WCI #72: Why Bonds?

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 White Coat Investor Podcast 72 why bonds?

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Our quote of the day today comes from Morgan Housel There's a lot of money to be made in the finance industry, which, despite regulations, has attracted armies of scammers, hucksters and truth benders promising the moon. I guess that's just what happens when you have a lot of money sloshing around in one industry. You're going to get people who are just in it for the money going after it, rather than people who really want to help you. If you haven't had a chance to read the White Coat Investor, the book, it's a great book. You should take a look at it. It's had hundreds of reviews, almost all of them are five star reviews and it's changed a lot of lives. It's a great way to catch up quickly, quickly to other listeners of the podcast or readers of the blog. And it contains information that isn't found either on the podcast or on the blog. And I'm surprised that I continue to not only sell lots of copies of it each month because it continues to help people, but also the feedback I get on it and just how many lives has changed. So if you haven't had a chance to read that, I'd suggest picking that up and reading it. And if you know somebody else that could benefit from them, get them a copy. While you're at it, be sure to also check out our YouTube channel. This is something where you can not only get some audio and video covering these important financial topics, but also another way in which we can put some really great content together that really only works in that format. So we're trying to use that more and more. Be sure to check it out and subscribe. The first topic we're going to hit today was sent in by a reader who asked us to cover this important question of why bonds? And by the way, you're going to be able to leave your own questions in your own voice soon that we'll be able to put onto this podcast. More info on that to come, but we think that's going to be a great addition to the podcast. But specifically, this doc wants to know why he should have bonds in his portfolio. Specifically for a 30 something MD like me only one year out of training, why should I put any of my 401k and other investment money in bonds as opposed to investing only in equities and a smaller amount in real estate? I understand the bonds have much lower risk, and every book I've read recommends a minimum of 10% bonds for anyone. But since I don't plan on touching any of these funds until retirement, it could be reasonable to invest no money in bonds for now and then add that to my portfolio maybe 10 years in the future. While this would be a relatively aggressive investment strategy, it seems that I could tolerate any changes in the total stock market over the next 10 years before I made my portfolio more conservative by adding bonds. Well, you know, this is an interesting question. Lots of people have this. There is no right answer to it, which makes it worth a discussion. Really. The truth of the matter is that you don't have to have bonds to be successful. Probably. You know, there may be a situation in which bonds outperform stocks over your investment horizon. Is that situation unlikely? Yes, and that's unlikely. You're more than likely going to do better with stocks and bonds over 30 to 60 years. That said, there are significant periods of time in history when bonds have outperformed stocks for periods of 10 up to almost 20 years. And that could certainly happen again, and it has certainly happened in other countries. And so bear in mind that when you decide not to invest in a major asset class like bonds, you're making a pretty big bet. And so I think it's probably a good idea for you to at least include a little bit of bonds in your portfolio for that reason. But a more important reason to include bonds in your portfolio is that you don't really know your risk tolerance when you're just starting out as an investor. This period of time when you think you can get away with not owning bonds because you want those high returns. That's also the period of time when you are an unproven investor. You're unproven to yourself. It seems like you ought to be able to stay the course in a big bear market, but you don't actually know that you can, because you've never done it. You're essentially an investing virgin. And I think it's a good idea to set your asset allocation up a little more conservatively than what you think you can handle until you go through your first bear market. My first bear market was the 2008 bear market. And I'll tell you what, by the end of that, I was pretty darn glad that I had 25% of my portfolio in bonds because it felt like stocks were going to keep going down and down and down forever. But by having those bonds in my portfolio, it made it easier for me to tolerate the losses I had had in stocks. And so you may find that you're in the same situation, but if you decided not to own any bonds, you may have exceeded your risk tolerance and end up doing the worst possible thing you can do in a bear market, which is cashing out and basically selling low. And so you're far better off holding 10, 20, 30, 40% bonds than you are selling low in a bear market. It's a little bit like the price is right. You want to have as many stocks as you can tolerate, but not any more than that. So you're trying to get as close as you can to the right amount of stocks for you without going over. So be very careful in that respect. There's also some other benefits of bonds. For example, some specialized kinds of bonds, municipal bonds, for instance, kick out tax free income, you know, when you hold those in your taxable account. Treasury inflation protected