WCI #55: Basics of Investing

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 Dahli.

Welcome to podcast number 55, the Basics of Investing.

Did you know that the White Coat Investor not only has a podcast and a blog, but but several books that will help you on your way to financial independence. These books cover topics such as asset protection and minimizing your taxes to keep more of your hard earned money. They discuss plans for insurance, housing spending, student loan elimination, investing and estate planning. You can learn how to become a millionaire within five to 10 years of leaving residency and how to invest in a sensible, low cost and effective manner with or without the assistance of a financial advisor. There's even a book geared directly toward medical and dental students so you can start optimizing your finances or early in your professional journey. Find the book that is right for you at the WCI store, at shop.whitecoatinvestor.com or on Amazon. You can do this and the White Coat Investor can help Our quote of.

The day today comes from Elizabeth Leamy who said save money on the big boring stuff so you can have something left over for life's little pleasures. Today I thought we'd talk a little bit about the basics of investing. This is actually the second podcast we recorded on April 17, and the reason for that is March. My assistant Cindy is getting ready to go to Fiji and she says we got to get ahead on these so that she doesn't have to record any of them while she's in Fiji. And I think that's a good idea because I don't know how I'd record these without her. But I've discovered over the years that there's a lot of you that listen to the podcast and don't read the blog, and others that read the blog and don't listen to the podcast. So sometimes when I hit some information on only one of them, it really doesn't get to a whole bunch of you. I wrote a blog post a few months ago called Investing101 and I think it's so important that we probably ought to talk about these subjects on the podcast as well. The idea behind that post was that there are things that I assume everybody knows about investing, but the truth of the matter is these are all things that I've picked up over the years that I think everybody ought to know about investing. And they're really the basics, but if you've never been taught them, you need to learn them. And so let's go over them today and just make sure you have them down. The first one is don't buy investments that you don't understand. It seems so basic, right? Don't buy stuff that you don't understand. If someone's explaining an investment to you and you can't figure it out in a couple of minutes, just drop it. There are no called strikes in investing. You don't have to invest in everything. So if something's too complicated, just skip it. On the other hand, make sure you understand what the investments you are invested in actually do so you understand what they can do. You shouldn't be surprised in a big nasty bear market when half of the value of your stock index fund goes away. That's what stock index funds do in big nasty bear markets. So it shouldn't be a surprise to you. It's interesting. A lot of times I run into people who have bought something that they didn't really understand when they got into it. It's usually an insurance product, often something like whole life insurance, and they just didn't understand how whole life insurance worked. And, and if they had understood it, they would have never bought it. And so before you get into something, especially something that's a lifelong commitment, make sure you understand how it works. The next thing you should Understand about investing 101 is to limit speculation. You're looking for investments that actually make money, not something that you just hope goes up in value. We're talking about Bitcoin and gold and Beanie Babies. There's a really interesting picture floating around on the Internet that shows this couple in 1999 sitting on the floor in a divorce court, dividing up their Beanie Babies because that was such a large part of their net worth. A few months later, all those Beanie Babies value went to like $3 and basically they lost all their wealth anyway. But it's such a classic picture just to think that they were people that cared enough about these little dolls to sell for, I don't know, five bucks that, that they would be arguing about them in divorce court. So limit speculation into stuff like that, okay? If you must speculate on something, limit it to 5 to 10% of your portfolio. Next topic. Higher risk is a necessary but not a sufficient condition for higher returns. Just because you're taking more risk doesn't mean you're going to get higher returns. Even though in general, as you take more risk on something like stocks instead of bonds, you're going to expect higher returns. Those expected returns don't always show up. And don't assume that you're going to get paid more just because you're taking on more risk. Some risks, like individual stock risk, are uncompensated risks, meaning you don't get paid to take them. Which brings us to the next topic. Diversify, okay? Diversify your investments. Diversification protects you against what you don't know. And there's a lot that all of us don't know. You want to diversify both between asset classes like stocks and bonds and real estate, as well as within real asset classes, where you want to own, you know, preferably hundreds of different securities so that your retirement is not dependent on what happens with any one company. Invest when you get the money. A lot of people are worried about investing a lump sum. Well, the truth of the matter is we get lump sums all the time. Every time you get a paycheck, you get a lump sum and you got to invest it. You're not going to divide that up over the next year and try to dollar cost average it. Just invest when you get the money. And over the years that you invest, you will take advantage of being able to buy, sometimes at a low price, sometimes at a higher