The Pareto Principle can be stated many ways, but the idea is that 20% of the work will get you 80% of the results. Physician finance is no different. It is the job of the financial industry to make things seem complicated. However, they don’t have to be, and you can certainly do all of this yourself. Today, let’s talk about the 20% that really matters.
Let’s dig in.
Writing a Book: Practical Investing Advice
I made a decision to write a book based on the Pareto Principle. Shameless plug: my email subscribers will likely get a free copy of this when I am done (hint: sign up for my email list).
I want medical students, residents, and early career attendings to be able to do all of this stuff on their own. Depending on the stage of the game you are in, the 20% that is necessary to know is a little different.
For example, as a medical student your 20% is pretty simple. You really only have two jobs: Study medicine and minimize debt. That’s it. The rest is simply just to not screw it up (unlike I did).
As a resident it gets a little more complicated. Like most things in life, you still need to do all of the things you were doing before (studying medicine and minimizing debt), but now you have to come up with a plan pretty early to deal with your debt, consider investing, and consider asset protection (life and disability insurance).
When you become an attending physician you must continue to perform all of the preceding functions. The additional work becomes figuring out when conflicts of interest exist, investing further, make any necessary changes to your debt repayment plan, and decide whether to invest or pay down your debt. You probably need to increase your asset protection (increase life and disability insurance; add umbrella and malpractice).
The following is an example of the 20% that you need to know about investing.
Investing: Set it and Forget It
When you invest, there are many ways that lead to success. That said, I am a “set it and forget it” kind of guy for two reasons.
- Research has shown that the more you check your portfolio, the more likely you are to make changes, and the worse you will likely do in the market. As long as you are not speculating on individual stocks (which is the opposite of set it and forget it), time in the market is the most important behavioral finance theme.
- Your job is to learn and practice medicine so that you can take care of other people. You should not be spending a boat load of time trying to figure all of this stuff out. Just learn the 20% you have to know. Then, focus on taking care of patients.
Because of my “set it and forget it” style of investing I mainly invest in passive funds and index funds. The reason is that these funds have shown time and time again to outperform actively managed funds because they do a great job at the important stuff: diversifying your portfolio and keeping costs down.
I may consider dabbling in real estate crowdfunding investments for further diversification, but this won’t happen until my loans are paid off. I think real estate is fascinating and allows for me to scratch that itch of feeling like I did the work to “pick a winner.”
That said, I never want to scratch that itch in the market by speculating on individual stocks, because getting the average market return is enough. Taking unmitigated risks just isn’t necessary.
Keep It Simple: Asset Allocation
Three Fund Portfolio
How simple can index fund investing be? Well, Taylor Larimore (one of the original Bogleheads), has read pretty much every financial book out there and has come to recommend a three-fund portfolio that captures a piece of all of the market. It can be that easy. What are the three funds?
- Stocks: Total Stock Market Index Fund (Examples: VTSMX, SWTSX, FSTMX, FSTVX)
- Stocks: Total International Stock Market Index Fund (Examples: VGTSX, SWISX, FTIGX, FTIPX)
- Bonds: Total Bond Market Fund (Examples: VBMFX, SWAGX, FBIDX, FSITX)
The Bernstein “No-Brainer” Fund
This is another example of a simplified portfolio. Dr. William Bernstein, a neurologist turned financial master of his time, offers a similar “no-brainer” portfolio that consists of investing in index funds in four key asset classes, all in index funds:
- 25% total bond index fund
- 25% european stocks index fund
- 25% small-cap value index fund
- 25% S&P (large cap) index fund
My Employer Doesn’t Offer Those Options
Of course, not every employer offers these three funds. Mine certainly doesn’t, but they do offer index funds. So, my job is to try and mirror the diversification shown above in my 403B. I do this by picking an asset allocation that approximates the above mixture.
I do not know the specific index fund company your employer uses, but they (hopefully) will have index funds broken up into individual asset classes. For example, it could look something like this:
- 25% Large Cap Index Fund
- 10% Mid Cap Index Fund
- 20% Small Cap Index Fund
- 20% International Stock Market Index Fund
- 25% Bond Market Index Fund
Take a Peek Occasionally (Rebalancing your Assets)
Once a year, take a peek at your investments to make sure that they are still mirroring your desired asset allocation. This is called rebalancing and the purpose is to lower risk and – hopefully – increase returns. There are two different techniques here. Either one is fine. Just pick one.
The purpose of rebalancing is to keep your portfolio diversified. Just because one class has done well over the last year or two doesn’t mean it will continue to do well. Stick to the plan and rebalance back to your pre-chosen asset allocation.
The time based rebalancing technique simply says that every year or two you look at your portfolio and then rebalance it to make it look like the asset allocation you decided on above. If anything is outside of 5% above or below your desired asset allocation, then you correct it.
