Investing for Physicians - Asset Allocation

Standing on the shoulders of giants.

The conclusions I have drawn are largely inspired by a number of notable individuals. My journey to defining an investment philosophy would not have been accomplished without these giants of the investment world. They include John C. Bogle, Rick Ferri, David Swensen, and William Bernstein.

To them, I give my thanks and appreciation.

The importance of asset allocation.

When people talk about asset allocation, what they are referring to is the proportion of stocks to bonds that you have in your portfolio.

It should be remembered that greater returns cannot be achieved without taking greater risk. It is generally believed that in order to obtain superior returns over a long time horizon, one should have a greater proportion of stocks to bonds in their portfolio. As the portfolio adjusts towards an increasing percentage of bonds to stocks, it is believed that the portfolio will achieve greater stability, but will not achieve as high of returns over the long run.

I believe that risk should be taken through the stock segment of your portfolio, and not in the bond segment. In other words, avoid so-called “junk bonds” and below investment-grade bonds.

We’ll discuss the types of stocks and bonds to invest in shortly.

Invest in index funds.

By naming the individuals above, I’m essentially showing my hand—I’m an index fund investor.

I believe that the market is efficient enough that it doesn’t make sense to try to find the inefficiencies necessary in order to “beat the market.” In contrast, I believe that individuals should focus on obtaining low cost, broadly diversified index mutual funds and ETFs that seek to capture market returns. Keep the fees low so that you can enjoy returns as close to market returns as possible.

Investing outside of the United States.

I believe that a large component of one’s stock segment should be invested domestically. For the portfolios that I have created, about 70% of the stock component is made up of U.S. equity in the form of stocks (about 60%) and real estate investment trusts (about 10%).

But should you seek foreign exposure in your portfolio as well?

As the United States does not make up the entirety of the world’s economy, I believe that it makes sense to allocate a portion of your stock component to foreign stocks. For the portfolio’s that I’ve created, I’ve set that percentage at about 30%, with the majority of that percentage going to a developed world fund, and about a third going to an emerging market fund.

Is 30% of the stock component the right amount of exposure? I think it’s probably reasonable to have even more of your portfolio allocated to foreign exposure, if you want. But 30% is what I’ve decided I feel comfortable with.

Alternatively, there are other investors who argue that one need not have any foreign exposure. You’ll find that there are a lot of opinions.

Something that this largely comes down to is how comfortable you are with “tracking error,” or how far the portfolio will deviate from the S&P 500. A portfolio with a greater foreign tilt may perform slightly better over the course of time, but may trail the S&P for years—even decades.

“Tilting” the portfolio.

Factor investing, or “tilting” the portfolio is very much in vogue in modern investing. There are numerous factors, but two that are very well known are those of size and value. Historically speaking, investors have enjoyed a premium for holding small stocks, and value stocks. The reason for these higher returns is not completely known, but is likely (in my opinion) due to increased risk, but may also be tied to human behavior (among other reasons). Will these factors persist into the future now that they are all the rage? It’s impossible to say. But the portfolios that I have constructed are characterized by a slight tilt to value, as well as smaller cap stocks.

Again, tracking error is likely to be an issue for those tracking the S&P 500 as “the market.” A tilt to small stocks and value stocks may mean a greater deviation from the S&P 500. Will that make you uncomfortable at the water cooler when others are talking about how well their portfolios are performing and yours isn’t doing so hot?


I believe that the bond component is important to maintaining stability, in particular during volatile markets.

As one arrives closer to retirement, it is not uncommon, and can be quite prudent, to increase the proportion of bonds in your portfolio from what you had in the growth phase of your life.

However, as interest rates change, long-term bonds can be quite volatile. My opinion is that short-term government and corporate bonds are the debt instruments of choice for one’s bond segment.

What about the alternatives?

Some alternative assets to invest in, include real estate investment trusts (REITs), commodities, and reinsurance. Personally, I incorporate REITs into my portfolio design, but none of the other alternatives. That’s not to say there isn’t necessarily a place for them, but I’m not currently convinced of their need in the portfolios that I build.

You should consider incorporating alternatives into your portfolio in order to reduce correlation among asset classes. In other words, if most of the assets in your portfolio are doing poorly, it would be nice to have one doing well. It’s possible that an alternative investment can accomplish this, though certainly not guaranteed.

Some final thoughts.

Wouldn’t it be nice to know what the perfect allocation is? Unfortunately, this is an impossible task, because the optimal allocation of the future is unknown. We won’t know it until after the fact as we look backwards at returns.

As William Bernstein wrote in The Four Pillars of Investing, “. . . during the next 20 or 30 years, there will be a single, best allocation that in retrospect we will have wished we had owned. The only problem is that we haven’t a clue what that portfolio will be. So, the safest course is to own as many asset classes as you can; that way you can be sure of avoiding the catastrophe of holding a portfolio concentrated in the worst ones.” (244)


The content you just read is for informational purposes only. Yes, I’m a financial advisor, but this article really isn’t intended as advice for you specifically. Your unique situation needs to be taken into account, and the ideas presented here may not apply.

So, please make sure you do your due diligence BEFORE implementing anything. Due diligence may include hiring a qualified professional who understands your situation completely and can offer you personalized advice.

Donovan Sanchez