Today, we are talking about asset allocation. We discuss if your asset allocation should ever change and specifically if it should change in retirement or after you are financially independent. We discuss if it is even worth investing in international when US stocks are doing so well. Bonds continue to disappoint, and we continue to give the same message—stay the course. Once we've talked all about asset allocation and investing, we move on to what you do once you have invested your money. You spend it. Funny enough, for some people, spending money is even harder than saving it. There is no point in having money if you are not going to spend it. Live a little!
Listen to Episode #280 here.
In This Show:
- Asset Allocation When You Are Financially Independent
- Should Asset Allocation Be Changed Over Time?
- Why Invest in International?
- Investing in US Stock Market vs. International Stock Market
- Bonds in This Bear Market
- Small Cap Value or Mid Cap Value?
- Taxable Accounts
- Spending Your Money
- Sponsor
- No Hype Real Estate Investing Course
- Quote of the Day
- Milestones to Millionaire Podcast
- Full Transcript
Asset Allocation When You Are Financially Independent
“This is Tom in Boston. Thanks for doing all you do. My question involves asset allocation for those who've reached financial independence. William Bernstein is frequently quoted as saying, “If you've won the game, stop playing,” meaning take less risk. However, would it not also be logically appropriate to say if you've won the game or you're really winning the game, keep going and finish strong? For example, if you have a high net worth, no debt, a large cash bucket as an emergency fund and to mitigate sequence of return risks, as well as a high-risk tolerance and a long-time horizon, couldn't you keep your high-risk status? Couldn't you maintain your high risk asset allocation with a lot of money in stock index funds, or even close to 90%-100% stock allocation and stock index funds. Couldn't you do that and not run the risk of losing the game? Why not crush the game? Why not keep going and finish strong? What am I missing? And what are the flaws in this argument?”
Thanks for calling in Tom, and thanks for the question. I hope Boston is treating you well these days. Why not spike the ball and just throttle your opponent now that you're up by 15 points on him, right? Well, here's the deal. I think there's an important concept to understand in finance and in life. That concept is enough. If you don't know how much enough is, you might blow right past it and not make the appropriate adjustments in your life for the fact that you're there. For example, if part of running up the score, part of knocking it out of the ballpark involves work—work that takes time and energy that could be placed elsewhere that may bring you more happiness than more money is going to bring you.
At this point in my life, we've been FI for around four years. Where is the money that we are earning now going to go? We can't spend more than we are now. Not on anything that's going to make us any happier. We basically put no limitations on our spending at this point. If we want to buy something, we go buy it. If we want to go on a trip, we go on a trip. If we want to pay for a service, we get the service. There is essentially no limitation on our spending. We have also decided that we only want to leave a certain amount of money to our kids. We've already got that amount of money. With any sort of reasonable future returns and future amount of spending, similar to what we're spending now, we're going to have that money to leave as much to our kids as we're planning to leave to them. That means everything else that I am earning, that I am working for, is going to charity. That allows me to think about what asset allocation should money that's not going to go to a charity for a fair number of years probably be invested at? Probably a pretty aggressive asset allocation.
Same thing if you're truly investing for your kids. If the expectation is you're not going to keel over for 30 or 40 or 50 years and that money's going to go to your kids, you can invest that money awfully aggressively for two reasons. No. 1, you have a long-time horizon. No. 2, you don't have to worry so much about sensibilities like emotions. You don't care if the money is highly volatile because it's not really your money. It's your kid's money, and they don't know about it. They don't care about the fact that it's really volatile. When William Bernstein is talking about stopping when you win the game, what he really means is to think about the real risk to your portfolio, the deep risks, if you're familiar with that term. We're talking about inflation, deflation, confiscation, and devastation and trying to account for those and insure against those as best you can. Those are the things that can really sink your plan.
It's basically taking those expenses that you know you're going to have and having that sort of money invested into safe investments. Things like bonds, particularly inflation indexed bonds—like TIPS and I bonds and inflation indexed immediate annuities—those sorts of things for that money that shouldn't be risked. Then, once you have that set aside, everything else is in the risk portfolio, and you can take all kinds of risk with it. It sounds like that's kind of what you're alluding to when you talk about this large bucket of cash that you have sitting there, especially with no debt. Then the rest of the money is this risk bucket that you can take risk with. You're really talking about the same thing there in a lot of ways. Don't read too much into just the phrase “stop playing when you win the game,” but keep in mind that there's some wisdom there. For example, if somebody barely has enough to be FI and they want to stop working right now, well, that's a different situation than someone who has twice as much as they need and is still interested in working.
That sort of person shouldn't keep taking that risk. Sometimes, we just get lucky. Let's say you rode the crypto train up and got out at the top or you're at the top and you're like, “What should I do?” Well, that's the person he's talking to when he is saying “When you've won the game, stop playing.” You got $5 million in Bitcoin. Man, sell $4 million of it and invest it in some sensible way so you don't lose it. Or if you rode GameStop up or Tesla stock up or whatever. You sold your tech company. Let's say you started some tech company, made this awesome app that everybody loves, and sold the thing for $10 million. What do you do with that $10 million? Do you take that $10 million and roll it into another super risky tech company? That's probably not the right move. You can take a couple million of it and do that. You have to take the other $8 million and stop playing that game. You've won the game, stop playing it. That's what Bill Bernstein is talking about. Good luck choosing your asset allocation, but it is going to be a mix, I suspect, of some safe money and some money where you're trying to shoot the lights out.
Should Asset Allocation Be Changed Over Time?
“Hi Jim, this is John from the Mountain West. My question is about defining an asset allocation and how or even if this should change over time. As part of a written investment plan, is asset allocation best thought of as static over one's investing career or dynamic? My understanding is that when defining a reasonable asset allocation, one of the key factors to consider is your risk tolerance. Major contributor to risk tolerance is your investing time horizon, and the remaining capital you have before retirement. As an early career attending, my time horizon is long, and I have considerable human capital left. So, I'm quite tolerant of risk, and I’m comfortable with, say, a 90% stock portfolio. However, as I near retirement, I'll be much less risk tolerant and will be more comfortable to something closer to say 50-50, or even a more conservative portfolio. With this in mind, should I plan to incrementally adjust my asset allocation year by year, akin to what Vanguard does with a target date retirement fund? If so, how is this best implemented? With a small portfolio, I can easily maintain my desired asset allocation with new contributions, but as my portfolio grows, this will be harder to accomplish. If I rebalance yearly but have a changing asset allocation, does this negate the benefits of rebalancing?”
When you start asking questions like this, you have won the financial literacy game. You have found the questions that don't have right answers, and you've thought about them, and you're not sure what to do. But you're still thinking that someone out there has the right answer. The truth is nobody does. There is no right answer to this question. You're right that, for most people, what they do is take more risk early on when they have, as you say, more human capital, more of their money tied up in their future earning ability, and less risk later on. That helps overcome the sequence of return risk, particularly around the date of retirement—the first few years before or the first few years after. The right move is to have a less aggressive asset allocation as you move into and through retirement.
But when do you get there? Do you go there all at once? Do you make an adjustment every five years? Do you make an adjustment every single year? There are a lot of ways to skin this cat. You can do all of those, and they're all right. What you ought to do is figure out what you're going to do, put it in your written investment plan, and follow that. I wouldn't try to time it. I wouldn't say, “Oh, the market has done really well the last three years; now I'm going to cut it back based on what I feel is going to happen in the next few years.” I would have a mechanical plan. And that plan might be, “I plan to retire at 55 and I'm going to dial back my asset allocation at 52 from 90-10 to 60-40 or whatever. And then at age 65, I'm going to dial it back to 50-50.” You could do that. Or you could say, “I'm going to be 90-10 now, and I'm going to go down 1% a year for the next 40 years.” That would also be totally reasonable.
Another approach that some people take is just leaving it the same. That's essentially what Katie and I have done. From the time we had very little money, four-figure portfolio, until now when we have a lot more money, we've had basically the same asset allocation. It was 75-25 for a long time with 7.5 of that 75 being real estate. We have a little bit more real estate, an adjustment we made five or six years ago. We're now 60% stocks, 20% bonds, and 20% REITs. But it's an awfully similar asset allocation to what we've had ever since we had a four-figure portfolio back in 2004. We're comfortable with that.
The reason why is we're comfortable with what happened in the last five market downturns. We have the risk tolerance to tolerate that, but also there are reasons for us to also increase the aggressiveness of our investing as we go as well as decrease it. We've found they, more or less, have just balanced each other out. As we have more money, we have less need to take risk. But we also have realized that more and more, we are investing our money for other people, whether it be our kids, whether it be for charity. Thus, the time horizon for these investments has become longer, in some ways longer than our own lifetimes. We found those factors to more or less balance each other out. We've just kind of kept it where we are, 60-20-20, and haven't felt the need to really dial it back.
