Member News — Clinical Updates

  • Robert C. Wang, MD, Texas Retina Associates, Dallas, Texas

How to Start Investing as a Young Retina Attending or Fellow

As you wrap up your life as an eternal student and start to pay off debt and accumulate wealth, the question comes up, “How do I invest this money?” 

In general, you should start with a solid financial plan to match your own life, goals, and family situation. Each individual’s plan will be unique. For example, do you already have 3 kids? If so, your savings distribution will look different than that of a single physician with no worries about children’s college savings. When you save, it’s all under the umbrella of your overall financial plan and goals. 

But many young physicians are so overwhelmed, they don’t know where to start. The most common advice is, “Invest in a low-load mutual fund.” What does that mean?  

Focus on the basics

First, some ground rules. You should try to:

  1. Limit fees
  2. Diversify your portfolio
  3. Rebalance periodically
  4. Minimize taxes 

Tax-deferred or taxable investments?

In general, you can have a tax-deferred and a taxable portfolio. A tax-deferred portfolio refers to your 401(k) or similar retirement plan provided by your place of employment. You invest pre-tax dollars (lowering your tax base) and your money grows tax-free. Also, there typically are no fees for buying or selling funds in the tax-deferred portfolio. The benefits are that the funds grow tax-free and are taxed only on withdrawal. 

So why not put as much money into your 401(k) as you can?  Well you should, but due to Employee Retirement Income Security Act of 1974 (ERISA) rules, you can contribute only up to a certain maximum amount, depending on the type of retirement plan you have. Also, within the 401(k), you are limited to the funds selected for that plan. 

A taxable portfolio is generally one that you can open up at any brokerage firm (Charles Schwab, Vanguard, etc). You can purchase stocks or mutual funds from all that are available, though some funds can be exclusive to a certain investment group.   

At this point in your career while you are in a lower income bracket, you should contribute the maximum (for 2016, $5500 a year for individuals under age 50) to a Roth IRA. Most financial planners realize this won’t be a significant part of a physician’s portfolio. 

However, a Roth IRA adds flexibility to your total portfolio in 2 ways:

  • You can withdraw money tax-free.
  • There are no requirements on when you must withdraw money (unlike traditional IRAs, which have a required minimum distribution at 70½ or the year you retire, whichever comes later).

Choosing funds in a 401(k)

Do you already have your 401(k), but are confused about the available funds? Within a 401(k) or tax-deferred account, the account manager and business generally pick “safe” mutual funds that represent segments of the stock market. For example, there can be an “index” fund that mimics the stocks in the Standard & Poor’s (S&P) 500 index. Though you can’t have all 500 companies in the fund, the index fund will try to purchase a wide variety of individual stocks within the fund to represent the S&P 500 or whatever index it might be trying to mimic. 

Other funds might include “large cap” (companies that have a market capitalization >$10 billion), “small cap” (<$1 billion), value funds (stocks that might be undervalued), funds containing REITs (real estate investment trusts), international funds, bonds, etc. 

Why pick any of these funds? Diversification

Sure, you could purchase a stock like General Electric, but your risks would be tied to a single company. If you have more companies in the fund, while one might go down, another up, so in general it decreases your risk. However, as a group, the stocks in the S&P 500 or any “asset class” tend to “move” (ie, gain or lose) the same way. 

So when you see the news that the S&P 500 dropped 4%, that means your fund that mimics the S&P 500 index most likely lost the same amount. Wait a minute—you diversified your risk but still lost money? How can you minimize that risk? By purchasing other funds that don’t correlate with each other, eg, a value fund, international, etc. Diversifying your portfolio to different asset classes will decrease your risk. 

What’s an index?
I have met many people who don’t seem to understand what an “index” is. They see on CNN that the “market” or S&P 500 dropped 8% and go into a panic about their retirement portfolio. While a drop that large is certainly a concern, you have to realize that number represents that index of stocks. While your fund that took a hit was the one that mimicked the S&P, your international fund could have gained 20%!  

People who emotionally move all their money out of certain funds don’t seem to understand that some asset classes could still be doing well despite a loss in another class. Don’t let emotions drive your investing. 

Choosing investments

Now that you know the general classes, the next question typically is, “OK, which fund do I choose and how much should I invest?” In your tax-deferred portfolio, you pick the percentage of your money you want in each fund. For example, I could have 50% in an index fund and 50% in a bond fund. 

How do you decide the percentages? That’s a tough one. As markets change, one asset class could do better than another. Even though I took financial planning classes at Southern Methodist University, it’s like, as the commercial says, I stayed at a Holiday Inn Express last night—I know just enough to be dangerous. I usually ask my advisor what distribution I should choose for my portfolio that year. Can’t afford a financial planner? That’s OK. I’m still here to help.

