Set for life insurance adVolatility, particularly on the downside, is not an investor’s friend. Most of us don’t do “the investing thing” to get a rush. This is serious business for us. I also am not planning on leaving gobs of money behind to my children or to charity. My children, like me, will much prefer getting money in their 20s, when they really need it, compared to later in life. I also try to do my charitable giving as I go along. My wife and I are primarily deferring spending now so that we can spend more later. So when I save money it can really hurt. I am faced with the choice of upgrading my boat, or maxing out my defined benefit contribution. A trip to Europe vs backdoor Roth IRAs. A habit of maxing out the 401(k) or a $2 Million house. Very little of anyone’s savings is truly “spare cash.” It all represents a decision to defer spending now in order to get something you prefer more of later. Thus, since it is so painful to save, I expect my money to work as hard as I do. That means I need my money to provide a solid return.

The Return That Counts

The only return that counts is my after-inflation, after-tax, after-expense return. Right now my bank account at Ally Bank is paying less than 1% nominal, or about MINUS 1% real (after-inflation), and even less than that after taxes. As I write this the yield on (and thus the market’s best guess of future return of) Vanguard’s Total Bond Market Fund is 2.13%, or about 0% real. If you’ll recall the rule of 72 (divide 72 by your rate of return to get the number of years it will take your money to double), you will quickly realize that at real returns of 0% or less, your money will never actually double. Even with corporate bonds (current real  yield 1%) it will take your entire life for your money to double once. For most people, whether they realize it or not, those types of returns are simply not adequate for a retirement portfolio. Most people only have 40 years or so to save for retirement. That might be as little as 25-30 years for a physician, especially one who wants to retire before 60.

2 Types of Market Risk
medical student loan refinancing

Many investors think market risk is the biggest risk their portfolio faces. There are really two types of market risk. The first, simple short-term volatility, is ignored by investing “adults” (a term popularized by Dr. William Bernstein in his recent books.) The second, the risk that the value of your investments will go down and NOT eventually come back, is obviously more serious, and primarily due to hyperinflation, depression, confiscation, and devastation. These types of scenarios, however, are much more rare and sometimes the solution to them is running MORE short-term volatility risk. However, in my opinion, the biggest risk an investor faces is the risk that his portfolio doesn’t grow fast enough to meet his financial goals. There is a relationship between how much you need to save, how long you have to save it, and how much your money needs to earn. The more you save, and the longer your time frame, the lower returns you can tolerate. What most people don’t realize, however, is just how big of a deal it is to make sure you’re getting reasonably high returns on your invested money.

Doctors Probably Only Need to Replace 25-50% of Pre-Retirement Income

I’ve written before about how most physicians don’t need to replace 100% of their pre-retirement income in order to have a great retirement due to lower taxes, lower expenses, and no need to save for retirement and college. The truth is that 25-50% of it ought to be plenty, especially when combined with Social Security. However, for this post, I have “run the numbers” using four different percentages of portfolio-supplied, pre-retirement income replacement- 25%, 40%, 50%, and 60%. For each of these percentages, I have listed the number of years you have to save across the top row and the after-inflation, after-expense, after-tax return you must achieve down the left column. The spaces in the chart represent the percentage of your gross income you must save each year. Obviously the chart is a bit of a simplification, as you’re not going to get the same return each year, so it completely ignores the very important sequence of returns risk. Despite this simplification (which means you probably need to save even more than the charts show), I think the exercise is still useful. Let’s take a look at the charts.

