Investing for Physicians: Series Overview

Rick Ferri describes the education of an index investor as occurring over four stages of development. First, we are born in darkness, Second, we find indexing enlightenment. Third, we inevitably complicate everything. And fourth, we finally embrace simplicity.

At my previous firms we had investment teams—professionals whose sole duty was to make sure that clients were invested properly. However, each firm took a different approach. One utilized actively managed funds, and the other largely did not.

So what’s the best choice? Investing can be complicated, but it doesn’t necessarily need to be. Of course there is portfolio construction and investment management knowledge that needs to be learned, but I’ve found Rick Ferri’s assessment to be largely correct. In fact, I experienced his four stages myself, especially when constructing the model portfolios for Skyview Financial Planning, LLC. I spent hours upon hours pouring over index funds and trying to construct the “optimal” portfolio. This ultimately became an exercise in paralysis by analysis with countless viewings and reviewings of historical returns (which would not predictive of future ones).

I finally came to my senses and recognized that the purpose of creating a well-diversified portfolio isn’t because we expect that it’s going to be the absolute best one ever. In the words of William Bernstein “[f]irst of all, to reiterate: there will be an optimal allocation among different kinds of stocks over the next 10, 20, or 30 years. Unfortunately, there is no way of knowing in advance what it will be . . . The important thing, then, is that your asset allocation be properly diversified and behave tolerably well under most circumstances.” (The Four Pillars of Investing, 124)

These somewhat counter-intuitive truisms can make investing difficult and more confusing than we would like. While we may believe that we are rational creatures, we are, by and large, emotional creatures that often make emotional decisions. So while we may “know” that the market (historically speaking) has had a long-term upward trend, short term losses can make us want to abandon ship and put all of our money in cash.

We also seek to find patterns and meaning in all things, including the stock market. Does it surprise you that the stock market largely follows what is known as a “random walk” and past patterns are largely useless in determining future choices? Frustratingly, this often leads to poor financial choices.

So while there’s an infinite number of topics that we could focus on for investing, my hope over the next several weeks is to provide high-value insight for some of the things that I have learned about investment management.

And again, we won’t likely create the perfect portfolio, but if you’re anything like the young physician couple that I met last week (paying too much in fees for actively-managed mutual funds, in my opinion), there are likely a few improvements that we can make. So come along for the ride, and I hope you enjoy the journey!

What follows is a brief review of topics that we will cover.

Risk Tolerance

Arguably the first item that you’ll need to determine as an investor is what amount of risk are you willing to take. But what does this actually mean, and how do we do it? Understanding yourself and truly how much you are able to bear in a fluctuating market is extremely important.
Asset Allocation

Understanding one’s risk tolerance helps us determine asset allocation. Though the phrase sounds technical, all it really means is how much of your portfolio is made up of bonds, stocks, and possibly alternative investments. We’ll explore why this is important and why it’s advisable to set up your portfolio this way.

We’ll also take a look at how your risk tolerance informs asset allocation.

Types of Accounts - Pre-tax, Post-tax, Taxable

Now that you’ve determined the makeup of your portfolio, it’s time to determine which accounts to begin funding first. You likely have a number of options through work and other sources. We’ll review the various types of accounts, how they are taxed, and review some ideas for where to start first, depending on your stage of life.

Should I invest or pay down debt?

One of the great questions of financial planning for physicians is whether or not it makes sense to start investing for retirement, or to continue (or begin) paying off student loans and other debt. We’ll look at some factors to consider, as well as when it makes sense to focus on one over the other.

Balancing Domestic and Foreign Exposure

Many financial professionals agree that it’s worthwhile to have a portion of your portfolio invested in companies outside of the United States.

While increased diversification can be beneficial, those investing in foreign stock introduce something called “tracking error” into their portfolio.

What is it? We’ll review this, and other important considerations, in more detail in this article.

Tilting and Factor Investing

Factor-based investing is very much in vogue among contemporary professional investors. Does tilting the portfolio in favor of small cap or value stocks make a difference? As more and more investors adopt this strategy, will future returns persist?

Alternative Investments

Simply: What are alternative investments? Should you incorporate them into use in your portfolio?

Active v. Passive Management

There’s a debate in the investment world dealing with active and passive mutual funds and ETFs. Actively managed funds seek to outperform the market over time. There is an additional cost associated with making this attempt. In contrast, passively managed funds are generally less expensive, and seek to model an index. Meaning that they are simply trying to mimic that index’s returns.

What does the data say about which is better? We’ll explore that more in this topic.

Asset Location

Asset location refers to the thoughtful process of determining where to place assets in an investment account based on the assets tax characteristics.

Asset location can help you save on taxes. We’ll discuss how it can do that in this article.

What to do in a down market?

Human behavior can be our enemy. Even though we may believe that in the long run we will be better off having our money invested in the market, short term fluctuations can make us want to throw in the towel.

So what can you do during a down market in order to maintain your composure and remain invested for the long haul?

Rick Ferri’s “The Education of an Index Investor”

During this article we’ll explore Mr. Ferri’s four stages of the education of an index investor and why they matter to you.

Does whole life insurance count as investing?

If you’re a physician, you’ve almost surely been pitched on utilizing whole life insurance. Some of the agents selling the product are even bold enough to tell you that you should use it as a component of your investment portfolio for diversification and “tax-free” income. But should you really?

Controlling the Controllables

There’s a whole lot that we can’t control in investing. But what are those things that we can, and should, try to control?

Portfolio Rebalancing

What is rebalancing, and why should I do it?

What is the optimal portfolio? Hint: There will be one in the future.

Determining the “optimal portfolio” is a fool’s game. Why? Because your crystal ball is out of order.

Greater returns may be available for taking greater risk.

I once had a client with a sizable investment account express discouragement about our “best guess” returns for the future. He reasoned that if returns wouldn’t likely be better than what I was suggesting, then why in the world he pay anyone to do it. We discussed that greater returns may be possible, but that means taking greater risk.

False Pretenses of Complexity

When your advisor makes investing seem complicated, he may be doing that in order to justify his fees. Investing can be simple. In fact, we’ll discuss why it’s important that it’s simple.

Can I increase returns without increasing risk?

Maybe. If you can reduce expenses and fees.

How much should you pay for investment management? (Hint: 1% can be expensive!)

The topic of compensation is one of my favorites. So how much should you actually pay your advisor?

Strategy - Roth v. Traditional

Wondering whether you should invest in Roth or Traditional retirement accounts? You’re not alone. In this article we’ll look at when you should contribute to the accounts and why.

The Back Door Roth IRA

If you’re a physician, you need to understand the value of the back door Roth. We’ll discuss it in detail during this article.

Some final thoughts.

While we can’t cover everything over the course of twenty-ish articles, we can help lay the foundation for a greater understanding and perspective.

I look forward to sharing the journey with you.

Disclaimer:

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