Now, as far as rebalancing goes, you ought to be rebalancing back to whatever the plan is. If your plan says, I got to be this year at 88-12, and you find that you're at 93-7, well, there probably ought to be some sale of stock and some buying bonds. But I would have those two things be totally separate plans. Then, just adjust those as they go. If your plan is to rebalance once a year, like lots of people, rebalance once a year to whatever your asset allocation is supposed to be that year. If you're keeping it static like we are, balance back to 60-20-20. Do that. If the plan is to gradually become less aggressive each year, then balance back to whatever you're supposed to be at. But I would treat those two processes separately. I wish I had the right answer. But I want to reassure you that not only do I not have the right answer, neither does anybody else.
More information here:
Adjusting Asset Allocation as You Approach Retirement
Why Invest in International?
“Why should we invest in international? The investing return of international stock market is less in comparison to US.”
I get a lot of emails like this. It's one line, maybe two half-sentences. I don't know where the person's coming from. I don't know what their level of investing knowledge is. I don't know what their current portfolio is. I don't know what article they just read that triggered this question. But here's the deal. When you say the investment return of the international stock market is less in comparison to US, recently, that's the way it's been. If you look at the last 10 years, international stocks have returned like 5.5% and US stocks have returned something like 13%. When I say recent underperformance, I'm talking about the last decade or so. If you look at the reasons for that, there are a couple of them. One is the outperformance of large and growth stocks and thus the underperformance of small and value stocks. International stocks are smaller and more value than US stocks on average. When large and growth does better, the US does better than international.
The other huge factor that's been going on the last few years is a strengthening dollar. When the dollar gets stronger, the US does better than international. That's like a headwind that international stocks are facing, at least for those of us who invest and spend in dollars. Those two factors say nothing about how the companies are doing. About how Nestle's doing or about how Toyota's doing or Mitsubishi or whatever, whatever international company you want to talk about. Unless you know what's going to happen with those two factors, the small and value factors, as well as what's going to happen with currencies, the dollar vs. the yen and the Euro and the British pound, then I wouldn't necessarily assume that those changes will persist. In fact, there's a lot of evidence that over time—and Jack Bogle loves to talk about this—there is a phenomenon of returning to the mean.
Jack would probably argue that over the next decade, international is far more likely to outperform than the US based on recent poor performance. You guys may or may not remember this, but 10 years ago, everyone was talking about something called the lost decade. They were talking about US stock returns from 2000-2010. They'd look at this chart of the S&P 500. Basically, it was at the same place in 2010, as it was in 2000. They ignored dividends and that sort of a thing, like they usually do in those times, and said, “US stocks suck.” Well, nobody's saying that now, because in the 2010s, US stocks did awesome. What does that mean? Does that mean, for sure in the 2020s, that international stocks are going to outperform US stocks, just like they did in the 2000s? No, there's no guarantee, but certainly, if you're going to bet one way, that's probably the way to bet. Instead, I think the better approach is set a fixed asset allocation, whatever that might be. In my case, about a third of our stocks are overseas. That's the way it was in the 2000s. It rewarded us very well. That's the way it was in the 2010s. It did not reward us so well.
But the truth is over time, you're probably fine no matter what that percentage is. Whether it's 10%, 20%, 30%, 50%, whatever the percentage is, it's probably fine, because international stocks are going to have their day in the sun. I can't tell you when that's going to be, but it's going to happen. In those times, everyone will be going, “Why don't you have more in international?” But that's just because people don't look very far and they don't know their financial history.
Investing in US Stock Market vs. International Stock Market
“Investing in total US stock market vs. international. I know, I know. Just choose something and stick with it. And 0-20% international is probably reasonable. My question specifically comes after reading one of Dr. Bernstein's books, where I believe he mentions he expects future US returns to be much less, 2%-3% less due to US equities doing well for so long. Have you changed your mind over the years over how much international tilt to have?”
No, I have the same tilt I had 15 years ago.
“Would there be something that would change that may change your perspective?”
Well, I guess there could be something. I can't think of what it might be. You expect long-term underperformance of some of the asset classes in your portfolio. You just don't know which ones they are. If you knew which ones they were, you wouldn't invest in them. But because you don't know and you don't know when they're going to turn, you stick with a static asset allocation, you rebalance it every year or two, and you know that every one of those asset classes is going to have their day in the sun.
One of the really great resources to look at out there is called the periodic investing table or something like that. Periodic table of investments. I don't know. It's done by Callan. And if you go to callan.com/periodic-table, it'll pull up and you can see there's lots of graphs. Basically, what they do with this thing is they show which asset class was the best for any given year. If you go back and you look at 2002, it was global bonds. In 2003, it was emerging market stocks. In 2004, it was real estate. The second was emerging market stocks. In, 2005, it was emerging market stocks; 2006 was real estate and then emerging market stocks; 2007 was emerging market stocks. You get in the picture here for a long time. In the 2000s, the top asset class to have was emerging market stocks—2003, 2005, 2007, 2009, and two other years where it was second best.
Where are US stocks? It's way down the list in all those years. But if you look at the last few years, you look at 2013, US small caps and then US large caps; 2014 was real estate, US large caps; 2015 was US large caps; 2016 was US small caps and high yield bonds, then US large caps; 2017 was emerging market stocks back on top and then developed US stocks, followed by US stocks. For the last number of years, US stocks have outperformed international stocks most of the time. That pendulum is going to swing back the other way. I can't tell you when, I can't tell you how hard it's going to swing, but the fact that people want to change their portfolios now after a period of outperformance, what you're probably doing is performance chasing. That's a recipe for crummy long-term returns.
You'll jump into US stocks heavy, or you'll change your asset allocation toward them now just in time for them to do poorly and international stocks to do well, or for bonds to do well, or for real estate to do well, or whatever. It's just our nature as human beings and having a fixed asset allocation will help you to avoid those behavioral errors. So, no, I haven't changed my mind. I don't think there's going to be anything barring nuclear war or something that might change my perspective.
Next part of the question says,
“I think I've heard you and others state something along the lines that you plan on retiring in the US. Therefore, you want your investments in US currency. Why is this? If you held international funds, couldn't you just sell it and receive dollars?”
Yes, you could. This is one of the reasons given for not holding the world portfolio. I don't know what it is exactly right now, but in recent years, it's been about 50% US and 50% overseas. That is the market capitalized world stock market. Some people argue, “Well, that's what the market is. You ought to allocate your funds just like the market does. You ought to put half your money in the US and half your money in international.” The argument that people have made to have less than that 50% in international, one of those arguments is simply that “Why spend in US dollars?” I ought to have a little bit more money in US dollars. I think that's reasonable. That's one reason why I don't have the world market portfolio. I have two-thirds of my stocks in the US and one-third overseas, and that's because I spend in US currency. Here's what can happen. Let's say you got a whole bunch of your money in overseas stocks, like total international stock market, and then the US dollar strengthens, and you end up having poor performance in those markets. You still got to spend dollars, but your money didn't grow as fast. By having a little bit of a tilt toward the US, you've hedged against that possibility. That makes sense. Can't have it both ways, though. Your first question is asking “Why not more US?” and the second one is “Why not more international?” I mean, pick something and stick with it.
More information here:
Don't Give Up on International Stocks
Bonds in This Bear Market
“Hi, Jim. My question involves bonds and how a total bond fund almost has as much equity risk nowadays during this bear market as even a total stock market index fund. I think, if I’m not mistaken, this is because of the concept of bond convexity when interest rates are so low and yields are so low on bonds, that they're sort of on a very steep end of this bond price and yield curve. And just a slight change in yield will really decimate the price of bonds. Is it something where in the future if I'm considering using bonds as balance to my equities or having a bond portion of my portfolio to mitigate my risk tolerance, that maybe I should not use the usual total bond index fund, but maybe something of shorter duration and more treasury bond fund? Especially when, again, if we were to encounter a low yield environment? Is there any research in maybe using a shorter duration treasury bond fund instead of a total bond fund when yields are low to properly have an asset allocation matching risk tolerance? Any insight in this would be great.”
Well, Rikki, you don't like it when your bonds go down in value, huh? That's what it sounds like to me. You are kind of being complainy pants that your bonds fell at the same time as your stocks. Sometimes, they do that. Bonds and stocks have a correlation of about zero. That means they are not anti-correlated. That would be a correlation of minus one. Bonds don't go up when stocks go down. They do whatever they want to do. They don't seem to be correlated with stocks. So sometimes, they both go down together. Sometimes they both go up together. There are really two kinds of risks involved in bonds. The first one is interest rate risk. If you own a bond that pays 2% and rates go up, your bonds are worth less because people would rather buy the new bonds that pay 3%. If you want to sell your bond, you've got to sell it at enough of a discount that the yield until maturity is about the same as what they can buy on the market.
That's interest rate risk. There's a fair amount of interest rate risk in a bond fund like the total bond market. The duration on that is five years or something like that. So, for every 1% that interest rates go up, you're going to lose 5% of the value of that bond fund.
The other risk is default risk. That's the risk of somebody not paying you back. In the total bond market fund, there's basically three kinds of bonds. There are treasury bonds, loans to the US government. There are corporate bonds, loans to companies in the US. And there are some mortgage-backed bonds. When mortgages are being paid back early and you get your money back, that risk can show up, or when people start defaulting on mortgages, that risk can show up. Obviously, when you are loaning to companies, that introduces what we call equity risk into the bond. If the company is not doing good, if it's doing really bad, it can't pay that, even make those bond payments. It becomes a higher risk of default.