Savings Rate for 25% Pre-Retirement Income Placement
Years To Save
Return 15 20 25 30 35 40
0% 41.7% 31.3% 25.0% 20.8% 17.9% 15.6%
1% 38.4% 28.1% 21.9% 17.8% 14.9% 12.7%
2% 35.4% 25.2% 19.1% 15.1% 12.3% 10.1%
3% 32.6% 22.6% 16.6% 12.8% 10.0% 8.0%
4% 30.0% 20.2% 14.4% 10.7% 8.2% 6.3%
5% 27.6% 18.0% 12.5% 9.0% 6.6% 4.9%
6% 25.3% 16.0% 10.7% 7.5% 5.3% 3.8%
7% 23.2% 14.2% 9.2% 6.2% 4.2% 2.9%
8% 21.3% 12.6% 7.9% 5.1% 3.4% 2.2%


Savings Rate for 40% Pre-Retirement Income Placement
Years To Save
15 20 25 30 35 40
0% 66.7% 50.0% 40.0% 33.3% 28.6% 25.0%
1% 61.5% 45.0% 35.1% 28.5% 23.8% 20.3%
2% 56.7% 40.3% 30.6% 24.2% 19.6% 16.2%
3% 52.2% 36.1% 26.6% 20.4% 16.1% 12.9%
4% 48.0% 32.3% 23.1% 17.1% 13.1% 10.1%
5% 44.1% 28.8% 20.0% 14.3% 10.5% 7.9%
6% 40.5% 25.6% 17.2% 11.9% 8.5% 6.1%
7% 37.2% 22.8% 14.8% 9.9% 6.8% 4.7%
8% 34.1% 20.2% 12.7% 8.2% 5.4% 3.6%


Savings Rate for 50% Pre-Retirement Income Placement
Years To Save
15 20 25 30 35 40
0% 83.3% 62.5% 50.0% 41.7% 35.7% 31.3%
1% 76.9% 56.2% 43.8% 35.6% 29.7% 25.3%
2% 70.9% 50.4% 38.3% 30.2% 24.5% 20.3%
3% 65.3% 45.2% 33.3% 25.5% 20.1% 16.1%
4% 60.0% 40.4% 28.9% 21.4% 16.3% 12.6%
5% 55.2% 36.0% 24.9% 17.9% 13.2% 9.9%
6% 50.7% 32.1% 21.5% 14.9% 10.6% 7.6%
7% 46.5% 28.5% 18.5% 12.4% 8.5% 5.9%
8% 42.6% 25.3% 15.8% 10.2% 6.7% 4.5%


Savings Rate for 60% Pre-Retirement Income Placement
Years To Save
15 20 25 30 35 40
0% 100.0% 75.0% 60.0% 50.0% 42.9% 37.5%
1% 92.3% 67.4% 52.6% 42.7% 35.6% 30.4%
2% 85.0% 60.5% 45.9% 36.2% 29.4% 24.3%
3% 78.3% 54.2% 39.9% 30.6% 24.1% 19.3%
4% 72.0% 48.4% 34.6% 25.7% 19.6% 15.2%
5% 66.2% 43.2% 29.9% 21.5% 15.8% 11.8%
6% 60.8% 38.5% 25.8% 17.9% 12.7% 9.1%
7% 55.8% 34.2% 22.2% 14.8% 10.1% 7.0%
8% 51.2% 30.4% 19.0% 12.3% 8.1% 5.4%


You Can’t Reach Your Goals AND Have a Low Volatility Portfolio

Now that you’ve had a chance to be mesmerized by the data, let’s draw a few conclusions. First, let’s say you want/need your portfolio to replace 60% of your pre-retirement income and you want to retire in just 15 years but you hate volatility so you’re going to invest your portfolio entirely in bonds and earn a 0% real return. How much of your income do you need to save? Well….all of it. That’s pretty unrealistic, obviously, but it illustrates the fact that you can’t have it all. You can’t have an early retirement, a high retirement income, AND a low volatility portfolio.

Be Careful What You Pay an Advisor

Now, let’s pick something a little more realistic for a physician. Let’s say you want to retire after 25 years, want/need 40% of your pre-retirement income, and think you can get a 5% real return. In that scenario, you need to save a more realistic, but still challenging, 20% of your income for retirement (incidentally, that’s my rule of thumb for a physician savings rate.) Now, consider the effect of paying an advisor 1% of your portfolio each year (effectively lowering returns by 1%). Obviously, for this comparison to be valid, you need to invest on your own just as well as the advisor would invest for you. By getting 1% lower returns, you either need to save 3.1% more of your income each year, or you need to work for ~ 3 more years. If you thought 3 years of residency was slavery, how does it make you feel to know you’re working for 3 entire years just to pay for investing advice?