securities or TIPS can also help protect you against inflation. And so that's also another great case for why you might want to own some bonds in your portfolio. But those are my main thoughts on whether you should own bonds in your portfolio or not. I certainly do and have throughout my entire career. I haven't regretted it. But the truth of the matter is if I went back and and had held 100% stocks instead of bonds, I would have more money today, assuming I was able to tolerate the ups and downs than I do now. And whether that continues in the future or not, of course, is anybody's guess. Alright, second question from the same listener. I'd love to hear your thoughts or even an entire episode on target date retirement funds. For example, I have Roth IRA funds in a Vanguard target date fund with an expense ratio of 0.15%. I can instead put that money directly into the component individual index funds with an expense ratio of about.04%. If I use the ETFs, I don't have enough funds to purchase Admiral shares in all categories. So is this difference in fees large enough to justify the time needed to rebalance the account and adjust the asset allocation through retirement? I understand I could choose a different asset allocation, a different glide path in retirement, but I don't have any evidence based reason to think that my choices are would be better than Vanguard Settings for its target date funds. Well, what a Target Date fund is is it is a fund of funds. It's a mutual fund that buys a bunch of other mutual funds. And at Vanguard they're basically invested entirely in the Vanguard Total Stock Market Index, the Vanguard Total International Stock Market Index, the Vanguard Total Bond Market Index Fund. I think they also now have the Vanguard International Bond Index fund in there as well. And I think even as you get into the later stages toward the less aggressive ones, they even throw their treasury inflation protected securities fund in there. And so it's a good mix of funds. It's not like you're going to go wrong picking a target Retirement fund. There are no bad funds in there at Vanguard anyway. Now some of the other companies have some higher expense funds you may want to avoid. But the problem with Target Retirement Fund is not only that you get the higher expense ratios that you don't get the lower ones you would get with Admiral shares or the ETF share classes at Vanguard, but also it's probably not available to you in all of your accounts. For instance, my 401k and my partnership doesn't offer target retirement funds. So this is supposed to be a one stop shopping solution. You just buy one fund and forget about it. Well that doesn't work if it's not available in your phone. 401k. The other problem with it is if you are investing in a taxable account, you're going to have some assets in there that you probably don't want in your taxable account. For example, most docs are in a high tax bracket and if they're going to hold bonds and taxable, they want to be holding muni bonds there or tax exempt bonds. And the bonds in the target retirement funds are not tax exempt bonds, they're taxable bonds. And so in that respect you may not want to hold it a taxable account if you're looking for the most tax efficient solution possible. Now the truth is most people who are using target retirement funds are looking for a simple solution. A one stop shop, something they can set and forget. They're not usually the people who are listening to financial podcasts and reading financial blogs and that worry about things like a 10 basis point difference in expense ratios. If you are the type of person who worries about those things, you probably don't belong in target retirement fund funds. You might as well roll your own asset allocation in that respect. But are they perfectly fine? Sure they are. Even some very sophisticated investors use those types of funds. For example, Mike Piper, who blogs at the Oblivious Investor. His entire portfolio is in a Vanguard Life Strategy fund, which is basically a target retirement fund that doesn't change its asset allocation as you move toward retirement. And so it's a very simple but elegant solution. It just doesn't work for most docs because they have all kinds of different investing accounts they're trying to manage. But certainly when you're starting out in residency and a Roth IRA and that's your only investment account, sure, throw it in a target retirement fund. That's a great choice. Alright, next question is about student loans, specifically a loan for disadvantaged students. This doc writes in I have about $150,000 in student loans at 6% with Great Lakes, $80,000 at 5% with Heartland. This smaller loan is a loan for disadvantaged students. I was not considering loan forgiveness at the time. I deferred the loan for disadvantaged students since 5% interest would be paid for during my training, including fellowships and put the rest in forbearance. I have been making payments on the Great Lakes loans to get the tax deduction over the last two years. I plan on finishing two fellowships, so that will put me at six years of training. I could still make four years of qualified payments. I'm not sure whether I will be in a nonprofit after training, but I'm not opposed to the idea. If I consolidate the loan for disadvantaged students, I lose the 5% benefit. Should I continue with these loans as is, put the Great Lakes portion into repay or pay and leave the loan for disadvantaged students out or consolidate them all and go for repay and pay and presumably eventually Public Service Loan forgiveness. Well, here's the deal. The most difficult part of this is deciding whether you're going for Public Service Loan forgiveness or not. If you're going for Public Service Loan Forgiveness, you