Some very wise people, some of which include Larry Swedroe, Bill Bernstein, etc., have talked about not taking your risk on the bond side, taking it on the equity side instead. That it is a more efficient place to take risk. Their argument is that you hold very safe bonds. Not only short duration, so you're not running much interest rate risk, but also not very high risk of default, meaning mostly treasuries. For many years, my main bond holding, at least on the nominal side, is the TSP G fund. The G fund is basically short-term loans to the government. They promise you treasury yield with money market risk. The duration is essentially one day; 1-4 days is the duration of the G fund. But you're getting yields comparable to a 10-year treasury.
A little bit of a free lunch there, but the bottom line is it's a very safe bond fund. No interest rate risk, basically no default risk. That's the approach I've taken. I've taken my risk on the equity side. On the equity side, I have lots of international stocks. I have lots of small cap value stocks. I take plenty of risk with real estate, etc, but I don't take risk necessarily so much on the bond side. As the years have gone on, I haven't been able to put all my bonds into the G fund because I don't have that much money in the TSP. So, my entire TSP is now G fund. You can't buy the G fund outside the TSP. I've had to do something else. What that's ended up with my current portfolio is muni bonds in taxable. They have both more interest rate risk as well as more default risk.
They're much more similar to the total bond fund than they are to that TSP G fund. But I still try to keep it fairly high quality. I'm not investing in high yield munis. I'm not investing in long term munis. Still the same philosophy, to mostly take the risk on the equity side, but I've had to make some compromises there. On the inflation index bond side, I've used TIPS and more recently I bonds, too. Again, essentially no default risk. They're all loans with the US government. Although some people may argue the US government is quite likely to default, they're considered to have pretty low default risk by comparison to companies and mortgage holders.
But that's what I've done with my bonds. I am a fan of not taking a lot of risk on the bond side. But look at what the total bond market has done year to date. As I record this podcast, it is down 8.34%. Over the last year, it's down 9.42%. Considering how much interest rates have risen, that's not too bad. You've been rewarded with the higher yield now, projected returns going forward from here are much better. But if you look at even the last 10-year returns, now you're down to 1.58% per year simply because of the poor returns over the last year as interest rates have risen. No surprise that you're not real happy with your total bond fund right now, but I would not necessarily blame that on just the stock market downturn. It's also from the rise in interest rates. There are multiple factors there that have caused that. And guess what? Not all of your asset classes are going to do well at any given time. If your goal is just to jump into the ones that are going to do well, you're going to need a very clear crystal ball. Otherwise, I recommend you pick a reasonable mix of investments, and you stick with them through thick and thin knowing that each one of them is going to have their day in the sun eventually. You're always going to own something that you're not entirely happy with.
More information here:
Bear Market! What (If Anything) Should You Do?
Small Cap Value or Mid Cap Value?
“Could you please discuss the pros and cons of small cap value vs. mid cap value? As I mentioned before, we don't have small cap value in our 403(b). In this situation, which one is better? Small cap blend or mid cap value?”
That's unfortunate. You have a couple options. No. 1, chances that your only investing account is just a 403(b) is pretty low. You've probably got a Roth IRA. Maybe your spouse has some retirement accounts. Maybe there's a 457. Maybe there's a taxable account. Just because there's not a small cap value fund in your 403(b), you can put something else in your 403(b). Put your bonds in there, put your international stocks in there, whatever, and use the other account to get your desired asset class in it. That might be one option for you.
If you're truly having to choose between small cap blend or mid cap value in the 403(b), you should be aware that the data on factor investing suggests that value is a more significant factor than size. If you have to just pick one, you're probably better off picking the value. That means the mid cap value fund rather than the small cap blend fund. But you could also pick a little bit of both and then you could have some small and some value and get both of those factors, both of those tilts into your portfolio.
Your final question is,
“Is it wise to invest a little bit more in small cap value and less in total US and international, such as 20% in small mid cap, 25% in US total and 15% in international?”
Here's the deal. Without knowing future returns, I can't answer that question. If I knew future returns, I would just have you put it all on whatever's going to do the best. I don't know what the proper mix is. Each of those is likely to have their day in the sun, and you'll be glad you own it when it does. You'll wish you own more of it when it has its day in the sun. Likewise, when it does poorly, you're going to wish you owned less of it or didn't own it at all. That's just the nature of a diversified portfolio. This tilt you're talking about, though, 20% in small and mid cap and 25% in a total market is a pretty heavy tilt. I mean, small value is basically 3% of the market. You start talking about putting 5%, 10%, 15%, 20% of your portfolio in there, or of your US stocks, putting 50% of them into small cap value, you better really believe in those factors. It's important that you don't tilt your portfolio more than you believe. Because when those inevitable periods of underperformance come, you don't want to bail out just in time for it to turn around and really start outperforming.
I would say, be less aggressive when setting your initial stock to bond ratio until you go through a bear market. Maybe you ought to be a little bit less aggressive in setting your tilt until you've gone through a period of underperformance of that factor. Personally, my stock portfolio is 25% US total stock market, 15% small value and then 15% total international and 5% small international. There are some tilts there and they're pretty significant tilts, but I also didn't bet the farm on them. I feel comfortable with that, but you've got to decide how much you feel comfortable with. You're talking about some pretty significant tilts, so you better read all the literature in small value and really believe in it in order to tilt your portfolio that much toward it.
Taxable Accounts
“Hi, Dr. Dahle. I have a few questions about taxable accounts. I am in a dual physician household, and we both max out our 401(k)s and Roth IRAs and are ready to start a taxable account. All of our accounts are currently at Vanguard. Is it OK to have our taxable account there as well? I read that at Vanguard, you cannot have any beneficiaries with a joint taxable account. So, if we both die in an accident at the same time, our account will go through probate before it goes to our children. I've been putting off this estate planning portion of the Fire Your Financial Advisor course because of the hard decisions and realistically won't have a trust formed by the end of the year.”
Congratulations on your success. Maxing out your retirement accounts is no small feat. Just the fact that you're ready to start a taxable account is pretty awesome. But what you must realize is you probably have money now that you're ready to invest and you're scared to invest because of these estate planning questions. The truth is you probably ought to just get that money invested. It's already in the taxable account, whether you've moved it to Vanguard or it's sitting in your bank account, it's probably already going to go through probate. It's not like probate is the end of the world. Maybe there are some fees. Maybe it takes a little while longer for your heirs to get the money than it otherwise would, but it's not the end of the world. So don't let the fear of probate keep you from investing money you know you need to invest.
If you really want to avoid probate, the way you do that is you open a revocable trust. That revocable trust—you can change it at any time; it’s totally revocable—will ensure that money doesn't go through probate. You can certainly have a trust account at Vanguard. Our trust account, taxable account, etc., is all at Vanguard. They can handle all that. It's no problem there. If that's your concern, go open a revocable trust. It's not that hard to do. Start investing that way. There may be some other custodians' brokerages that do allow you to have some sort of payable on death aspect, that you can name a beneficiary somehow for a taxable account. But I don't think that's typical. I think most of the time, it goes to probate if you're not going to put it in a trust. That's the point of a revocable trust; it’s to avoid probate. That should be your solution, whether you get it in place this year or next year or in 20 years. It's fine as long as you don't die between now and then. Drive safely. But most of us don't worry too much about that. Just try to get it in place before too long.
More information here:
Difference Between an Irrevocable Trust and Revocable Trust
Spending Your Money
“One topic I would be fascinated to hear you discuss on a podcast is not investing money, but spending it. For example, I've heard on your podcast discussions of spending money on home renovations and travel but still driving an older car and not getting a Tesla. How do you decide what to spend money on and what not to, especially after reaching FI? The second question is after college, med school, residency, plus fellowship, 2-5 years of living like a resident, how does one transition, to a degree, to increasing spending after never really doing this? I think it is Dave Ramsey who makes the analogy of working on a muscle. If you haven't worked on spending, how do you approach this?”
It's actually not that hard. The bigger problem most people have is they go overboard with it, and they just spend too much. If you're worried that that's you, you're probably like most people and you need to be careful with how much you ramp up your spending. There are a few of us on the other end of the spectrum that the bigger concerns are that we become miserly. You don't want to do that either. You've worked hard to get this money. You should enjoy spending at least some of it. Go spend it on what you care about.
I did a post on the website in 2015. It's called Loosening the Purse Strings. It talks about when we were going through this. At that point, as you recall from my first book, we became millionaires in about 2013. We were doing well; we weren't financially independent, but we were doing great. In fact, by 2015, we were even starting to make a little bit of money at The White Coat Investor. Things were going well, and we decided we were going to loosen the purse string some. It talks about some of the things we bought. We bought a really nice table set. That was a big deal for us. We had this cheap old table that we bought in med school. We bought an $11,000 table set. We did a little bit of a home remodel that year. We later did a huge one. We started taking a little bit more expensive vacations. I finally got a decent mountain bike. We upgraded our boat. We went from an old beater boat to a pretty nice boat. It was a gradual thing.