price. But over the years it will work out well for you if you just invest when you have the money. It's too hard to time the money, time the market, and try to get it in there and buy low every time. It's just not going to happen. And what happens is you get so tripped up trying to buy low that you end up not buying at all and buying later at an even higher price. Here's another one. Don't catch a falling knife. And what I mean by that is when you see the market dropping, you know, if you're paying really close attention and you try to buy right after it goes down, a lot of times it's just getting started on its way down. And so don't try to time the market. It's hard to do even after the price has gone down. Now, the only thing you know when the price has gone down sharply is at least you're better off buying it now than you were a few days ago when the price was higher. But that doesn't necessarily mean it's going to go up anytime soon. It might just continue going down. Past performance does not guarantee future performance. This is such a truism that mutual funds are literally legally required to put it in their prospectuses. And so you want to really make sure that you understand that is the case. You cannot look at something and look at what it's done in the past and assume that that is what it is going to do in the future. Another important point among the basics of investing is that you better have a good reason to not use an index fund. The data showing index funds are better than actively managed funds is so robust and so well researched that you really need a good excuse to use something that isn't an index fund. Now, a good excuse might be, well, I want to invest in this asset class that doesn't have an index fund or my 401k doesn't have any index funds in it. Those are reasonable excuses. But just because you can find an actively managed mutual fund which has better returns than the index fund in the last five years is not a reason to buy the actively managed fund. Because that was probably just luck and chances of it persisting for another five years are not good. Here's another important truism. Stop playing when you've won the game. Remember that investing is a single player game. You're not playing against your brother in law. You're not playing against the market.

You're.

You're only playing against your own goals. So when you reach your goals, feel free to dial back the risk. That might mean paying off your debt like your mortgage. It might mean a less aggressive asset allocation. But don't feel like you have to continue taking risk after you don't have a need to take that risk anymore. Be careful adding new asset classes to the portfolio when you get interested in investing, there's always this temptation to have more and more and more as far as asset classes go. And before you know it, you got 15 or 20 of them in a portfolio. At that point you're just kidding yourself. You're just adding complexity you don't need in your life. I think there can make a very good case for going to at least three to seven asset classes in your portfolio. But once you get beyond there, the law of diminishing returns kicks in very rapidly and I see no reason for anybody to ever have more than 10. Make sure you rebalance your portfolio every now and then. If you're rebalancing between a high expected return asset class like stocks and a low expected return asset class like bonds, rebalancing probably will not boost your returns. What it will do though is control your risk. And that's more important in investing than boosting your returns. Remember that there are many roads to Dublin. There are a lot of different methods of investing that can be successful. You don't need to argue with people about why your method is better than anybody else's. The truth of the matter is there are a lot of very successful investors that have slightly different methods of investing, and so it's okay to have something that's different than everybody else as long as it's reasonable. Here's another truism. Make sure you stay the course in both a bull market and a bear market in the beginning, when you're a beginner investor, the hardest thing to do is stay the course in a bear market when you're hemorrhaging money. But surprisingly, as you become an intermediate investor, it starts becoming hard for you to stay the course in a bull market. You feel like it's been going up so rapidly or it's gone up, you know so much that it's got to go down next. Well, the truth of the matter is you don't know. So stay the course with your written investing plan, whether it's dropped a bunch lately or whether it's gone up a bunch lately. Don't mix your investing in insurance. When you do that, you end up with a crummy investment and usually a crummy insurance product as well. Use your retirement accounts. If you're given the choice, always invest inside a tax protected account. Taxes are some of the biggest investing costs out there and the more you can minimize them, the better off you're going to be. Likewise, don't let the tax tail wag the investment dog. Don't do something just for tax reasons if it doesn't make sense as an investment, above and beyond the taxes. And remember that your costs, whether they be taxes or they be commissions or advisory fees, they compound just like your investments do. So over the years they can really add up to a significant amount of money. Be sure to negotiate them at every chance possible. And of course, remember that the investor matters more than the investment. If you can concentrate on being a good investor, it matters less what you invest in. And the reason why is because the difficult things to do as an investor is to control your own, fear your own greed, and avoid performance chasing all right, let's move on to some questions that readers have sent in. In fact, I've got an entire podcast worth of questions from one reader here. This is actually a doc who as a resident arranged for me to come out and speak to his residency and he says, I think I've converted