Income is not Wealth

Dr. James Dahle, The White Coat Investor, focuses on helping healthcare professionals get smarter about managing their money.

In a long conversation with Christine Benz, Morningstar’s director of personal finance, and Jeff Ptak, Morningstar’s global director of Morningstar research, he shares some amazing insights for regular investors.

Understand your limitations.

I read the books of John Bogle, William Bernstein, Rick Ferri, Larry Swedroe, and time and time again the evidence showed that index funds were outperforming actively managed funds.

I asked, “Self, what makes you think you're in the 10% that can pick the winners? If you can't even pick a winning manager, what makes you think you can be a winning manager yourself picking individual stocks?”

I realized that you could get exposure to U.S. stocks and international stocks and bonds and real estate and so on and so forth, through index funds for essentially free--2, 3, 4, 5 basis points a year for these mutual funds. You never had to worry about manager risk. You didn't have to really follow the investments because you knew that they were going to perform as well as the asset class performed. This allowed me to concentrate on the other things in life that I cared about.

Do what great investors say, not what they did.

If you ask Warren Buffett how he thinks a typical person should invest, he will tell you: Go buy index funds. I tried to do what he said, not necessarily what he did, because I saw that they (Buffett, Lynch, etc) had a different skill set than I did. And the reason we know these names and we use these names over and over and over for decades is because they were so successful and so unique. But the question isn't what about Warren Buffett. It's why aren't there more Warren Buffetts? Because, statistically, there should be a lot more than they are, even with random chance.

I don't need to crush the market in order to meet my financial goals. I already have a high income and the ability to have a high savings rate. I need an investment plan that's highly likely to work, that is unlikely to blow up, and that is relatively easy for me to follow for decades.

Be aware that your crystal ball is cloudy.

I needed a plan that would not require me to be able to predict the future. Anybody who thinks they can do this should try an exercise where they take a notebook and they write down what they think is going to happen--which asset classes are going to outperform, which stocks are going to do well, what interest rates are going to do, what's going to happen in the political sphere, etc.

You will convince yourself that your crystal ball is very cloudy and that you really need something that's going to work in a wide range of future economic outcomes and not require you to be able to predict the future in order to be successful.

That's why I found the idea of investing in a static asset allocation of low-cost, broadly diversified index funds very attractive. It is highly unlikely to be unsuccessful over the long term. If I can stick with the plan and stay disciplined with it, each of those asset classes are going to have their day in the sun.

The logic of a static asset allocation.

I'm talking about not using a tactical asset allocation, not looking at current market events, putting your finger up into the political winds and trying to decide which is going to outperform over the next year or five years or 10 years. I really have no idea whatsoever whether U.S. stocks are going to beat international stocks this year. I try to use an asset allocation that doesn't require me to know that.

When my wife and I drafted up our financial plan in 2004, we wrote out what our asset allocation was going to be--we set fixed percentages for U.S. stocks and international stocks. In some years, international stocks do better, and we end up selling some international stocks and buying more U.S. stocks. In other years, the U.S. stocks do better, and we do the opposite.

By owning all these asset classes, I'm going to own them when they have their day in the sun and over the long run it's all going to even out. Instead of trying to predict the future and move these asset allocations around based on what I thought was going to do well over the short term, it just seemed much wiser to me to set it up as a static asset allocation from the beginning and rebalance back once a year or every couple of years.

Divorce how you feel about the market from what you actually do with your investments.

Be very rational and very intentional and stay the course with your financial plan.

If you go back to Internet forums and financial publications in 2010, you will see that people were saying, “Get out of bonds, they're going to have terrible returns; interest rates have nowhere to go but up.” What happened? Interest rates stayed low and have even fallen. Yes, I expect that international stocks are going to outperform U.S. stocks, but the market can remain irrational for longer than I can remain solvent.

I think the most important thing about a plan is to stick with it through thick and thin, because there are going to be times where you feel like this can't possibly happen, and then it happens again and again and again for several more years. And you want to be able to make sure that you get those gains when that does happen even though you didn't expect the gains.

Your income is not wealth.

We all tend to spend all of the money we make. Income is not wealth. Doctors have a high income, but when they come out of residency, they are among the poorest people on the planet as far as wealth goes. Most of them come out of their residency owing $200,000 or $300,000. They have a negative net worth. Once they understand that, they realize that the whole point of this financial game is taking their high income and turning it into a high net worth.

They really need to be saving 20% of their gross income for retirement. And if someone will do that from the beginning to their career to the end, they will be able to maintain the same lifestyle they had throughout their career.

Get rid of the student loans relatively early in your career. Keep living like a resident even while they have an attending physician salary for two to five years. Keep saving 20% or so of your gross income for retirement and don't make any big huge mistakes with it. In a lot of ways, they've already won the game.