The Alternative Investments of a Physician with a Moderate Income

By Bill Jackson December 11, 2023 10 mins read 88 Views

By Dr. Charles Patterson, WCI Columnist

Readers of The White Coat Investor know that the theme and general audience tend to favor a long-term, low-cost, tax-efficient approach to portfolio construction. This is typically built on some mix of index funds, bonds, and real estate. Beyond this boring world of slow growth and behavioral management lies a cornucopia of alternative investments screaming to be fed by your excess income. Alternatives here will be defined as any investment vehicle or strategy outside of the passive growth model endorsed by the Dahleans (a term coined here first, you’re welcome), Bogleheads, and the like.

The Alternative Investments of a Physician with a Moderate Income

From collectibles to currency trading to vacation rentals, there is an endless supply of places to put your extra dollars. Cryptocurrencies and the industry that supports them also find their home among alternatives, and they pose a particular quandary for those apt to add some prospective exposure (read: speculation). Of course, risk accompanies such a bounty of questionable ideas and the allure of rich rewards. Sometimes, tremendous risk.

For the Moderate-Income Physician, alternative investments can be an enticing means of “catching up” with higher-earning peers. The Moderate-Income Physician, here defined as the group of professionals with an annual household income of less than $250,000, must answer a litany of personal finance questions aimed at maximizing returns. Despite an income that often fails to qualify for accredited investor status, those peddling alternatives don’t discriminate between a part-time pediatrician and a plastic surgeon.

Whether through incompetence or a particular malice, Moderate-Income Physicians are also targeted for alternatives of varying levels of credibility. Recently, a friendly neighbor who happens to be an insurance agent, upon discovery of my occupation, was thrilled to pitch the “incomparable benefits” of infinite banking and my need for the same. While not all alternatives are scams, many are. Because the Moderate-Income Physician has fewer means of recovering from large mistakes, great care must be taken when evaluating and executing these investment plans.

In the following paragraphs, we will dive deeper into the Moderate-Income Physician’s approach to alternatives, with the objective of illustrating how they may (or may not) fit into one’s portfolio.

Defining Priorities

In the first place, why are you saving? For goodness sake, you work hard; you’re paying down your debt; and, depending on your specialty, there is a solid chance that you are closer to life’s end than the beginning. While this question of “why” may be firmly answered for most of the WCI readership, it may not be explicitly stated (or, better yet, written) by the young investor. Savings goals should be clearly defined to provide clarity, motivation, and purpose. In our (fairly standard) case, priorities include retirement/financial independence, mortgage execution, education savings for our kids, health savings, and short-term expenses such as vacations and vehicle replacement.

Having goals allows one to understand risk tolerance. How willing are you to go deep on crypto in a retirement account? Similarly, would you bet the college savings farm by investing heavily in farming? Maybe that’s the right choice for you. But savings goals and risk tolerance go hand in hand. It may not be a big deal if your travel fund is ravaged by Robinhood—perhaps next year’s vacation is a trek through Yellowstone instead of a saunter down the Amalfi Coast. Would you be so easygoing if your exclusive financial savant was revealed to be a charlatan and you were forced to work another decade? There are few if any truly riskless investments, and an equities-heavy portfolio is certainly not a panacea. But understanding the implications of investment selection and performance on your life is critical in constructing a reasonable portfolio.

While risk management is important to all investors, high income or not, the effects of poor choices are amplified for the Moderate-Income Physician. Poor returns or an unfortunate sequence of returns may mean later retirement, greater loan burden, and a deflated lifestyle. Rich-people problems, yes, but still problems. Can you lay in the investment bed you make? Are you satisfied with your ability or inability to monitor the progress of your alternatives? Do alternative investments and their variable performance jive with your life priorities and savings goals?

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Working Backward, Navigating Risk

A worthwhile exercise in teasing out the role of alternatives in your portfolio is to start at the end and work backward. Supposing that you have imagined what your lifestyle and associated costs will look like in your post-career years and conservatively estimating the number of years you will be using your money, you can model your growth and monitor progress in a variety of ways. A financial advisor or manager who is a fiduciary should have more sophisticated modeling techniques, but for the DIY investor and those like me who enjoy a good old-fashioned spreadsheet, the most basic software packages (Microsoft Excel, Google Sheets, etc) have more functions than you probably need.