at least 100 people to WCI enthusiasts. Well, if you can convert a hundred people to be in WCI enthusiasts. I can probably feature you on the podcast here. So let's talk about some of his questions. Although truth be told, he could probably be given a lecture on a lot of these questions he's had. He says, I don't think this has been addressed anywhere, but can you talk about the best practices for your sensitive documents like taxes but passports and Social Security cards, etc. And then talks about what he does, which I think is a great idea. He says, I keep hard copies in a filing cabinet at home, but everything is starting to go digital and everyone needs a backup in case the house burns down. And so he actually keeps digital backups of all this stuff as well as in a filing cabinet. I think another great practice there is a fire safe. Now, I understand if the fire gets too hot, like a forest fire comes through your neighborhood, like it did for one of our fellow physician bloggers not that long ago that I think even the fire safes burned down as well. But I think that's a good idea to keep your Social Security card and your passport and maybe some money inside a fire safe in your house. But a backup electronic copy somewhere in the cloud is also a great idea. Only downside is it introduces some security risks. You know, as you have seen, anything online can be hacked. And so there is a certain amount of risk to having the security of a backup. And you've got to be a little bit careful with that. You can also scan things with even your phone and send it right into the cloud anytime you have it and that helps keep your paperwork down. I mean, I've got two four drawer filing cabinets at our office and they're just about full. And I think if I was really hardcore about it, I think it'd be great to, you know, have electronic records of that stuff. This doc also uses Time machine for a local backup for his Mac and then also a paid service like Backblaze that secures those files. I'm not familiar with either one of those, but they are basically digital solutions to this sort of approach problem. The nice thing about having a system is once you put it in place, it's kind of set. All right, his next question was, when does USAA or another reputable insurer like Amica not make sense financially? This is what I struggle with myself, right? I've got USAA insurance that I picked up while I was in the military and they're well known for excellent service. I mean, when you have a claim, they bend over backwards and seem to get it all taken care of, right? Away. But I think a lot of people that go and compare the price they're paying at USAA to somebody else. For example, Warren Buffett's firm. What's the one with the lizard? Geico. Cindy says it's Geico. Geico's got these low prices a lot of times and they're cheaper than usaa. So when do you give up that famous USAA service in exchange for a lower price? Well, at a certain point in life, you don't care so much about the price. So if you're at that point, I guess I'd focus more on what you want as far as service goes. But I think if it's a little bit cheaper, it's probably not worth changing. If it's a lot cheaper, then maybe it is worth the additional hassle you could have in a claims process with a less reputable insurer. I don't know. If I had to draw a line, I'd say if it's 50% cheaper, it's probably worth changing over and dealing with that hassle. How many quotes would you recommend getting? I think two or three are probably enough. I mean, who wants to spend all day getting quotes from insurance companies? This isn't something I shop around every year. I'm not sure I've shopped it in the last decade, which probably means if I went to Geico, I probably could get a 50% discount on my insurance. I wouldn't be surprised. I think it's like anything when you go and renegotiate your cable and your Internet and those kinds of things. If you're the squeaky wheel, oftentimes you get an additional discount. All right, his next question is about health insurance. If I am able to deduct health insurance premiums for my wife's plan, the other plan with me and my son, well, we filed jointly, but technically on the independent contractor, her name is the only one on her health insurance. Okay, well, this is kind of a unique situation where they've got different health insurance policies, one on her and one on him. I don't know that I would go through the hassle of trying to have separate health insurance policies. I'd probably try to get most of the family on one. It can make sense to have separate ones if an employer is paying for one or the other. But you've got to be in a pretty unique health situation for it to make sense for your family to actually manage two separate health plans. But I guess technically his question is if he's the only one who's self employed. Only his policy can be deducted. I don't think he can go and deduct her policy if he's the one who is self employed and it's not a family policy that covers her. When do you recommend increasing disability insurance? Should you do it as soon as you sign your attending contract or after you get your first paycheck or later? I think the idea with disability insurance is your risk is never higher than when you're young and broke. So as soon as you can is the time to increase it to the amount you need and then you should be decreasing it throughout the rest of your career. I mean, ideally as a resident, you're buying as much as you'll need the rest of your life. But the truth is, because it's expensive stuff, most of us can't afford it as a resident and so we're forced to buy less than we really need. And then once we get a little more income as an attending, we can actually buy the amount we need. So I'd say as soon as you have the money to do it, which probably means your first attending paycheck. Okay, I have a small i401k for survey money with Vanguard, as this is going to be a down income year compared to my future as an attending. What do you think about closing that