For example, if you want 25% large caps and the large caps have exploded and are now 35% of your portfolio, well just sell some of your large caps and buy some of the other index funds in the other classes that didn’t perform so well.
You may be concerned about taxes here. Well, inside of a retirement account (401K, 403B, 457, IRA) you can buy and sell as much as you want because you are not actualizing any returns until you sell them for cash in retirement.
However, in a taxable account these concerns are founded. When you sell something there, you are likely going to get hit with a long-term capital gains tax. That said, it’s not a big deal.
If you can rebalance things by buying and selling inside of your retirement accounts, that is preferred. If you must rebalance stuff in your taxable account, just do it efficiently.
This type of rebalancing technique simply says that anytime something goes above or below a certain percentage of your desired asset allocation (say, again, 5%), then you rebalance.
I personally don’t love this technique as much because it encourages you to look at your portfolio more often. As I’ve stated before, I am a fan of “set it and forget it” investing. This style of rebalancing implies that you are going to keep a closer eye on your portfolio.
As I’ve outlined above, I don’t always think that is a good thing. But I do want you to know this exists, because it is an option that may be preferred by some of you.
Risk Tolerance as We Age
One other piece that you absolutely need to understand is that your asset allocation will likely change with age. When you are fresh out as an attending physician you might be 90% stocks and 10% bonds. ‘
This will likely produce a higher return over a longer anticipated investing period. The reason for the higher returns is that you are taking more risk. Investing 101 teaches us that more risk = more reward. (You may be asking why I support index and passive funds… you want an appropriate balance of risk and return; these funds optimize this for you).
However, as we age and get closer to retirement, 90% stocks is likely too aggressive. So, early on set a timeline goal. For example, at age 40 I’ll go 80% stocks/20% bonds. At age 45-50 I’ll go 75/25 and then at age 50-55, I’ll go 70/30. I think the lowest I’ll ever go is 60/40. That could change, though.
Make a predetermined plan that has nothing to do with the market. That’s always best because the biggest piece of financial success is just STICKING TO THE PLAN! The worst thing you can do is buy high and sell low, which is why “set it and forget it” is so important. It keeps you from actualizing your losses.
That’s it. That’s the 20% of investing you absolutely need to know in terms of asset allocation, picking funds, and taking a peek occasionally. Not too bad, right? You just read that in about ten minutes. There is more practical financial advice to come in the book I am working on.
For the rest of you who just eat this stuff up…
For the Financial Nerds: The other 80%
The purpose of this post is to highlight just how simple things can be. Of course, you could optimize things slightly or get a little fancier with your investments, but the point is that you don’t have to. 20% of the work will gain you 80% of the results. But what kind of things does the other 80% include?
Well, you could spend time really trying to optimize your asset classes. Maybe you want to do some research and spend more time putting more or less money into international stocks. Maybe you want more money in emerging markets. Or you want to dabble in hard money loans, real estate crowdfunding, or REITS.
All of that is fine, but you just don’t have to do it. The more diversification you have, theoretically the better. So, some investments of some kind in real estate is probably not a bad idea…. but you certainly don’t have to do this. Getting the market return will get you to your goals if you are saving enough.
How simple can diversification be? Well, Gas’em wrote a guest post over at Xrayvsn discussing a two fund model that out-performed the three fund model mentioned above in his Monte Carlo models. Two models is pretty simple, though it doesn’t expose you to international stocks.
You could also feed your entrepreneurial spirit and work on some side hustles. You could buy a brewery and make profit from it as an owner. Or an art studio, restaurant, or any other interest you may have. You could also perform expert witness work, write a blog/book, or create a medical invention.
The point is that this other stuff could help you get to your goals faster, but it just isn’t necessary if you don’t have the time. Focus on the 20% that really matters, and spend the rest of your time being a great doctor who is set to achieve financial independence.
Fancy Investing Stuff
You could learn about tax-loss harvesting and the merits of trying to turn losses into tax gains inside of your taxable account. It will really help if you are interested in learning about it. This is pretty close to being in the 20% you should know about, if I am being honest.
Or what about tax efficiencies (the idea that municipal bonds are the only ones you want in a taxable account, because most other bonds aren’t tax efficient). That’s important stuff! But not important enough that you need to go and read on it for hours. Just keep most of your bonds in your retirement accounts where tax-efficiency matters less. That’s the 20% you need right there.
Focus on the 20% that you really need to know to get 80% of the financial success. Then, spend the rest of your time focusing on your family, friends, and your job.
It can be complicated if you want it to be, but it doesn’t have to be. And, if you need some help along the way, make sure that you get your financial advice from someone without conflicts of interest. That someone is going to be a fee-only, flat hourly-rate financial advisor who specializes in working with physicians.
If you need any recommendations, just shoot me an email and let me know.
What do you think? Is there a piece of the 20% that I left out for asset allocation and picking funds? Do you subscribe to set it and forget it investing? Why or why not? Leave a comment below.