But the point of saving money is not so you can never spend it. It is so you can spend more money later or give more money later. I would encourage you to do that deliberately. Yes, there should still be a “live like a resident” period of some type after you finish your training. But after that, feel free to spend your money. Yeah, you probably still need to save 20% of it for retirement. But after that, spend the rest on whatever you care about, and only you can decide what you care about. Maybe it's travel. That is for lots of people. Maybe you're a car person and you want to get a Corvette or you want to get a Tesla S or you want to get a BMW or whatever. If you can afford it, go buy it. Especially if you don't have to finance it. I was just talking to our content editor, Josh, and I gave him a hard time about financing his Tesla. I think half the readership gave him a hard time about financing when he wrote about it in one of his Sunday columns on the blog.
Then as time goes on and you hit financial independence, especially if you're still working, then you can really go crazy spending if you want. You can probably spend just about anything you want, and that's kind of where we're at in our lives. You look back at our last year, and we went to Spain in November. We went to Greece in December. We went to Canada to go heli-skiing in March. I went to Roatan in May to go scuba diving. I ordered a brand-new F-250.
As I mentioned earlier in the podcast, the alternative to spending at this point for us is to leave it to charity. We don't need any more for ourselves. We don't want to give more to the kids. Whatever we earn and don't spend will be given to charity. For some reason, that fact helps me to spend a little bit more. I was proud of myself for willingly paying $25 to park at the ski resort the other day rather than parking out on the road and walking an additional 10 minutes up to the lift. But I'm also not necessarily ordering lunch every day. I'm going downstairs and making PBJs.
How I decide where to spend? I don't know; a lot of it is convenience. I still don't have a lawn service coming over and mowing the lawn. If the kids don't do it, I do it. But we have someone that comes in and cleans our home because we really hate cleaning stuff and I don't mind mowing the lawn. Everybody is a little bit different in what they don't mind spending on. You've just got to make sure it's reasonable, that you're saving enough money and you can spend the rest, but try to be deliberate and spend on what you care about the most.
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Loosening the Purse Strings
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Full Transcript
Transcription – WCI – 280
Intro:
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.
Dr. Jim Dahle:
This is White Coat Investor podcast number 280 – Asset allocation, international stocks, bonds, small and mid-cap value factors.
Dr. Jim Dahle:
If you are finding our podcasts informative and helpful, check out our website! Since 2011 we have been working hard to provide valuable personal finance and investing information through thousands of blog posts written by an array of authors. You can find information on how to manage your student loans, fix and avoid common financial mistakes, understand your retirement accounts, optimize your investments, find professional help at a fair price, get started investing in real estate, and so much more, all at no cost to you. You can find out more about the courses we offer, the conferences we put on, the newsletters we provide, and interact with other WCI readers through our online forum. Head over to whitecoatinvestor.com to start learning today.
You can do this and The White Coat Investor can help.
Dr. Jim Dahle:
Hey, thanks to those of you out there for what you're doing. Work is difficult. It's difficult no matter what you're doing. It's difficult whether you're trying to produce White Coat Investor podcast, it’s difficult whether you're at the hospital. It's difficult whether you're sitting in a law office trying to do estate planning for somebody.
Dr. Jim Dahle:
Whatever it is that you have dedicated your life to, that you have spent years training for, that you probably haven't been thanked for lately, let me thank you for doing it. It's not easy and I know that you don't get thanked nearly as often as you should. Especially those of you working crazy shifts, working long nights, working with difficult patients and that's not a small percentage of them sometimes. So, thank you.
Dr. Jim Dahle:
All right. Well, we're recording this on August 31st. It's a pretty exciting time for us. And the reason why is that we're launching the No Hype Real Estate Investing course on September 6th. Today is the 31st. Tomorrow is the 1st. I spent the morning in a partnership meeting for my physician partnership. And then I have a shift in the evening and then we leave for the weekend.
Dr. Jim Dahle:
Hopefully, if we have this real estate course completely done by then, then we get to spend the Labor Day weekend down at Lake Powell. And I'm really looking forward to that. I've been getting everything ready for that because Katie has been working literally 16 hours a day all week to try to get this course ready to launch next Tuesday.
Dr. Jim Dahle:
So, by the time you hear this on what? The 15th? I think this drops on September 15th. This course has been available for about nine days. So, we're about halfway through the promotional period. The promotional period means we give you a huge discount. It's $400 off until September 26th at midnight.
Dr. Jim Dahle:
But this thing is awesome. This has been a labor of love, yes, but a labor. We've been at this for months. I've been writing scripts for this since January. Doing research, reading books, reviewing books I've read in the past, talking to people, recruiting guests, faculty for the course.
Dr. Jim Dahle:
There are over 15 instructors in this course that have made contributions to it from all over the physician real estate investing space to introduce you to real estate investing. Everything from fixing flips and turn key investments, short term rentals, long term rentals, syndications, private real estate funds, public real estate investments.
Dr. Jim Dahle:
All this stuff, we cover it in the course. We teach you where you fit in on that real estate spectrum, where you should concentrate your efforts, how much to invest and where, and how to maximize your returns and minimize your taxes and how to actually do this.
Dr. Jim Dahle:
But I love that the course is called No Hype Real Estate, because that's really what we're trying to do. It's not that real estate investing doesn't work. It does work. It's not a get rich quick scheme. You shouldn't take some massive amount of risk doing it to try to speed things up.
Dr. Jim Dahle:
But to pretend it doesn't work is silly. There's lots of docs out there that have become very successful at real estate investing. They have essentially divorced the way they make their money from their profession. So, they can still practice medicine all they want, but they make their money, at least the money they need to live out of their real estate investments. And that can be done.
Dr. Jim Dahle:
Does it take some work? Absolutely, it takes some work. Is there some risk? Absolutely, there's some risk. But too many of the courses, books, webinars out there kind of blow smoke about how easy all this is and how it's totally risk free and how anybody can do it.
Dr. Jim Dahle:
We're going to give you the straight scoop. We're not going to lie to you. We're not going to blow any smoke. We're going to tell you how real estate investing works. We're going to give you the vocabulary you need to speak that language, and we're going to help you understand how it fits into your life, and help you to be successful at it.
Dr. Jim Dahle:
Whether you're wondering how to get started with short term rentals or whether you're wondering how to evaluate a syndication, this course is going to teach you. No Hype Real Estate Investing. You can get the information for that at whitecoatinvestor.com/nohype.
Dr. Jim Dahle:
This is a long course. It's about four times the size of Fire Your Financial Advisor. That's why it's taken so much work to put it together. But we're not charging four times the price of Fire Your Financial Advisor. It's just over two times the price at the sale price. So, we think it's a really great value. The sale price is $1,799. We think it's a very fair price. We consider it a quite significant discount. You've noticed some much shorter courses out there in the physician financial space that are charging significantly more for the course.
Dr. Jim Dahle:
So, we think it's a really good value, but there's no risk to you. Try it. If you don't like it, just shoot us an email. We'll give you all your money back. That's all it takes. One week guarantee on it. You can take a look at it. As long as you haven't taken more than 20% of it, we'll give you your money back. So, there's literally no risk to you. Check it out whitecoatinvestor.com/nohype.
Dr. Jim Dahle:
If you want to learn more about it, I'm going to put on a webinar. It's coming up in just a few days. It'll be on the 20th of September 7:00 PM mountain time. You can sign up for that at whitecoatinvestor.com/nohypewebinar. I'll tell you all more about it. I'll answer any question you have about it, or about real estate investing and it'll be great.
Dr. Jim Dahle:
All right, enough about that. Let's talk about you guys, about your life, about your financial questions, about your successes. By the way, I hope you listen to at least occasionally The Milestones to Millionaire podcast that we do. We drop one every Monday. Obviously not every one of them is going to relate to your financial life but they all have some common themes of people that deliberately made some steps in their lives that improved their finances and thus improved the rest of their lives. And that's what this podcast is really all about.
Dr. Jim Dahle:
All right, let's take a listen to a question coming in off the Speak Pipe. This one is about asset allocation for the financially independent.
Tom:
This is Tom in Boston. Thanks for doing all you do. My question involves asset allocation for those who've reached financial independence. William Bernstein is frequently quoted as saying, “If you've won the game, stop playing,” meaning take less risk. However, would it not also be logically appropriate to say if you've won the game or you're really winning the game, keep going and finish strong?
Tom:
For example, if you have a high net worth, no debt, a large cash bucket as an emergency fund and to mitigate sequence of return risks, as well as a high-risk tolerance and a long-time horizon, couldn't you keep your high-risk status? Couldn't you maintain your high risk asset allocation with a lot of money in stock index funds, or even close to 90% to 100% stock allocation and stock index funds.
Tom:
Couldn't you do that and not run the risk of losing the game? Why not crush the game? Why not keep going and finish strong? What am I missing? And what are the flaws in this argument? Thanks for doing all you do.
Dr. Jim Dahle:
Thanks for calling in Tom, and thanks for the question. I hope Boston is treating you well these days. Why not spike the ball and just throttle your opponent now that you're up by 15 points on him, right?
Dr. Jim Dahle:
Well, here's the deal. I think there's an important concept to understand in finance and in life. And that concept is enough. If you don't know how much enough is, you might blow right past it and not make the appropriate adjustments in your life for the fact that you're there.
