Financial Planning for Doctors

The Pareto Principle can be stated many ways, but the premise is that 20% of the work will get you 80% of the results. Investing advice for doctors is no different. It may seem complicated, but with a little knowledge about what falls into the 20% doctors need to know about personal finance it doesn’t have to be.  You can certainly do all of this yourself.

Today, let’s talk about the 20% that really matters.

Practical Investing Advice for Doctors: The Pareto Principle

At The Physician Philosopher, I want medical students, residents, and early career attendings to be able to be able to become financially literate and to perform personal finance on their own.  It’s the reason I am making a personal finance curriculum at the medical school at Wake Forest.  Depending on the stage of the game you are in, the 20% that is necessary to know changes.

For example, as a medical student your 20% is pretty simple.  You have two jobs: Study medicine and minimize debt.  That’s it.  The rest is simply to not screw it up.

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).  However, residents have to come up with a plan pretty early to deal with their debt, consider investing, and to learn the top ten things they need to know about disability insurance.

Again, 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 more, consider getting a student loan consult to refinance your loans, 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) and work on an estate plan, too.

That may seem like a lot!  You basically need a checklist (fortunately you can find that financial checklist for new attendings here!)

The following is an example of the 20% that you need to know about 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” investor for two reasons.

  1. Research has shown that the more you check your portfolio, the more likely you are to make changes in a down market.  Changes typically lead to worse performance in a down market.  Time in the market and staying the course are possibly the most important rules in all of investing.
  2. Your job is to learn practice good medicine.  Patients depend on that.  You should not be spending a lot of time trying to figure all of this stuff out.  Just learn the 20% you need to know.  Then, focus on taking care of patients.

One of the best pieces of investing advice for doctors is to follow a “set it and forget it” method is through passive index funds.  These funds have been shown time and time again to outperform actively managed funds.  Why?  Because they do a great job with the important stuff: diversifying your portfolio and keeping costs down.

Best Asset Allocations

There’s more than one way to skin this cat.  In fact, the White Coat Investor keeps a list of 150 portfolios that are better than yours.

That said, I am trying to make this simple and effective.  Remember, this is the 20% of investing advice for doctors that you need to know to get 80% of the results.

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.  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)

Investing advice for doctors can be that easy. Just three funds.

The Bernstein “No-Brainer” Fund

This is another example of a simplified portfolio.  

Dr. William Bernstein, a neurologist turned financial advisor, 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% international stock index fund
  • 25% small-cap index fund
  • 25% large cap index fund

What investing advice would you give a doctor who doesn’t have those options?

Of course, not every employer offers these 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 and my 457 plan.

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
  • 25% Small Cap Index Fund
  • 25% International Stock Market Index Fund
  • 25% Bond Market Index Fund

Take a Peek Occasionally (Rebalance 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.

Time Based

The time based rebalancing technique simply says that every year or two you look at your portfolio. Then, you rebalance it to make it look like the asset allocation you decided on above.  Anything more than 5% above or below your desired asset allocation, you correct it.

For example, if you want 25% large caps and the large caps have exploded and are now 35% of your portfolio, 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.  However, 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 actually sell them to take money home.

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. If your account is small enough, you can simply change your future allocations to purchase more of the funds you need more of and less of the funds that are plentiful. As your accounts grow, this can become more challenging.

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.

Band Based

This other type of rebalancing technique involves exchanging funds anytime an asset goes above or below a certain percentage of your desired asset allocation (say, again, 5%), then you rebalance.  In other words, you rebalance when you break past a “band” threshold that you’ve previously set.

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.

Risk Tolerance as We Age

One other piece that you absolutely need to understand is that your stock to bond asset allocation will likely change with age. While the rule of thumb for people who start investing early is that your portfolio should have the same percentage of bonds as your age.  However, doctors typically start saving later.

Solid investing advice for young doctors might involve investing in 90% stocks and 10% bonds (90/10).  If you are risk averse, you might lower this to 80/20 or 75/25.

A higher percentage of stocks implies more risk, which ought to eventually lead to higher returns.  The reason for the higher returns is that you are taking more risk.  Investing 101 teaches us that more risk = more reward.

However, as we age and get closer to retirement, 90% stocks is likely too aggressive.  So, early on set a timeline goal.  Purely as an example, at age 40 you might transition to 80/20 stocks/bonds.  At age 45-50 maybe you’d further transition to 75/25 and then at age 50-55 to 70/30.

Personally, the lowest I’ll likely 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 best investing advice for doctors (and for anyone else) is to STICK 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.

Take Home

That’s it.  We’ve covered much of the 20% of investing advice doctors 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.

