better time to do this. Would you recommend working 10 years in the U.S. to save as much as possible in retirement before going? Any certain amount we should save up before going or other tips?”.
[00:20:36] You know this is interesting and these guys are doing awesome right. They're making a million dollars a year. They're paying off eight hundred fifty thousand dollars in student loans within just a few years and they're asking me for advice. I mean really they ought to be giving the advice. So anyway I don't know. I don't know there is a right answer here as far as when the best time to go to New Zealand is. Obviously the more you save first the better off you're going to be financially. But life isn't always about money. It might be tough to do that New Zealand thing once the seven year old is in high school. So if you're going to go temporarily I think I'd go before the seven year old hits high school. If you're going to go permanently, I'd probably do it before high school as well. So maybe they can work for five years and then go. I don't know. So there's not really a certain dollar amount you should save in the U.S. for before going to New Zealand, it's just too personal of a question for me to answer. Than I suggested they send in a guest post about what they decide to do on that subject.
[00:21:33] So some great questions today. please send in your questions and we'll cover those in the podcast. I love hearing what you guys are wondering about and what you're interested in and getting that information here available for you.
[00:21:46] Be sure to check out the White Coat Investor book if you haven't yet. Check out our youtube channel. And thank you for supporting our sponsors.
[00:21:52] This episode was sponsored by Adam Grossman of Mayport Wealth Management, a longtime sponsor of our podcast. Adams a Boston based adviser but works with physicians across the country by phone, teleconference, etc. And unlike most other advisers offers straightforward flat fees for both standalone financial planning and investment management. So whatever stage you're out in your career Adam can help you get organized with a personal financial plan and can help you implement it with a low cost index fund portfolio. To learn more visit Adams website Mayport dot com slash Whitecoat to download a free eBook especially for physicians. Head up shoulders back. You've got this and we can help. See you next time on the white coat investor podcast.
[00:22:32] My dad, your host, Dr. Dahle, is a practicing emergency physician, blogger, author, and podcasters. He is not a licensed accountant, attorney, or financial advisor. So this practice is for your entertainment and information only and should not be considered official, personalized financial advice.
Bond investing is as you said a good way to smooth out the volatility of equities. It is hard to say what % is correct to have in your portfolio as it really does depend on your risk tolerance profile. I have sort of bucked tradition and gone with a relatively low % of bonds in my portfolio (5%). I have 75% equities and 20% classified as alternatives (REITS primarily). I have taken this more aggressive approach because of my passive income streams I have created that have provided a good income floor which I could rely on and not be forced to sell in down markets and lock in losses.
Invest in bonds?! What? Heresy I say.
I hope Johanna doesn’t see this. I drew a graph of equity prices. It has gone up for 10 years so I expect that to continue for 10 more based on the extrapolation. 100% equity is the way to go, don’t you think?
I’m trying to be facetious here. I’m heavily invested in bonds. But then again I ain’t no investing virgin. I lost that in 1987, 2000, and 2007 (if you can lose it more than once?)
In The Intelligent Asset Allocator by William Bernstein he notes that adding a small bond allocation reduces long term expected returns only slightly while dramatically decreasing risk since the assets are historically not correlated. (Fig 3.1). In his example of historical portfolios going from all stock to 25% bonds decreases expected returns by only about 0.5% while decreasing risk (SD) from about 22 to 15%.
It has seemed worth it to us to keep about 20% bonds. Of course no one knows the future.
Bogle has made similar observation in his books. 10% bonds has a negligible decrease in returns compared to 0% bonds but drops risk by 3-5%. Your goal as an investor is to obtain the largest return for the lowest risk. The risk-return curve is nonlinear and this can be used to your advantage.
The problem I have w bonds and the reason I think many physicians are avoiding an “age in bonds” allocation is that bonds are inversely correlated to interest rates. While no one should specuculate which way rates will go for the long term but there is very little room for it to go down from here which means bonds have a huge downside but very little upside.
So to me the question is why pick bonds instead of an alternative asset class? Real estate becomes more attractive to me in this instance.
For what’s its worth I’m 90% stock/ 10% bond. My stocks are split 5% reit/65% us/30%intl.
I don’t know why people keep saying “Bond yields can’t go any lower” when they clearly can. The 10 year treasury yield has climbed from 1.385% in mid 2016 to 3.15% today. It seems to me that bond yields could fall at a minimum 1.7%. Seems like plenty of room.
I suppose you are correct. If the rate was 0.3% a fall to 0.15% would still be a doubling so the absolute values are maybe irrelevant.