Dr. Jim Dahle:
For example, if part of running up the score, part of knocking it out of the ballpark involves work, work that takes time and energy that could be placed elsewhere. Somewhere that may bring you more happiness than more money is going to bring you.
Dr. Jim Dahle:
At this point in my life, we've been FI for what? Four years. Four or five years, something like that, maybe four years. So where is the money that we are earning now going to go? Well, we can't spend anymore. Not on anything that's going to make us any happier. We basically put no limitations on our spending at this point. If we want to buy something, we go buy it. If we want to go on a trip, we go on a trip. If we want to pay for a service, we get the service. There is essentially no limitation on our spending.
Dr. Jim Dahle:
We have also decided that we only want to leave a certain amount of money to our kids. We've already got that amount of money. With any sort of reasonable future returns and future amount of spending, similar to what we're spending now, we're going to have that money to leave as much to our kids as we're planning to leave to them.
Dr. Jim Dahle:
That means everything else that I am earning that I am working for is going to charity. That allows me to think about that. Well, what asset allocation should money that's not going to go to a charity for a fair number of years probably be invested at? And so, that's probably a pretty aggressive asset allocation.
Dr. Jim Dahle:
Same thing if you're truly investing for your kids. If the expectation is you're not going to kill over for 30 or 40 or 50 years, and that money's going to go to your kids, you can invest that money awfully aggressively, right? Because for two reasons.
Dr. Jim Dahle:
Number one, you have a long-time horizon. And number two, you don't have to worry so much about sensibilities like emotions. You don't care if the money is highly volatile because it's not really your money, it's your kid's money and they don't know about it. So, they don't care about the fact that it's really volatile. You may find that you can invest it pretty darn aggressively because of those reasons.
Dr. Jim Dahle:
When William Bernstein is talking about stopping when you win the game, what he really means is to think about the real risk to your portfolio, the deep risks, if you're familiar with that term. We're talking about inflation, deflation, confiscation, and devastation, and trying to account for those and ensure against those as best you can, because those are the things that can really sink your plan.
Dr. Jim Dahle:
And so, it's basically taking those expenses that you know you're going to have, and having that sort of money invested into safe investments. Things like bonds, particularly inflation index bonds, like TIPS and I bonds and inflation index, immediate annuities, those sorts of things for that money that shouldn't be risk.
Dr. Jim Dahle:
And then once you have that set aside, everything else is in the risk portfolio and you can take all kinds of risk with it. And so, it sounds like that's kind of what you're alluding to when you talk about this large bucket of cash that you have sitting there, especially with no debt. And then the rest of the money is this risk bucket that you can take risk with.
Dr. Jim Dahle:
And so, you're really talking about the same thing there in a lot of ways. So don't read too much into just the phrase “stop playing when you win the game”, but keep in mind that there's some wisdom there. For example, if somebody barely has enough to be FI and they want to stop working right now, well, that's a different situation than someone that has twice as much as they need and is still interested in working.
Dr. Jim Dahle:
So, you got to keep that in mind. But that sort of person shouldn't keep taking that risk. And sometimes we just get lucky. Let's say you rode the crypto train up and got out at the top or you're at the top and you're like, “What should I do?” Well, that's the person he's talking to when he is saying “When you've won the game, stop playing.” You got $5 million in Bitcoin. Man, sell $4 million of it and invest it in some sensible way so you don't lose it. Or if you rode Game stock up or Tesla stock up or whatever. You sold your tech company.
Dr. Jim Dahle:
Let's say you started some tech company, made this awesome app that everybody loves, sold the thing for $10 million. Now, what do you do with that $10 million? Do you take that $10 million and roll it into another super risky tech company? That's probably not the right move. You can take a couple millions of it and do that. You got to take the other $8 million and stop playing that game. You've won the game, stop playing it. That's what Bill Bernstein is talking about.
Dr. Jim Dahle:
I hope that's helpful. Good luck choosing your asset allocation but it is going to be a mix I suspect of some safe money and some money where you're trying to shoot the lights out. So, good luck with that.
Dr. Jim Dahle:
Let's listen to John's asset allocation problem off the Speak Pipe.
John:
Hi Jim, this is John from the Mountain West. My question is about defining an asset allocation and how or even if this should change over time. As part of a written investment plan is asset allocation best thought of as static over one's investing career or dynamic?
John:
My understanding is that when defining a reasonable asset allocation, one of the key factors to consider is your risk tolerance. Major contributor to risk tolerance is your investing time horizon, and the remaining capital you have before retirement.
John:
As an early career attending, my time horizon is long and I have considerable human capital left. So, I'm quite tolerant of risk and I’m comfortable with say 90% stock portfolio. However, as I near retirement I'll be much less risk tolerant and will be more comfortable to something closer to say 50-50, or even a more conservative portfolio.
John:
With this in mind, should I plan to incrementally adjust my asset allocation year by year, akin to what Vanguard does with a target date retirement fund? If so, how is this best implemented? With a small portfolio, I can easily maintain my desired asset allocation with new contributions, but as my portfolio grows, this will be harder to accomplish. If I rebalance yearly, but have a changing asset allocation, does this negate the benefits of rebalancing? Thank you for all that you do.
Dr. Jim Dahle:
All right, John, congratulations, you win. When you start asking questions like this, you have won the financial literacy game. You have found the questions that don't have right answers, and you've thought about them, and you're not sure what to do, but you're still thinking that someone out there has the right answer. And the truth is nobody does. There is no right answer to this question.
Dr. Jim Dahle:
You're right. That for most people, what they do is they take more risk early on when they have as you say more human capital, more of their money is tied up in their future earnings ability and less risk later on. And certainly, that helps overcome the sequence of return risk, particularly around the date of retirement. The first few years before, or first few years after. And so, that's usually the right move is to have a less aggressive asset allocation as you move into and through retirement.
Dr. Jim Dahle:
But when do you get there? Do you go there all at once? Do you make an adjustment every five years? Do you make an adjustment every single year? There's a lot of ways to skin this cat. You can do all of those and they're all right. What you ought to do is figure out what you're going to do, put it in your written investment plan and follow that.
Dr. Jim Dahle:
I wouldn't try to time it. I wouldn't say, “Oh, the market has done really well the last three years, now I'm going to cut it back based on how I feel what's going to happen in the next few years.” I would have a mechanical plan. And that plan might be “I plan to retire at 55 and I'm going to dial back my asset allocation at 52 from 90-10 to 60-40 or whatever. And then at age 65, I'm going to dial it back to 50-50.” You could do that. Or you could say, “I'm going to be 90-10 now, and I'm going to go down 1% a year for the next 40 years.” That would also be totally reasonable.
Dr. Jim Dahle:
Another approach that some people take is just leaving it the same. That's essentially what Katie and I have done. From the time we had very little money, four figure portfolio, until now when we have a lot more money, we've had basically the same asset allocation. It was 75-25 for a long time with, 5 of that 75 being or 7.5 rather of that 75 being real estate. We have a little bit more real estate, an adjustment we made five or six years ago. We're now 60% stocks, 20% bonds and 20% REITs. But it's an awfully similar asset allocation to what we've had ever since we had a four-figure portfolio back in 2004.
Dr. Jim Dahle:
And we're comfortable with that. And the reason why is we're comfortable with what happens in the last five market downturns. We have the risk tolerance to tolerate that, but also there are reasons for us to also increase the aggressiveness of our investing as we go as well as decrease it. And we found they more or less have just balanced each other out.
Dr. Jim Dahle:
As we have more money, we have less need to take risk. But we also have realized that more and more, we are investing our money for other people. Whether it be our kids, whether it be for charity and thus the time horizon for these investments has become longer, in some ways longer than our own lifetimes. We found those factors to more or less balance each other out. And so, we've just kind of kept it where we are 60-20-20, and haven't felt the need to really dial it back.
Dr. Jim Dahle:
Now, as far as rebalancing goes, you ought to be rebalancing back to whatever the plan is. If your plan says, I got to be this year at 88-12, and you find that you're at 93-7, well, there probably ought to be some sale of stock and some buying bonds. But I wouldn't let those two things. I would have those two things be totally separate plans. And then just adjust those as they go.
Dr. Jim Dahle:
If your plan is to rebalance once a year, like lots of people, rebalance once a year to whatever your asset allocation is supposed to be that year. If you're keeping it static like we are, balance back to 60-20-20, do that. If the plan is to gradually become less aggressive each year, then balance back to whatever you're supposed to be at. But I would treat those two processes separately.
Dr. Jim Dahle:
I hope that's helpful. It's a great question, John. I wish I had the right answer but I want to reassure you that not only do I not have the right answer, neither does anybody else.
Dr. Jim Dahle:
All right, let's do our quote of the day. This is from Jacob Reese. He says “When nothing seems to help, I go and look at a stonecutter hammering away at his rock, perhaps a hundred times without as much as a crack showing in it. Yet at the hundred and first blow it will split in two, and I know it was not that last blow that did it, but all that had gone before.”
Dr. Jim Dahle:
And that's in a lot of ways what investing is like. That's a lot of ways what life and success is like. It took me 20 years to become an overnight success. But the truth is it's all about your habits. It's all about the simple things you do every week, every month, that eventually add up to a great deal of success.