If you want to learn the rest of the 20% doctors need to know about personal finance to get 80% of the results, then read The Physician Philosopher’s Guide to Personal Finance (or listen to it on Audible).

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 a financial advisor you can trust. That someone is going to be a fee-only, flat rate financial advisor who specializes in working with physicians.

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.

TPP

21 thoughts on “Investing Advice for Doctors: The Pareto Principle”

  1. Good stuff, I like the other quote related to it by Woody Allen – “80% of success is just showing up”.

    So if you conclude that just showing up (meaning just make the decision to invest) is 80%, and then you can get another 80% of the results with just 20% of effort after that… well I just made a confusing math problem. 🙂

    But the good news here is that none of it requires 100% effort!

  2. I love this, becoming successful is really not that difficult… all you have to do is really focus on that 80% of things that make the biggest difference. You’ve really boiled that down for readers here. Awesome post!

    The other 80% is really just icing on the cake.

  3. Great job in covering the 20% of investing that will produce 80% of the results.

    I agree with you that the other 80% that you mentioned will not benefit an investor as significantly as the 20% you outlined. In fact, some will say that tax loss harvesting is just lowering your cost basis and may increase your tax burden later on. But I guess if you tax arbitrage by withdrawing those funds when you are in a lower tax bracket, it does work out. Just not sure by how much is benefited.

    Some will also say that an investor should be diversified with in the different sectors of the economy. Not sure how important that is. But maybe that could be part of the 80% too.

    • I think good diversification is definitely part of the 20%. You want a portfolio where some of it zigs when the other part zags. However you accomplish that goal is fine with me. Adding some REIT’s or another form of real estate could help there, possibly.

  4. Good stuff. A problem I see however is in your understanding of diversification. It is common in bogelhead land to simply pile more and more issues. More and more is not better. It turns out market risk is realized at 20 stocks spread over the market sectors. 1000 stocks provide virtually no better diversity

    https://www.investopedia.com/articles/01/051601.asp

    What actually matters is investment efficiency. When you buy a stock or index you buy two things return and risk. When you buy a stock and bond you buy non diversified diversification. The combination yields an entity which has its own specific return and risk. The allocation adjusts return and risk. The efficient mix of these allocations represent a curved line called the efficient frontier If you live on that line you pay the correct amount of risk for your return. If your portfolio is off the line you pay too much risk for the same return. This is why the 3 fund in my analysis performs more poorly. It pays too much risk. This isn’t”t guessing. Harry Markowitz won a Nobel for describing this effect. It is the basis for modern portfolio theory. For the Pareto portfolio I would suggest S&P 500 fund and a bond fund like VBMFX. S&P gives a significant foreign exposure because it’s stocks and profits are world wide. S&P has a dividend which can be reinvested. In low markets that reinvested dividend buys shares low automatically. In high markets it just buys shares. It’s accumulating shares that is important, but not exclusively. Owning bonds is important for diversification and risk reduction. If you rebalance and you should the rebalancing forces you to sell high and buy low. If stocks go up, and you get too much you take a little off the table and stick them in bonds. You are selling a little bit high as things go up. When the bear comes and stocks crash you have all that bond money you’ve been stashing to buy more shares low. Rebalancing every year or two would be my aim making sure any gains are long term as far as taxes.

    90 10, 80/20 70/30 and so on all live on the efficient frontier. Unless you know what you’re doing I would not go to a 3 fund. You can risk adjust a 3 fund but bogelheads don’t do that. So it makes it even easier Med student or resident 90/10 S&P/bonds. Religiously add money yearly or monthly. When you make attending go 80/20, add more money monthly. This would be my Pareto base. Once you get smarter about finance you can add some other things. There are calculators that can help you risk adjust or just use Personal Capital which has a built in asset allicator which will put you on the efficient frontier. Enjoy the ride

    • I like your two fund portfolio, gasem. I’m gonna have to do some more digging into that idea. Simple is always better in my book (as long as it works). I’ve read about the idea of efficient frontier investing. Being on that line is obviously the goal, but it works in retrospect.

      Even Bernstein had this to say about the efficient frontier in his book on the Investing Manifesto: “In my opinion, MVO (Mean Variance Optimization used to determine the efficient frontier) is primarily useful as a teaching tool, but investors should avoid it when it comes to design real-world portfolios.”

      I know that Bernstein is a lot smarter than me on the topic. I don’t know that it has to be that complicated to be successful. Hell, your two fund portfolio might be enough.