Beware Low Risk Portfolios

Many investors decide they can’t or won’t tolerate a portfolio with particularly high market risk. So instead they settle for something with lower risk. While it is true that you are far better off with a more conservative portfolio that you can actually stick with, seeking a low volatility portfolio has its own consequences. Consider an investor that, either on his own, or in conjunction with an insurance agent, chooses a portfolio with lower volatility but a lower expected return. For example, the expected long term return on a whole life insurance policy is in the 0-3% real range. A portfolio composed of >50% bonds at today’s low yields may also have an expected return that low. Even well-designed insurance-based investing products designed to get a higher return than whole life (such as indexed universal life or variable universal life) have long-term expected returns 1-3% below that of stocks (and don’t even look at the short term returns, they’re terrible.) 2% lower returns means you need to go from saving 20% of your income to 26.6% of your income. For a doctor grossing $250,000 a year, that’s an extra $16,500 on top of the $50,000 you were already saving for retirement. That’s a new luxury car every 3 years, 2 nice vacations a year, or a much fancier house. There are real consequences at stake when you decide to take less market risk.

Another Benefit of Being a Cheapskate

Being willing to be frugal not only helps you to save more money during your career, but those habits also carry on into retirement. For example, if you are willing to live on 25% of your pre-retirement gross income instead of 40%, you can retire about 7 years sooner, run less market risk, or even hire an advisor to do everything for you.

Only Thing Worse Than Not Enough Risk Is Too Much

So what does this all mean? Does it mean that you should be 100% equities your entire life? Probably not. There are a few other factors at play. First, you must tolerate the short-term market gyrations of whatever portfolio you decide on. Sometimes this is where an advisor is most useful. If an advisor can get you to tolerate a portfolio with a 1% higher expected return than a portfolio you can tolerate on your own, then he has at least earned his keep. Second, true market risks (inflation, deflation, confiscation, and devastation) are sometimes best dealt with by holding assets with relatively low expected returns, like TIPS, long-bonds, or even precious metals. Third, the less volatile your portfolio, the less sequence of returns risk matters.

Jealously Guard Your Returns

But the fact remains that you cannot afford to give away much of your return. If you’re like most high-income professionals, for the majority of your investing career, you need to have the majority of your portfolio invested into assets with a high expected return, like stocks and real estate. You need to minimize the taxman’s take on your investment returns. That means maxing out retirement accounts, including the extra ones like the Backdoor Roth IRA and the Stealth IRA, and being familiar with the tax advantages of other accounts such as 529s and UGMAs. It also means investing in a tax-efficient way in your taxable accounts, using techniques such as tax-efficient asset location, tax-loss harvesting, donating appreciated shares instead of cash to charity, minimizing short-term capital gains distributions, and taking advantage of the step-up in basis at death.

It also means you need to minimize your investing expenses, including what you pay to an advisor. Advisors might not work for free, but the difference between a high cost advisor (2-3% of your assets per year) and a low cost advisor (0.3-0.5% per year, $1000-5000 flat fee per year, or an hourly rate for a few hours a year) can be profound.

Lastly, it means that accepting lower returns just to feel better might really cost you. This might be a decision to invest in a cash value insurance policy. It might be a decision to pay off a mortgage or student loans costing you 0% after taxes and inflation instead of maxing out your 401(k). It might be a decision to invest in real estate in your home market instead of one across the country promising higher returns.

The stock market has been kind to investors the last five years. That’s no reason to donate your returns to an advisor, an insurance company, or Uncle Sam. There simply isn’t enough of a return there for all of you, and since you’re the one taking most of the risk, I think you ought to be the one getting most of the return.

What do you think? What are you doing to capture more of the returns you deserve? How did you decide how much market risk to take? Comment below!