Dr. Jim Dahle:
All right. Here's another asset allocation question coming in via email. “Why should we invest in international? The investing return of international stock market is less in comparison to US.”
Dr. Jim Dahle:
I get a lot of emails like this. It's one line, maybe two half sentences. And I don't know where the person's coming from. I don't know what their level of investing knowledge is. I don't know what their current portfolio is. I don't know what article they just read that triggered this question.
Dr. Jim Dahle:
But here's the deal. When you say the investment return, the international stock market is less in comparison to US. Yeah. Recently, that's the way it's been. If you look at the last 10 years, international stocks have returned like 5.5% and US stocks have returned something like 13%.
Dr. Jim Dahle:
When I say recent underperformance, I'm talking about the last decade or so. And if you look at the reasons for that, there's a couple of them. One is the outperformance of large and growth stocks and thus the underperformance of small and value stocks. International stocks are smaller and more value than US stocks on average. So, when large and growth does better, the US does better than international.
Dr. Jim Dahle:
The other huge factor that's been going the last few years is a strengthening dollar. And when the dollar gets stronger, the US does better than international. That's like a headwind that international stocks are facing, at least for those of us who invest and spend in dollars.
Dr. Jim Dahle:
Those two factors say nothing about how the companies are doing. About how Nestle's doing or about how Toyota's doing or Mitsubishi or whatever, whatever international company you want to talk about.
Dr. Jim Dahle:
Unless you know what's going to happen with those two factors, the small and value factors, as well as what's going to happen with currencies, the dollar versus the yen and the Euro and the British pound, then I wouldn't necessarily assume that those changes will persist. In fact, there's a lot of evidence that over time, and Jack Bogle loves to talk about this, there is a phenomenon of returning to the mean.
Dr. Jim Dahle:
Jack would probably argue that over the next decade, international is far more likely to outperform than the US based on recent poor performance. You guys may or may not remember this, but 10 years ago, everyone was talking about something called the lost decade. And they were talking about US stock returns from 2000 to 2010. They'd look at this chart of the S&P 500. And basically, it was at the same place in 2010, as it was in 2000. They ignored dividends and that sort of a thing like they usually do in those times and said “US stocks suck.” Well, nobody's saying that now, because in the 2010s, US stocks did awesome.
Dr. Jim Dahle:
So, what does that mean? Does that mean for sure in the 2020s that international stocks are going to outperform US stocks just like they did in the 2000s? No, there's no guarantee, but certainly if you're going to bet one way, that's probably the way to bet. Instead, I think the better approach is set a fixed asset allocation, whatever that might be. In my case, about a third of our stocks are overseas. That's the way it was in the 2000s. It rewarded us very well. That's the way it was in the 2010s. It did not reward us so well.
Dr. Jim Dahle:
But the truth is over time, you're probably fine no matter what that percentage is. Whether it's 10%, 20%, 30%, 50%, whatever the percentage is, it's probably fine because international stocks are going to have their day in the sun. I can't tell you when that's going to be, but it's going to happen. And in those times, everyone will be going, “Why don't you have more in international?” But that's just because people don't look very far and they don't know their financial history.
Dr. Jim Dahle:
Here's another email, very similar question. “Investing in total US stock market versus international. I know, I know. Just choose something and stick with it. And 0 to 20% international is probably reasonable. My question specifically comes after reading one of Dr. Bernstein's books, where I believe he mentions he expects future US returns to be much less, 2% to 3% less due to US equities doing well for so long. Have you changed your mind over the years over how much international tilt to have?”
Dr. Jim Dahle:
No, I have the same tilt I had 15 years ago. Would there be something that would change that may change your perspective? Well, I guess there could be something. I can't think of what it might be. No, you expect long term underperformance of some of the asset classes in your portfolio. You just don't know which ones they are. If you knew which ones they were, you wouldn't invest in them.
Dr. Jim Dahle:
But because you don't know, and you don't know when they're going to turn, you stick with a static asset allocation, you rebalance it every year or two and you know that every one of those asset classes is going to have their day in the sun.
Dr. Jim Dahle:
One of the really great resources to look at out there is called the periodic investing table or something like that. Periodic table of investments. I don't know. It's done by Callan. And if you go to callan.com/periodic-table, it'll pull up and you can see there's lots of graphs.
Dr. Jim Dahle:
And basically, what they do with this thing is they show which asset class was the best for any given year and you can look at it. So, if you go back and you look at 2002, it was global bonds. And in 2003, it was emerging market stocks. And in 2004, it was real estate. And then second was emerging market stocks. 2005, emerging market stocks. 2006, real estate and then emerging market stocks. 2007, emerging market stocks. You get in the picture here for a long time. And in the 2000s, the top asset class to have was emerging market stocks. 2003, 2005, 2007, 2009 and two other years where he was second best.
Dr. Jim Dahle:
And where's US stocks? It's way down the list in all those years. But if you look at the last few years, you look at 2013, US small caps and then US large caps. 2014, real estate, US large caps. 2015, US large caps. 2016, US small caps and high yield bonds, then US large caps. 2017, emerging market stocks were back on top and then developed XUS stocks, followed by US stocks.
Dr. Jim Dahle:
And so, for the last number of years, US stocks have outperformed international stocks most of the time. That pendulum is going to swing back the other way. I can't tell you when, I can't tell you how hard it's going to swing, but the fact that people want to change their portfolios now after a period of outperformance, what you're probably doing is performance chasing. And that's a recipe for crummy long-term returns.
Dr. Jim Dahle:
You'll jump into US stocks now heavy, or you'll change your asset allocation toward them now. And just in time for them to do poorly and international stocks to do well, or for bonds to do well, or for real estate to do well or whatever. It's just our nature as human beings and having a fix asset allocation, to fix static asset allocation will help you to avoid those behavioral errors.
Dr. Jim Dahle:
So, no, I haven't changed my mind. I don't think there's going to be anything that's barring nuclear war or something that might change my perspective.
Dr. Jim Dahle:
Okay. Next part of the question. “I think I've heard you and others state something along the lines that you plan on retiring in the US.” That's true. I like the US. I think it's a great place to live. British Columbia is awfully nice too, but probably in the US.
Dr. Jim Dahle:
“Therefore, you want your investments in US currency. Why is this? If you held international funds, couldn't you just sell it and receive dollars?” Yes, you could. This is one of the reasons given for not holding the world portfolio. I don't know what it is exactly right now, but in recent years it's been about 50% US and 50% overseas. That is the market capitalized world stock market. And so, some people argue, “Well, that's what the market is. You ought to allocate your funds just like the market does. You ought to put half your money in the US and half your money in international.”
Dr. Jim Dahle:
And the argument that people have made to have less than that 50% in international, one of those arguments is simply that “Why spend in US dollars?” So, I ought to have a little bit more money in US dollars. And I think that's reasonable. And that's one reason why I don't have the world market portfolio. I have two thirds of my stocks in the US and one third overseas was because I spend in US currency.
Dr. Jim Dahle:
Because here's what can happen. Let's say you got a whole bunch of your money in overseas stocks, like total international stock market, and then the US dollar strengthens and you end up having poor performance in those markets. You still got to spend dollars, but your money didn't grow as fast.
Dr. Jim Dahle:
And so, by having a little bit of a tilt toward the US, you've hedged against that possibility. That makes sense. Can't have it both ways though. Your first question is asking “Why not more US?” and the second one is “Why not more international?” I mean, pick something, stick with it.
Dr. Jim Dahle:
All right. So, let's talk about bonds. This one is coming from one of the WCI columnists, Rikki Racela. Let's listen to Rikki’s question.
Rikki:
Hi, Jim. My question involves bonds and how a total bond fund almost has as much equity risk nowadays during this bear market as even a total stock market index fund. I think, if I’m not mistaken, this is because of the concept of bond convexity when interest rates are so low and yields are so low on bonds, that they're sort of on a very steep end of this bond price and yield curve. And just a slight change in yield will really decimate the price of bonds.
Rikki:
Is it something where in the future if I'm considering using bonds as balance to my equities or having a bond portion of my portfolio to mitigate my risk tolerance, that maybe I should not use the usual total bond index fund, but maybe something of shorter duration and more treasury bond fund? Especially when, again, if we were to encounter a low yield environment?
Rikki:
Is there any research in maybe using a shorter duration treasury bond fund instead of a total bond fund when yields are low to properly have an asset allocation matching risk tolerance? Any insight in this would be great. Thanks.
Dr. Jim Dahle:
All right. Well, Rikki, you don't like it when your bonds go down in value. Huh? That's what it sounds like to me. You are kind of being complainy pants that your bonds fell the same time as your stocks.
Dr. Jim Dahle:
Well, sometimes they do that. Bonds and stocks have a correlation of about zero. That means they are not anti-correlated. That would be a correlation of minus one. Bonds don't go up when stocks go down. They do whatever they want to do. They don't seem to be correlated with stocks. So sometimes they both go down together. Sometimes they both go up together.