want to get as many of your loans as eligible for Public Service Loan Forgiveness as you can. And if consolidating helps you do that, you want to do that. You also want to make as many tiny payments during your training as you can because the amount that's left to be forgiving after 10 years of payments in the Public Service Loan Forgiveness Program, the difference between a real payment, a full payment that you'll make as an Attending and the tiny little payments you make as a resident and a fellow. And so it's hard to answer this question without knowing the future, whether you're going to be working for a qualifying institution for Public Service Loan Forgiveness. If you're not, well, certainly there's no reason to consolidate that loan for disadvantaged students. This is a subsidized loan and they're covering the interest for you during residency. That is a great deal. However, you're not making payments toward Public Service Loan Forgiveness. So which one's the better deal? Well, the Public Service Loan Forgiveness is probably the better deal. But if you end up working in private practice, you will have paid a lot of interest that you didn't have to pay by taking that loan out of that program and putting it into a typical loan program. And so that's the first thing to decide is whether or not you're going for Public Service Loan Forgiveness. If you are, then go ahead and consolidate that LDS loan. If you are not, then leave it where it is right now and let the government cover the interest on it. Next question comes from an anesthesiologist. I'm finishing my first year in practice as pain management anesthesiologist at a county hospital. I have about five years left to plan Public Service Loan Forgiveness based on my payments from residency and fellowship. Been saving money in a taxable account just in case something happens with the Public Service Loan Forgiveness Program. Good. That's what you should be doing. That being said, we've saved about 100,000 so far and plan to have 150,000 by the end of the year, which is what I expect the remaining balance to be after five years. Should the Public Service Loan Forgiveness Program be abolished? If I plan to potentially use that money for loan payoff in five years, what is the best allocation strategy? So he's asking, what should you do with your Public Service Loan Forgiveness side fund? And I've got a blog post coming up on this. It really gets into the nitty gritty and the details of it, but here's what the few principles you ought to consider when looking at this. The first is how likely are you to use this to actually pay off the loan? And in my view, you're pretty unlikely to use it. This money is almost surely going to be used for something else, probably retirement, because I don't think Public Service Loan Forgiveness is going away. And even if it does, in the next five years, I think this doc is going to be grandfathered in. So the most likely thing is that this money is just going to be added to the retirement portfolio, in which case it ought to be invested aggressively like the rest of the retirement portfolio. However, if you think for some reason that you're very unlikely to stay in a job that's going to qualify for public service loan forgiveness and you really are going to use this money to pay off your loans, then I would invest it much less aggressively. Perhaps even just in a money market fund or a short term bond fund, something like that, a high yield savings account. But if it were my money, I'd be investing it pretty aggressively just because I think it's unlikely that you'll actually use it for that purpose. Alright, next letter. This comes from somebody who has three separate questions. We'll go through them one by one. My husband and I found your podcast and website a year ago and have implemented several suggestions and feel we have improved our financial situation substantially. That's great. When we finished medical training, we had about $850,000 in combined medical school debt. Ouch. We had high interest rates 7 to 9%. Ouch. So refinanced with SoFi and DRB for interest rates in the 3 to 4% range. That's great. My husband is four years out of anesthesia residency. I'm two out of allergy fellowship and we're on track to pay off all our debt by early next year. That's awesome. $850,000 in debt by early next year. We've achieved this by paying about $20,000 per month toward the loan since I finished fellowship. That's awesome. I Now make about 200,000 a year. Supposed to increase substantially, but my group sold to private equity and now I'm pretty much stuck with that salary long term. My husband is in private practice. Anesthesia makes about 800,000 a year, but with a pretty grueling schedule. We got four kids and live in the Midwest. All right, so here's the questions. We have 401k retirement accounts through our current jobs that we max out each year, Roth IRAs and a separate investment account with TD Ameritrade. Should we invest in the same low cost index fund for all accounts, the Vanguard index S&P 500 or is it better to diversify somewhat? Well, that's one of those questions I get all the time. And the answer to it is you need a written investment plan. If you can draw one up yourself, that's fine. I've got a post about how to do an investing plan if you're not ready to do that but you want to learn how to do it yourself, you might consider taking my online course. I call it fire your financial advisor, which got all my advertisers that financial advisors kind of riled it up. Riled up when I titled it that. But it's useful in that it teaches you how to not only interact with a financial advisor, but also to draw up your own financial plan if you should want to. But there are basically lots of reasonable asset allocations