The other reason a physician may want to avoid “age in bonds” is the glide path to retirement is compressed when you are starting your attending level salary earnings later in life.
More need to take risk yes but less capacity to do so.
I’m a little curious about opinions. We took max loans against our solo Roth 401k’s (we won’t be terminating employment) and charge ourselves max interest. It’s after tax money paying the loan, but compared to a taxable investment account, which is after tax money anyway, it’s a wash. Once the payment is into the Roth, it then can grow tax free. My interest charge is more than current bond yields. I trust my own employment security (covered with disability insurance which would cover the payment in case of disability) more than the bond market. It frees up capital for my own cash flow. I feel better paying myself the interest instead of the banks by paying off some debt with the loan. I may be missing bigger returns by not investing in equity market, but I have a higher yield than the bond market, and feel like I am exposed to less volatility risk.
Interesting investing technique. One downside is that you can only borrow up to half of what’s in there with a max of $50K. So this works for $100K of your portfolio at most. What’s your interest charge? Prime + 1%? I think Prime is 5%, so 6% seems pretty good. However, you might want to read Michael Kitce’s thoughts on your technique:
https://www.kitces.com/blog/401k-loan-interest-to-yourself-opportunity-cost-tax-rules/
I find his argument persuasive and thus recommend you stop doing this.
Perhaps I’m not thinking this through fully, but if you could borrow the max of $50k from the Roth and pay it back plus 6% interest, over 10 years, you’d have an additional ~16k of interest in the account or about $1600 per year above the allowed 5500 contribution, about 30% more each year.
If you invested the 50k of the loan in a taxable account with the same asset allocation as the Roth, you’d continue to have similar gains, minus the tax drag, which would likely be less than your 6% interest to yourself and you also get the benefit of 30% more money to grow tax-free in the Roth at completion of payback?
You think it’s better to have your investments in a taxable account instead of a Roth 401(k) just to have more money in a Roth 401(k). I’m not convinced. I guess if you really think your long term return on the investments in that Roth 401(k) is less than 6% nominal after-tax. At least with the Roth 401(k) instead of a traditional 401(k) you avoid the double taxation on the interest you paid into the account.
Also, the $5500 is a Roth IRA contribution limit, not a Roth 401(k) contribution limit. You can’t borrow from a Roth IRA, only from a 401(k).
Bond investing is a great recommendation. A great bond equivalent is a CD.
There are some yield curve contrarians, but bonds balance out the risk associated with stocks.
Bonds are not completely risk-free, but have much less risk than stocks. What you won’t get are surprises. When you invest in a bond, you’re lending money at a stated rate for a stated period of time. No less, no more.
The longer you own a bond, the safer it becomes. In other words, the closer you get to the maturity date, the higher the probability that the amount invested will be returned to you.
when you hit retirement the sequence of risk issue becomes paramount
a huge loss in assets will possibly be unattainable
I make this comment all the time when this question comes up, but I think Long Term Treasury Bond Funds are the must underrated asset class for the long term accumulator or even for a retiree. They provide outstanding low-correlation diversification with an equity heavy portfolio, add a deflationary hedge, and show up in any portfolio optimizing model that aims to maximize long term growth and minimize volatility.
Perhaps they work well as part of a portfolio, but by themselves I have a hard time convincing myself the additional yield is sufficient to justify the additional duration. Right now at Vanguard, you get paid 24 more basis points for taking on an additional 11 years of duration (5.9 to 17). Doesn’t seem worth it to me. Rates go up 2%, the intermediate fund loses 12% (and makes it up in just 6 years), but the long term fund loses 34% (and takes 17 years to make it up.) Seems like a lot of risk for 24 basis points to me.
This is a perfectly timed post. I was reviewing my kids 529 plan today (one plan ages 2, 5, 9. It is currently in an age (oldest child) based vanguard fund and now is 70/30 distribution. Roughly 40% total US equities and 30 total international.
The 30% bond allocation is 90% total bond market and 10% international bonds. I started the plan in 09 with a lump sum and yearly contributions after (only after maxing out all retirement accounts first). I stopped contributing 2 years ago and the fund is currently $385K. Since the fund has done so well and I still have 8 years of growth before I would even need to touch the funds.
I am now concerned with the bond allocation. I am ok with between 50-70% equities but for the bond portion would anyone consider mimicking the age based portfolio but using the vanguard interest accumulation portfolio instead of bond funds. Current yield is 2.1% and there is no downside risk if rates continue to rise.