and rolling it into a Roth ira? I always think that's a great year. The year you leave residency is a good year to do Roth conversions if you have the money to be able to pay the taxes to do it. And basically with an i401K, unless that allows you to do in plan Roth conversions, which I don't think the Vanguard one does, you're gonna have to close the plan and roll that money out. Okay. Then he asked for maybe a post or a podcast going over every section of your auto policy and explaining what each of them means and what kind of coverage you have and why. Well, I've got full coverage on our autos for a few reasons. I think the main one is when I go rent a car, I don't want to have to buy their insurance. And that's probably the main reason I have full coverage on our autos. It would be kind of a drag to replace our new Sequoia. It's probably still worth 50 grand. That'd be kind of a drag. So maybe that's worth. And having it insured so that I could replace it if it were totaled and it were my fault, I don't know that I need to have that on my old sequoia that thing's probably worth less than ten grand. We could certainly replace that out of pocket. As far as the other parts on the policy, I mean, I've talked in other podcasts about the importance of liability insurance. That's where I really focus when I buy auto and home insurance, because that's my biggest risk. I mean, your liability is way higher even than the value of your house in a lot of ways. And so I think it's key to go over your liability coverages with a fine tooth comb and understand what it covers and what it doesn't. Then as far as other coverage, if it would be a financial catastrophe to lose the car, then get full coverage. Otherwise, I wouldn't sweat it so much. But a lot of the little things, like the uninsured or underinsured motor coverage, you'd be surprised how little that actually covers. In a lot of ways, it's basically insurance that costs a fair amount and doesn't provide a lot of benefit. So when I go over that from time to time with somebody on the phone, I ask exactly what does this cover and how much does it cost and think about dropping those things that I don't need. Next question. Is jewelry insurance ever worth it? Well, you know, I think I do have a policy still on my wife's wedding ring. Do we still need it? Probably not. Is it dirt cheap? Yeah, it doesn't cost as much. It's a few bucks. I think when we first got married, it probably would have been a financial catastrophe to lose that ring. At this point, it probably isn't. But I think in general, the key point here is to realize that your typical homeowners or renters policy doesn't cover jewelry, it doesn't necessarily cover expensive computing equipment, and it generally doesn't cover expensive firearms. So if you've got any of that stuff and you want an insured, it's probably an addition on that policy. And I think that's the moral of the story. All right, the last one of his questions that I think I'm going to go over on this podcast is how much is your time worth? When you become an attending, your hourly rate of pay is pretty high. And so you got to look at everything else in your life and compare it to what your time's worth and probably to an after tax figure of what your time is worth. You know, if you're spending hours and hours on the lawn, but you could be spending that time working another shift, you know, maybe you ought to be hiring out some of that stuff and really looking at your whole life through the perspective of what your time is worth. But don't carry it away too much. I mean, at a certain point I think there's some value in actually knowing how to do some things in your life and being a little bit of a jack of all trades. But from a purely monetary standpoint, a lot of stuff doesn't make sense for a high earner. Like starting a blog doesn't make sense. Most blogs are never going to pay you anything on an hourly rate that's anything at all comparable to your, you know, what you can make as a position all right, let's move on and talk about a few other questions that I've got from other readers in the last few weeks. This one comes from a doc who says my husband and I are two well compensated subspecialists who have our financial affairs in order. Many thanks to you, and are considering setting aside some money for our kids as a jump start on life fund. Boy, I wish I was their kids. I know this is a controversial topic, but we've decided to go forward with it. My in laws did that for my husband. It's been such a gift to us to be nearly debt free, except for a Bay Area mortgage which I'm aggressively trying to pay off. And I've narrowed this down after research to either doing a UTMA or a Uniform Transfer to Minors account versus a spendthrift trust fund. I'm hoping to have quite a bit accumulated, maybe 500,000 for two kids by the time they're 30ish, so the dividends will likely exceed the kiddie tax threshold eventually. Their 529s are already funded as much as I care to do. Front loaded those $100,000 at birth. My concerns regarding the UTMA is the kiddie tax rule and the low age of maturity, although I think I can stipulate that as being 25 in California. That's pretty unusual. I'm not sure if that's actually true. I'd have to look that up. My concern with the trust fund is the taxes at trust rates, which kick in at much lower threshold than income taxes. Well, this doc has a pretty good understanding of the upsides and downsides of these two options. A UTMA is basically a child's taxable investing account, which means when they turn 18 or 21 usually, and maybe 25 in California. I don't know. I'd have to look that up. It's their money. If they want to blow it on cocaine, they can. They want to blow it on a Porsche. They can. So it really, you have to know the kid well to know whether that's a good option for them. And if that's not a good option for them, then a spendthrift trust probably is. A spendthrift trust is basically a trust that details when they get the money and under what circumstances. You