out there. You need to pick one that you can stick through, stick with through thick and thin. And then when you go to choose investments, you choose them according to that asset allocation, according to that written investing plan. And so you know, if you can't just call me up and ask me, what fund should I invest in? My answer is what's your plan say you should invest in? If you don't have a plan, go get a plan. But I get lots of questions like that that people just want to know what should I should invest in in my 529 or what I should invest in in my HSA? And the answer is you need a plan. So go get one. Alright, next question. After we pay off the loans, where should we direct funds? Option one is an emergency fund. Is that supposed to be six months of what we usually spend? Yes, three to six months of what you spend is an emergency fund fund. Option two, pay off the mortgage. We currently owe $450,000 at 3.5%. Option number three, investments. If so, which ones? Option number four, investment properties. Okay, well, yes, if you don't have an emergency fund, you ought to get an emergency fund. It's probably okay to have a small one while you're trying to knock out your student loans, but probably ought to get a little bit bigger one, a real one. Three to six months of what you spend after you pay those off. So that's priority number one. And the next question is, should we invest or should we pay off the mortgage? Well, I think both are reasonable things to do. As long as you have additional tax protected space, I think you ought to invest. But once you're looking at your taxable money, I think it's reasonable to consider paying off your mortgage with all or part of that savings above and beyond your retirement account. This also assumes you're putting at least 20% of your gross toward retirement, even if that's being invested in a taxable account. But what investments they should go into? Again, it comes down to what is your written investment plan that might be more index funds, very similar to the ones in the retirement accounts, it might be investment properties if your plan calls for you to invest in real estate in that manner. So of course there's no right or wrong answer to that question, what should be done with your money. But they do want to make sure they're putting 20% toward retirement. In this case, given that her husband is burning the candle at both ends, making $800,000 as an anesthesiologist, I think one of the things they ought to invest in is letting him cut back a little bit. His longevity is pretty critical to their long term financial plan. It sounds like given that he's bringing in about 80% of their income right now. And so I think cutting back on that would make it more sustainable long term and give them some career longevity. But all that's good to do, paying down a mortgage, boosting the emergency fund, saving for college, and of course getting a written investing plan in place. Next question. We have another long term goal to move to New Zealand, perhaps permanently. We realize this would lead to much lower salaries and are considering this for various reasons such as a better work life balance, simpler lifestyle, less stress, safer environment for our children, etc. Is there a better time to do this? Would you recommend working 10 years in the US to save as much as possible in retirement before going? Any certain amount we should save up before going or other tips. You know, this is interesting. These guys are doing awesome, right? They're making a million dollars a year, they're paying off $850,000 in student loans within just a few years and they're asking me for advice. I mean really, they ought to be giving the advice. So anyway, I don't know there's a right answer here as far as when the best time to go to New Zealand is. Obviously the more you save first, the better off you're going to be financially. But life isn't always about money. It might be tough to do that New Zealand thing once the 7 year old's in high school. So if you're going to go temporarily, I think I'd go before the seven year old hits high school. If you're going to go permanently, I'd probably do it before high school as well. So maybe they could work for five years and then go, I don't know. So there's not really a certain time amount or dollar amount you should stay in the US for before going to New Zealand. It's just too personal of a question for me to answer. And then I suggest that they send in a guest post about what they decide to do on that subject. So some great questions today. Please send in your questions and we'll cover those in the podcast. I love hearing what you guys are wondering about and what you're interested in and getting that information here available for you. Be sure to check out the White Coat Investor Book. If you haven't yet, check out our YouTube channel and thank you for supporting our sponsors.

If you're looking to boost returns, lower taxes and build wealth, join the WCI Monthly Real Estate Opportunities List for tips and strategies to maximize your real estate returns. And for introductions to exclusive investment opportunities, expect educational emails that introduce you to syndicators, fund companies, online courses and online real estate platforms. Go to whitecoatinvestor.com reopportunities to sign up today. You can do this and the White Coat Investor can help.

Head up, shoulders back. You've got this and we can help. See you next time on the White Coat Investor Podcast. My dad your host, Dr. Dahl, is a practicing emergency physician, blogger, author and podcaster. He is not a licensed accountant, attorney or financial advisor. So this podcast is for your entertainment and information only and should not be considered official personalized financial advice.