      TPP

  5. Buffet suggests 2 funds. Bogel suggests 2 funds. People think it’s all about return but it’s all about risk. If you have less risk for the same return, that’s called free money. It doesn’t much matter what you specifically own once you get to market risk. In a downturn risk dominates period. The thing missed in the analysis is time. If you fall 50% with an s&p it takes 100% to get even. That takes time. If you go down 33% it takes only 66% to get even. In my own portfolio in 2008 I went down about 33% I was even by 2011. The s&p was even in2013 and in 2013 I was about 15% ahead compounding away. Repeat that a few times over the accumulation phase. I’ve read all of Bernsteins stuff and that quote as well. Bernstein runs an investment business with a minimum aum of 25m. Do you think he’s going to hawk a 2 fund portfolio? Pareto is about simplicity. It’s about getting 80% of the job done. In the end its time in and amount saved yearly or monthly and rebalancing. My portfolio is much more complicated but it lives on the efficient frontier. I know exactly how much risk I am paying for my return. Answer this if you could buy a AAA bond the yields 8% with 3% vol for 50 years or a stock fund that pays 8% and 12.5% vol which one are you choosing?

    • I am not sure what you mean. Does “vol” mean volatility? If so, I guess it depends on what we presume inflation is going to be. More volatility potentially means a higher risk, which in investing usually means higher returns. So, I’d probably take the stock. The bond provides a more guaranteed return. That said, a better idea is to have a mixture of the two, right? I want more risk early in my career and more certainty towards retirement.

      P.s. point taken about Bernstein. Didn’t know that.

  6. Never heard of the Pareto principal before this and it makes sense.

    If you could get the majority of things accomplished at 20% effort then there is significant diminishing returns over the next 80% that really make it not worthwhile.

    I definitely check my portfolio quite often and calculate net worth to coincide with my bi monthly pay (got into that habit so that I could direct my contributions for that period into whatever asset was underperforming, sort of my version of rebalancing with new money)

    • As long as you are continuing to contribute to the same funds and “sticking to the plan” that is probably fine. The only place I really see the major advantage of your method is in a taxable account though, because inside of a retirement account you can buy and sell as you please without tax consequence. In a taxable account, pitching into the underperforming funds is definitely the more tax efficienct way to rebalance.

      TPP

  7. If you think risk only buys you return then why not a portfolio of amazon Apple netflix and facebook? The projected risk is only 23% and the projected return is 50%. The cost of ownership is virtually zero. You can buy 4 stocks for $20. At 50% return you more than double your money in 2 years. In 10 years you’re up 580 times. Put in a mil this year worth half a billion 2028. Why are you messing around with this mutual fund nonsense?

    The reason is risk does not mean more return its independent of return If I offered you a fund that paid 10% but had a 23% risk would you buy it? The sp has 11% return and 15% risk. The answer is no. The fund in question is vnq vanguard reits. The reason you would not take that deal is you pay too much risk for essentially the same return. This is the point of modern portfolio theory. Risk and return are not related in a linear way they are related in a quadratic way. As such you have to understand when you pay too much risk for your return. This is why the efficient frontier is located on a plane every point on the plane has a risk and a return and the points on the frontier get the most return for the least risk. Same return for less risk = free money. It’s not a guesstimate its quantitative analysis. The bogelhead3 has a risk of 12.33% and a return of 7.75%. Spy/vbmfx 64/36 has a risk of 9.72 and a return of 7.89 so what are you going to buy? This is a quantitative argument and Those are the numbers. You pay way too much risk owning the bogelhead3 for the same return.

    Buffet suggests SPY/bonds

    Bogel suggests sp500 fund/ bonds.

    Why do the damn bogelheads think they know more than Buffet and Bogel? Maybe buffet and bogel understand something about paying too much risk. After all that’s how buffet got rich as hell by understanding risk

    • Point taken. Less risk, same return. Sounds like a solid deal to me.

      I am a proponent of simple passive/index investing. Two funds seems better than three if you can get the same return. I surely don’t think I am smarter than Bogle or Buffet. In fact, I often tell people that if I can learn this stuff, then anyone can.

      One reason to talk about the asset allocation, though, is that many employers – mine included – don’t offer an S&P 500 index fund and total body specifically. I have to break up the asset allocation where I work myself.

  8. I don’t consider you a bogelhead just a student like my self. My writing style is a bit accusatory but that’s mostly for effect and it gives the reader something to react against. Anybody gets to invest any way they like. I just want people to understand there is something beyond looking at your thumbnail and guessing when it comes to asset choice and allocation.

    • I appreciate your perspective, Gasem!

      I think you and I can both agree that the most important part is creating a reasonable plan – maybe not perfect – and then sticking to it over and over throughout the years.

      TPP

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