know, you can require them to graduate from college or to have a real job or you know, whatever you want. Provisions you can put in that trust. And you can have them not get the money until they're 30 or 40 or 50 or 60 or whatever. That's all part of the trust. That sounds pretty cool to have that much control, although I'm not sure I'd want to have quite that much control over my kids lives from the grave. But it comes with a significant downside. Number one, it costs money to put a trust in place and to update it and to keep it in force and all that stuff. Stuff. Number two, once you put money in that trust, it's taxed at a pretty high rate. The trust rates max out pretty quickly on a relatively low amount of income. And so that is a significant downside to it. What would I do if I were this couple? I'd probably split the difference. I'd probably put $100,000 or so of it into a UTMA account. Remember that if you invest that very tax efficiently, it doesn't kick out that much in income. The problem with the kiddie tax is basically your first thousand dollars in unearned income that your kids have is tax free. And the next thousand dollars is taxed at their tax rate. But after that it's all taxed at your tax rate. And so if you've got that invested in a stock index fund or something, that's about $100,000 before it starts getting taxed at your tax rate. I guess you could put more than that in there if you invested it in something like muni bonds that come out tax free. But for the most part that's kind of the upper limit on it unless you want to be paying taxes on it at your rate. So if you wanted to put $500,000 for a kid away, maybe I'd put 100 or 200 into the utma and the rest into a spendthrift trust. There's no reason why it has to be one or the other. You could do both. And that might help limit how much you pay in taxes as well as the fees on the trust that you have to pay to the attorneys. Good question. Really. First world problems, like everything we talk about on this podcast. But you know, the truth is, no matter how much income you have, you still have financial issues and concerns and worries. And we talk about those here at the White Coat Investor because very few places do. Usually when you start talking about how you want to leave half a million dollars to your kids, everyone just makes fun of you. And I think that's probably not appropriate. I mean, just because you're a high earner or you're a wealthy person doesn't mean you just have some money worries, even if they are first world problems. All right, next question comes from another long term reader. I've read your website, newsletter, book and everything WCI related since medical school when WCI started. Wow, pretty impressed with that. Long story short, I'm an anesthesiologist. I received a $10,000 signing bonus for a 24 month commitment, maybe 5,800 after taxes. And then I decided to separate from the institution at 20 months. I reviewed my contract and realized that wasn't prorated, but I basically have to pay it all back. HR asked me to send him a check and then hire an accountant on my own and amend my tax returns for the year the bonus was paid to recover the loss. I wonder if there was a less inconvenient way to do this, like holding my last paycheck, etc. I contacted an attorney who recommended to forget about it since they won't come after me for only 5,800 bucks anyway and they probably won't take them to court. Well, he's just looking for advice on this. The attorney's probably right in that they're not going to come after you. This big hospital system isn't going to come after you for five or six thousand dollars. That said, I don't think your integrity is worth only five or six thousand dollars. I certainly wouldn't sell mine out, especially for that price. And so I think the right thing to do is you signed a contract that if you didn't stay for 24 months, you'd pay back the bonus. You didn't stay for 24 months. I think you ought to pay back the bonus. And I don't know of a really easy way to do this that is fair to both the employer and employee other than just cutting them the check and amending those taxes. The good news is it's really easy to do a 1040x. It's literally probably a half hour of work to amend that and get it, get your money back. And so that's probably what I would do with that. So that's what I told the doc when he emailed that question to me. All right, I think that brings us to the end of our questions today. I hope it's been a useful podcast to you. I want you to remember the basics of investing because the truth of the matter is most investing is pretty basic and once you learn those basics, you can use them throughout your life. And if you can apply the basic principles throughout your career, it's amazing how quickly you can accumulate wealth versus if you only learn these things at the time of retirement did you know that.

The White Coat Investor not only has a podcast and a blog, but several books that will help you on your way to financial independence? These books cover topics such as asset protection and minimizing your taxes to keep more of your hard earned money. They discuss plans for insurance, housing spending, student loan elimination, investing and estate planning. You can learn how to become a millionaire within five to 10 years of leaving residency and how to invest in a sensible, low cost and effective manner with or without the assistance of a financial advisor. There's even a book geared directly toward medical and dental students so you can start optimizing your finances early in your professional journey. Find the book that is right for you at the WCI store, at shop.whitecoatinvestor.com or on Amazon. You can do this and the White Coat Investor can help make sure you're.

Keeping up with the site. If you're not following us on social media, you're missing all the latest and greatest, so be sure to follow us on WC Investor or the White Coat Investor Facebook page. Head up, shoulders back. You've got this. We can help. See you next time.