Dr. Jim Dahle:
There are really two kinds of risks involved in bonds. The first one is interest rate risk. If you own a bond that pays 2% and rates go up, your bonds worth less because people would rather buy the new bonds that pay 3%. So, if you want to sell your bond, you've got to sell it at enough of a discount that the yield until maturity is about the same as what they can buy on the market.
Dr. Jim Dahle:
And so, that's interest rate risk. And there's a fair amount of interest rate risk in a bond fund like the total bond market. The duration on that is five years or something like that. So, for every 1% that interest rates go up, you're going to lose 5% of the value of that bond fund.
Dr. Jim Dahle:
The other risk is default risk. That's the risk to somebody not paying you back. And in the total bond market fund, there's basically three kinds of bonds. There are treasury bonds, loans to the US government. There are corporate bonds, loans to companies in the US. And there are some mortgage-backed bonds.
Dr. Jim Dahle:
And so, when mortgages are being paid back early and you get your money back, that risk can show up, or when people start defaulting on mortgages, that risk can show up. Obviously when you are loaning to companies, that introduces what we call equity risk into the bond. So, if the company is not doing good, if it's doing really bad, it can't pay that, even make those bond payments. And so, it becomes higher risk of default.
Dr. Jim Dahle:
And so, some very wise people, some of which include Larry Swedroe, Bill Bernstein, et cetera, have talked about not taking your risk on the bond side, taking it on the equity side instead. That it is a more efficient place to take risk. Their argument is that you hold very safe bonds. Not only short duration, so you're not running much interest rate risk, but also not very high risk of default. So mostly treasuries.
Dr. Jim Dahle:
For many years, my main bond holding, at least on the nominal side, is the TSP G fund. The G fund is basically short-term loans to the government. They promise you had treasury yield with money market risk. The duration is essentially one day, one to four days is the duration of the G fund. But you're getting yields, comparable to a 10-year treasure.
Dr. Jim Dahle:
And a little bit of a free lunch there, but the bottom line is it's a very safe bond fund. It's very, very safe. No interest rate risk, basically no default risk. And so, that's the approach I've taken. I've taken my risk on the equity side. And on the equity side, I have lots of international stocks. I have lots of small cap value stocks. I take plenty of risk with real estate, etc, but I don't take risk necessarily so much on the bond side.
Dr. Jim Dahle:
As the years have gone on, I haven't been able to put all my bonds into the G fund because I don't have that much money in the TSP. So, my entire TSP is now G fund. And you can't buy the G fund outside the TSP. So, I've had to do something else. And what that's ended up with my current portfolio is muni bonds in taxable. And they have both more interest rate risk as well as more default risk.
Dr. Jim Dahle:
And so, they're much more similar to the total bond fund than they are to that TSP G fund. But I still try to keep it fairly high quality. I'm not investing in high yield munis. I'm not investing in long term munis. And so, still the same philosophy, to mostly take the risk on the equity side but I've had to make some compromises there.
Dr. Jim Dahle:
On the inflation index bond side, I've used TIPS and more recently I bonds too. Again, no default risk, essentially. They're all loans with the US government. Although some people may argue the US government is quite likely to default. They're considered to have pretty low default risk by comparison to companies anyway, and mortgage holders.
Dr. Jim Dahle:
But that's kind of what I've done with my bonds. I kind of am a fan of not taking a lot of risk on the bond side. But if you look at what the total bond market has done year to date, as I record this podcast is down 8.34%. Over the last one year, it's down 9.42%. Considering how much interest rates have risen, that's not too bad. You've been rewarded with the higher yield now, projected returns going forward from here are much better. But if you look at even the last 10 years returns, now you're down to 1.58% per year simply because the poor returns over the last year as interest rates have risen.
Dr. Jim Dahle:
No surprise that you're not real happy with your total bond fund right now, but I would not necessarily blame that on just the stock market downturn. It's also from the rise in interest rates. So, there's multiple factors there that have caused that.
Dr. Jim Dahle:
And guess what? Not all of your asset classes are going to do well at any given time. If your goal is just to jump into the ones that are going to do well, you're going to need a very clear crystal wall. Otherwise, I recommend you pick a reasonable mix of investments and you stick with them through thick and thin knowing that each one of them is going to have their day in the sun eventually. And you're always going to own something that you're not entirely happy with.
Dr. Jim Dahle:
Okay, this next question comes in via email. “Could you please discuss the pros and cons of small cap value versus mid cap value? As I mentioned before, we don't have small cap value in our 403(b). In this situation, which one is better? Small cap blend or mid cap value?”
Dr. Jim Dahle:
Oh, that's unfortunate. Well, you got a couple options. Number one, the fear doctor. So, chances that your only investing account is just a 403(b) is pretty low. You've probably got a Roth IRA. Maybe your spouse has some retirement accounts. Maybe there's a 457. Maybe there's a taxable account.
Dr. Jim Dahle:
So just because there's not a small cap value fund in your 403(b), you can put something else in your 403(b). Put your bonds in there, put your international stocks in there, whatever, and use the other account to get your desired asset class in it. So, that might be one option for you.
Dr. Jim Dahle:
But if you're truly having to choose between small cap blend or mid cap value and the 403(b), you should be aware that the data on factor investing suggests that value is a more significant factor than size. So if you have to just pick one, you're probably better off picking the value. That means the mid cap value fund rather than the small cap blend fund. But you could also pick a little bit of both and then you could have some small and some value and get both of those factors, both of those tilts into your portfolio.
Dr. Jim Dahle:
And your final question is, “Is it wise to invest a little bit more in small cap value and less in total US and international such as 20% in small mid cap, 25% in US total and 15% in international?”
Dr. Jim Dahle:
Well, here's the deal. Without knowing future returns, I can't answer that question. And if I knew future returns, I just have you put it all on whatever's going to do the best. I don't know what the proper mix is. Each of those is likely to have their day in the sun and you'll be glad you own it when it does. And you'll wish you own more of it when it has its day in the sun. Likewise, when it does poorly, you're going to wish you owned less of it or didn't own it at all. And that's just the nature of a diversified portfolio.
Dr. Jim Dahle:
This tilt you're talking about though, 20% in small and mid cap and 25% in a total market is a pretty heavy tilt. I mean, small value is basically 3% of the market. And you start talking about putting 5%, 10%, 15%, 20% of your portfolio in there, or of your US stocks putting 50% of them into small cap value.
Dr. Jim Dahle:
You better really believe in those factors, because it's important that you don't tilt your portfolio more than you believe. Because when those inevitable periods of underperformance come, you don't want to bail out just in time for it to turn around and really start outperforming.
Dr. Jim Dahle:
So don't tell more than you believe. Just like I would say, be less aggressive when setting your initial stock to bond ratio until you go through a bear market. Maybe you ought to be a little bit less aggressive in setting your tilt until you've gone through a period of underperformance of that factor.
Dr. Jim Dahle:
Personally, my stock portfolio is 25% US total stock market, 15% small value and then 15% total international and 5% small international. So, there's some tilts there and they're pretty significant tilts but I also didn't bet the farm on them. So, I feel comfortable with that, but you've got to decide how much you feel comfortable with. You're talking about some pretty significant tilts, so you better read all the literature in small value and really believe in it in order to tilt your portfolio that much toward it.
Dr. Jim Dahle:
All right. If you'd like to leave your questions here on the White Coat Investor podcast, you can do so whitecoatinvestor.com/speakpipe and we'll get them on, get your questions answered.
Dr. Jim Dahle:
This show is about you and your questions and your portfolios and your finances and your life. The blog, I kind of write about whatever I feel like writing about, but on the podcast, this is entirely driven by you guys. If you want to hear a guest, send us an email, tell us to get that guest on. But we let this be driven by what you guys are interested in.
Dr. Jim Dahle:
All right. Here's a question from Carrie about taxable accounts.
Carrie:
Hi, Dr. Dahle. I have a few questions about taxable accounts. I am in a dual physician household and we both max out our 401(k)s and Roth IRAs and are ready to start a taxable account. All of our accounts are currently at Vanguard. Is it okay to have our taxable account there as well? I read that at Vanguard, you cannot have any beneficiaries with a joint taxable account. So, if we both die in an accident at the same time, our account will go through probate before it goes to our children.
Carrie:
I've been putting off this estate planning portion of the Fire Your Financial Advisor course because of the hard decisions and realistically won't have a trust formed by the end of the year. Thank you so much for all that you do.
Dr. Jim Dahle:
Great question, Carrie. Congratulations on your success by the way. Maxing out your retirement accounts is no small feat. Just the fact that you're ready to start a taxable account is pretty awesome.
Dr. Jim Dahle:
But what you must realize is you probably have money now that you're ready to invest and you're scared to invest because of these estate planning questions. The truth is you probably ought to just get that money invested. It's already in the taxable account, whether you've moved it to Vanguard or it's sitting in your bank account, it's probably already going to go through probate.
Dr. Jim Dahle:
And it's not like probate is the end of the world. Probate, maybe there's some fees. Maybe it takes a little while longer for your heirs to get the money than it otherwise would, but it's not the end of the world. So don't let the fear of probate keep you from investing money you know you need to invest.