Keep an eye on fees

In general, most funds in a tax-deferred portfolio are “low load” or low in fees. Why is that important? Let’s say you have a fund that had a historic 5-year, 10% return. Sounds great, right? But if the management fees are 8%, your gains are only 2%. What if the gains are only 1% this year? Yes, you still pay the 8% management fee! That is, you have to make more to just pay the fees to manage the fund. 

Low-load funds are generally the most effective, as the gains generally outweigh the small fees. How do you find out the fees? Easy. Just look up the fund name! Let’s look up Vanguard’s fund that mimics the S&P 500, VFINX. You can looks this up on Morningstar, Yahoo, etc.

http://www.morningstar.com/funds/XNAS/VFINX/quote.html

https://finance.yahoo.com/q?s=VFINX 

You can see the expense ratio is pretty low: 0.17%. Great! I am already following rule #1. 

Web resources help you diversify

Well, I need to diversify to meet rule #2. How do I decide if I don’t have a financial planner? Easy. There are now good resources as a “start” on the web. One of my old favorites is Paul Merriman, a planner in Seattle whose podcasts I used to follow. What I liked about him was he tried to make a low-fee fund that anyone could follow and talk about it freely without charging you for the advice. 

On Merriman’s website, you can see his distribution for a tax-deferred fund with all Vanguard stocks.

http://paulmerriman.com/2014-new-site/mutual-funds/ 

What I like about Merriman’s method is that he lists percentages for an aggressive, moderate, or conservative distribution. Also, he updates the percentages through time (though the last update was 2014).  

Wait, there is a problem—you don’t have that exact fund in your portfolio? It’s OK. You are just picking something in that asset class. So for example, in Merriman’s distribution for an aggressive allocation, he has 11% in VFINX (S&P 500 fund) and 11% in VIVAX (a value fund). Don’t have VIVAX as a choice in your 401(k) account? That’s OK—just pick the value fund in your plan that has low fees (generally there is only one) and fill in the rest of the asset classes. 

Well that’s great, but the S&P 500 is tanking right now, and every month I put money into the account, it puts more into the VFINX fund! How do I keep from taking a loss? Easy—you “buy low, sell high.” How do you do that? Again, super easy. You rebalance your portfolio. What does that mean? 

How to rebalance your portfolio

In your tax-deferred portfolio, there usually is an option that lets you rebalance your portfolio at a set amount of time you choose—for example, every year, every 6 months, etc. How does that let you buy low and sell high? 

Let me go back to that simple portfolio we had of 50% S&P and 50% bonds. Let’s say that bonds are doing great, and every month that percentage of your portfolio grows because it is making more gains. So as it grows, the dollar percentage becomes 75% and your S&P fund 25%. When you rebalance your portfolio, you sell “high” your growing bond fund and rebalance it back to 50% and buy “low” the index fund, raising it back to 50%.   

Great, you say, but if the bond fund is doing so well, you don’t want to sell! Why not ride it as high as it can go? Again, it’s about risk. By not diversifying, you set up your portfolio to take a bigger hit if all your eggs are in one basket. What if the bond market crashes while your position is 80% in bonds? Devastating. 

Still too confusing or hard to do? No problem

In most 401(k) or tax-deferred plans, there are “target funds” for which managers do the picking for you. You just choose the fund that is named with a “number" around your year of retirement. So let’s say the Vanguard 2036 if I plan to retire in 2036. The manager will change the asset allocation depending on the economic outlook yearly. As you start to approach retirement, the manager will move more into fixed-income funds to lessen a loss from the more volatile equity market.  

This is basically what you would do also as you age—move a higher percentage of your asset allocation to fixed income/bonds to preserve the wealth you have accumulated. However, most studies have shown that you do better investing yourself rather than investing in one of these “target” funds. 

Make sense? One final thing about a tax-deferred portfolio: In general, it’s preferable to have any REITs in a tax-deferred account vs a taxable account. The reason is that you will get taxed on gains from property in a taxable account. But in a tax-deferred account, the tax doesn’t occur now, so you keep more of your money. For more information, please see http://www.dividend.com/dividend-education/the-complete-guide-to-reit-taxes/ 

Some funds have done really well. Dimensional Fund Advisers (DFA) have some of the lowest-cost funds (lower than Vanguard), but you typically need a broker to access these funds.

See https://www.bogleheads.org/wiki/Dimensional_Fund_Advisors 

Prefer to ‘set it and forget it’?

Finally, you don’t have to follow the above distribution. Here is one where they listed a group of “lazy” portfolios (invest and forget) and their returns. Paul Merriman’s used to be the second-highest return, though it was his DFA fund, not the Vanguard one.

http://www.marketwatch.com/lazyportfolio 

(Click on each one to see what they invested in.) 

Hope that helps start you on your way to investing and growing your portfolio!

Financial disclosures

Dr. Wang – SANTEN PHARMACEUTICAL COMPANY, LTD: Advisory Board, Honoraria; SYSTEEM MEDICAL INFORMATION SYSTEMS, LLC: Investigator, Other Financial Benefit.