Some could even argue just put it all in an interest account and even if rates stay the same it would be worth 450K before my oldest starts school.
But my ultimate goal for theses funds is to mostly use interest to assists with college and graduate education. I would love to be able to leave some funds in the account for the next generation. So I am willing to take some risk with equities to achieve these goals.
I am curious how others are approaching bonds versus cash equivalents in their portfolios as I believe risk of rising rates is significant.
Did you believe the risk was high two years ago? Because rates went up 1.7% over the last 2 years.
If you don’t need to take much risk, then you can cut back on the risk level. But bond risk pales in comparison to the stock risk you are and have been taking there.
I guess my question was not about risk tolerance and more about how to position oneself in a rising rates environment.
Two years ago there was no real alternative. But now with interest accumulation portfolios paying close to 2% why even have a bond position and not just go with cash or cash equivalents.
If market dropped I would just add to my stock position.
Just curious your thoughts on cash/cash equivalents in this enviroment. Since time frame for this account is 8 years if bonds slowly rise over next three to four years it would not be until another 6-7 years after that the rising bond rates in the account would offset the earlier bond positions. But with a cash position the only downside is lower rate of return in bond rates actually drop.
Using the phrase “rising rates environment” implies you can predict the future. I submit you have no idea what interest rates will be five years from now. Maybe higher. Maybe lower. Maybe about the same. If you’re honest with yourself, you’ll recognize that. If you really feel you know what’s going to happen, you can make a huge bet on it and make a killing.
If you’re worried about rising rates, keep your duration short. But as long as you plan to hold them longer than your duration, bonds do better with higher rates.
Absolutely,
But my question is where should one place the non equity position in a 529 plan where individual short term bonds are not an option?
The only options are bond funds, or cash equivalents. My argument is that cash equivalents have a lower downside than bond funds. If rates rise you win, if the stay the same basically a push. But I would argue risk with rise is greater than the risk with a fall as there just isn’t as much room to fall.
I like the 70/30 allocation being 8 years from needing the funds but should I exchange the 30% bond fund allocation for an interest accumulation position? Am I correct that the benefits outweigh the risks if rates do rise?
Cash pays less than short term bonds, because there is less interest rate risk. Short term bonds pay less than intermediate term bonds, because there is less interest rate risk. Intermediate bonds pay less than long term bonds, because there is less interest rate risk.
I have no idea what interest rates will do in the future. If you do, then I suggest allocating your portfolio accordingly. If you know when rates are going up, stay in cash until they go up, then go to long-term bonds when interest rates are going to stay level or drop. If, like me, you have no idea, then pick something reasonable you can stick with long term and rebalance periodically. Then you can console yourself if you own bonds and rates go up that in the long run you’ll make more money even though you took a short term hit. If rates stay the same or drop, you’ll be glad you didn’t sit in cash waiting for them to go up.
Hope that helps.
It’s hard not to believe rates will be rising. As they did today and that Fed issues a statement to expect 3 additional increases next year.
Sure something could change and cause a reversal of policy. I still think the cash play has a significant shorterm upside. I’ll let you know how it works out.
Average yield of vanguards bond fund is 3.3% with 8 years average bond time. Cash accumulation account currently yielding 2.2 % so If rates stay the same I lose 1.1% max. If they continue to rise I get more upside. If they drop I lose a bit more.
Like you said risk is all with the 60-70% equity position anyway but wouldn’t it really suck if both bonds and stocks dropped? At lease with the cash position you preserve equity with minimal downside over the short term 3-5 years and are positioned to buy if there is a drop in equities.
And if I am correct and rates rise, then I can just buy back bond funds when the yield is more in line with my objectives.
Those announced rises are already “baked in” to rates.
Don’t get me wrong, I keep durations short for the same issue you’re worried about. But I’ve become very skeptical of my own ability (and that of others) to predict the future. People have been saying “rates are going up” for a decade, but they didn’t until 2 years ago.
Just realize you’re making a bet, and it may or may not pay off.
Thanks,
This exercise made me realize that the 70/30 position I am currently in is probrably too much risk for that account and time frame. Based on private 4 year tuition to cover all three kids with 385k already saved and almost 9 years before we need to touch the funds I really only need around 5-6% return to achieve the objectives of the account assuming future college tuition matches inflation and does not keep rising at 4-5%.
So now I am just deciding between a 50/50 versus 60/40 position. I made one bet in 08 and won no reason to continue at same risk level.
Thanks again it was a very helpful exercise to think it through.