Dr. Jim Dahle:
If you really want to avoid probate, the way you do that is you open a revocable trust. That revocable trust, you can change it at any time, it’s totally revocable, will ensure that money doesn't go through probate. And you can certainly have a trust account at Vanguard. Our trust account, taxable account, etc, is all at Vanguard. They can handle all that. And it's no problem there.
Dr. Jim Dahle:
So, if that's your concern, go open a revocable trust, it's not that hard to do and start investing that way. There may be some other custodians brokerages that do allow you to have some sort of payable on death aspect, name a beneficiary somehow for a taxable account, but I don't think that's typical. I think most of the time it goes to probate if you're not going to put it in a trust.
Dr. Jim Dahle:
So, that's the point of a revocable trust, it’s to avoid probate. That should be your solution, whether you get in place this year or next year, or in 20 years. It's fine as long as you don't die between now and then. Drive safely. But most of us don't worry too much about that. Just try to get it in place before too long. All right. Good question though.
Dr. Jim Dahle:
Here's another one via email. All right. It doesn't sound like we want to talk about asset allocation any longer. We're going to talk about spending now. “One topic I would be fascinated to hear you discuss on a podcast is not investing money, but spending it.” It's a lot more fun anyway.
Dr. Jim Dahle:
“For example, I've heard on your podcast discussions of spending money on home renovations, travel, but still driving an older car and not getting a Tesla. How do you decide what to spend money on and whatnot to, especially after reaching FI?
Dr. Jim Dahle:
And the second question is after college, med school, residency, plus minus fellowship, two to five years of living like a resident, how does one transition to a degree increasing spending after never really doing this? I think it is Dave Ramsey, which makes the analogy of working on a muscle. If you haven't worked on spending, how do you approach this?”
Dr. Jim Dahle:
Well, it's actually not that hard. The bigger problem most people have is they go overboard with it and they just spend too much. If you're worried that that's you, you're probably like most people and you need to be careful with how much you ramp up your spending.
Dr. Jim Dahle:
There's a few of us on the other end of the spectrum that the bigger concerns are that we become miserly. And you don't want to do that either. So, you've worked hard to get this money. You should enjoy spending at least some of it. So go spend it on what you care about.
Dr. Jim Dahle:
I did a few posts on the website. I think the first one was probably in, I don't know, 2014, 2015. Yeah, here it is. January 14th, 2015 is when it ran on the blog. It's called Loosening the Purse Strings. And I wrote it, I don't know, a few months before then. But it talks about kind of us going through this.
Dr. Jim Dahle:
At that point, as you recall from my first book, we became millionaires in about 2013. So, we were doing well, we weren't financially independent, but we were doing great. In fact, by 2015, we were even starting to make a little bit of money at the White Coat Investor. And things were going well and we decided we're going to loosen the purse string some.
Dr. Jim Dahle:
And so, it talks about some of the things we bought like a table. We bought a really nice table set. That was a big deal for us. We had this cheap old table that we bought in med school. And so, we bought this $11,000 table set.
Dr. Jim Dahle:
We did a little bit of a home remodel that year. We later did a huge one. We started taking a little bit more expensive vacations. I finally got a decent mountain bike. Now, I guess it's old, it's seven years old now, but it was a really nice bike at the time. We upgraded our boat. We went from an old beater boat to a pretty nice boat. And so, it was kind of a gradual thing.
Dr. Jim Dahle:
But the point of saving money is not so you can never spend it. It so you can spend more money later or give more money later. And so, I would encourage you to do that deliberately. And yes, there should still be a “live like a resident” period of some type after you finish your training. But after that, feel free to spend your money. Yeah, you probably still need to save 20% of it for retirement. But after that, spend the rest on whatever you care about and only you can decide what you care about.
Dr. Jim Dahle:
Maybe it's travel. That is for lots of people, lots of people love to travel. Maybe you're a car person and you want to get a Corvette or you want to get a Tesla S or you want to get a BMW or whatever. If you can afford it, go buy it. Especially if you don't have to finance it, which is a hard time I gave to our content editor, Josh. I was just talking to him a few minutes ago, I gave him a hard time about financing his Tesla. I think half the readership gave him a hard time about financing when he wrote about it in one of his Sunday columns on the blog.
Dr. Jim Dahle:
And then as time goes on and you hit financial independence, especially if you're still working, then you can really go crazy spending if you want. You can probably spend just about anything you want and that's kind of where we're at in our lives.
Dr. Jim Dahle:
You look back at this last year, well, we went to Spain in November. We went to Greece in December. We went to Canada to go heli-skiing in March. I went to Roatan in May to go scuba diving. I ordered a brand-new F-250. I still don't have it yet. They haven't even started building it yet. I ordered it last December and here I am sitting in September, they haven't even started it yet but hopefully by the end of the year.
Dr. Jim Dahle:
As I mentioned earlier in the podcast, the alternative to spending at this point for us is to leave it to charity. We don't need any more for ourselves. We don't want to give more to the kids. So, whatever we earn and don't spend will be given to charity. And for some reason, that fact helps me to spend a little bit more. I was proud of myself for willingly paying $25 to park at the ski resort the other day rather than parking out on the road and walking an additional 10 minutes up to the lift. But I'm also not necessarily ordering lunch every day. I'm going downstairs and making PB and Js.
Dr. Jim Dahle:
So, how I decide where to spend? I don't know, a lot of it is convenience. I still don't have a lawn service coming over and mowing the lawn. If the kids don't do it, I do it. But we have someone that comes in and cleans our home because we really hate cleaning stuff. And I don't mind mowing the lawn.
Dr. Jim Dahle:
So, everybody is a little bit different in what they don't mind spending on. And you just got to make sure it's reasonable that you're saving enough money and you can spend the rest, but try to be deliberate and spend what you care about the most. All right. That was a great question to end on. Now that we've talked all about asset allocation and investing, and then what you do once you have invested the money.
Dr. Jim Dahle:
If you are finding our podcasts informative and helpful, check out our website! Since 2011 we have been working hard to provide valuable personal finance and investing information through thousands of blog posts written by an array of authors. You can find information on how to manage your student loans, fix and avoid common financial mistakes, understand your retirement accounts, optimize your investments, find professional help at a fair price, get started investing in real estate, and so much more, all at no cost to you. You can find out more about the courses we offer, the conferences we put on, the newsletters we provide, and interact with other WCI readers through our online forum. Head over to whitecoatinvestor.com to start learning today.
You can do this and The White Coat Investor can help.
Dr. Jim Dahle:
All right. I told you at the start of the podcast about our new real estate course. You really should check that out. It's at whitecoatinvestor.com/nohype. Seriously, no risk, check it out. We think it's awesome. Let us know what you think. Go check it out.
Dr. Jim Dahle:
Also, if you are interested in coming to WCICON, the conference website is up, we've got the speakers announced there. You can go to www.wcievents.com and check that out. So, lots of cool stuff going on there. I think October 11th is when registration opens.
Dr. Jim Dahle:
I hope it's kind of like before the pandemic, when we sold these things out in 24 hours. It's kind of sad if you don't get on and register in the first 24 hours, but it sure was fun to get it all done at the beginning and not even have to talk about it for the next six months afterward until I got to see all you guys and hang out with you.
Dr. Jim Dahle:
So, we'll see, I don't know. A lot of people are much more willing to travel now than they have been. And so, maybe it will sell out super-fast again. There are pluses and minuses both ways, but if you want a reminder to register right when it opens, you can also get sign up for that at wcievents.com but that'll go on sale next month.
Dr. Jim Dahle:
All right. Thanks for those of you leaving us five-star reviews. Our most recent one came in from Blue12345 who said “Best podcast in its class. I really enjoy listening to this podcast twice a week, a definite bright spot during my long commute. I have learned so much from these episodes. I started with the original White Coat Investor book and I am so grateful for the lessons learned by listening to this podcast as so many financial principles are reinforced every week, especially the Q&A where so many interesting scenarios are discussed. Thank you so much for what you have done and continue to do.” Five stars.
Dr. Jim Dahle:
Thanks for that great review of the podcast. I appreciate those reviews and the reason why isn't just because it helps us feel more like making more podcasts, it also actually helps spread the word. It helps other people to find the podcast when they're looking for podcasts. And a lot of you have been introduced to the White Coat Investor community not through the book, but through the podcast. And so, part of that is because previous listeners have left five-star reviews. So, we appreciate when you do that.
Dr. Jim Dahle:
Obviously, if you have something bad to say to us, we prefer hearing about that in private. Shoot us an email, tell us how we can improve and we'll work on doing it. Like I said earlier, this podcast is driven by its listeners. What you want to hear about is what we talk about. So, I'll leave us questions, send us feedback and we'll try to get that information that you're looking for on the podcast.
Dr. Jim Dahle:
All right, time to end. This has been going on long enough and you're probably almost to work anyway. So, keep your head up, shoulders back. You've got this and we can help. I hope you have a great day. We'll see you next week on the podcast.
Disclaimer:
The hosts of the White Coat Investor podcast are not licensed accountants, attorneys, or financial advisors. This podcast is for your entertainment and information only. It should not be considered professional or personalized financial advice. You should consult the appropriate professional for specific advice relating to your situation.