One strategy for modeling and monitoring utilizes the future values function to create tables of projected growth at fixed points. By estimating growth at different rates, one can see where they could be at different points in their investment career. Five years ago, I made a series of tables with assumed growth rates ranging from 3%-12% and over discrete points in time over a 35-year horizon [Notably, market growth is non-linear, and assuming fixed annual contributions is fraught. The model is imperfect, but the point is not to predict the future; it's to modulate behavior]. Now on an annual basis (or more frequently depending on my enthusiasm), I can compare the growth (or loss) of the value of my portfolio to that which was estimated. This exercise serves three purposes: it tempers expectations, it instills patience, and it encourages conservative diversification.

If evaluating past returns is the best means by which to hedge on the future, we might build confidence in long-term market performance by reviewing the available data. This, in turn, discourages allocating savings to alternative investments that lack robust data to scrutinize. Imagine that financial independence for your household requires a portfolio valued at $X in 15 years. Are you more likely to get there by adding alternatives? What is the surest way to achieve the growth you need? What are you willing to risk, and how well do you trust yourself to resist making changes or bailing out early? Spreadsheets like the one described above allow the investor to calculate rates of return and compare them to the total market.

Guidelines for Alternative Investments

While expectation management tends to assuage the urge to pursue alternative strategies, I freely admit that one investor’s dogma is another’s folly. The hands writing these words belong to an investor whose philosophy dovetails with the Bogleheads (Dahleans). As a moderate-income physician with defined goals and a written investment plan, I recognize that much of my own behavior management strategy hinges on my ability to allay anxiety, ignore short-term fluctuations, and stay the course. Alternative investments, though lustrous, do not fit within my plan. With that said, I would suggest that when evaluating their role in a hypothetical portfolio, an investor consider the following:

#1 How Much Risk Am I Willing to Take?

The lower the allocation to a given asset, the lower the risk of individual impact on long-term performance. Stated differently: diversification works in part by hedging portions of a portfolio to uncorrelated markets. A broadly endorsed dictum posits that alternatives should occupy no more than 5% of one’s investments. To the Moderate-Income Physician, even this is serious money. True, if 5% of your portfolio is adjourned to day trading or trading cards or ATM syndications, it's less likely to have an impact on your life in the long term. However, it's worth looking at the opportunity cost: 5% of an annual $30,000 investment contribution ($1,500) compounded annually within a broadly diversified index fund at (a very conservative) 5% real is $135000 over a 35-year investment career. Is there an alternative that will reliably yield more? If so, should one take more risk?

#2 How Active Do I Need to Be to Make This Alternative Investment Successful?

alternative investments moderate income physician

Quantifying the time cost of an investment can be difficult. Obviously, you can roughly calculate the value of your time from your income and hours worked, but even this falls apart when factoring in the stimulation (or even enjoyment) in the endeavor. For instance, it takes 1.1 minutes for me to coldly and mindlessly purchase more VTSAX, the return of which is all but guaranteed not to outpace the market. On the other hand, it may take weeks to vet a syndication or broker the acquisition of a piece of art or research pretty much any new and exciting alternative. But if the expedition to understand these alternatives is an enriching affair, if the possible rate of return is uncorrelated with the broader market, and if the underlying risk is still palatable in light of the time it takes to get the gist of it, then perhaps it is worthy of (a reasonable portion) of your investable income.

#3 How Will I Monitor Progress?

Monitoring is easier and more accurate with mainstream investments (hence the above rabbit hole describing projected valuations). Conversely, monitoring and projecting returns without the advantage of a century of data is trickier, particularly when the alternatives require periodic turnover, depreciation, upkeep or maintenance costs, and/or active engagement by the investor or third party. By the time all is calculated (and taxes are paid), it makes FSKAX look pretty appealing.

#4 How Much Do I Enjoy This Process?

In fairness, I’ve heard from many investors whose portfolios consist largely (or even completely) of alternatives. Savvy physicians with a love of comic book trading or real estate contract sales or numismatic fanaticism have done properly well from a financial perspective. From them, I have observed a particular enthusiasm from their hobby turned side gig. For that, more power to them. To the Moderate-Income Physician, this curiosity and enjoyment is a prerequisite; it simply takes too much bandwidth (monetarily and logistically) otherwise.

#5 Am I Conflating Investment with Speculation?

This is such a concern for alternatives that it deserves special attention and due diligence. By definition, investment is the act of exposing resources to conditions that yield growth. In contrast, speculation is the act of vetting a novel mechanism with the intention of growth. The difference is in the evidence: while historic returns are no promise of future performance they are a greater metric than talking (yelling) heads. As my college Ecology professor would say: “In God we trust; all others bring data.”

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The Bottom Line

For the Moderate-Income Physicians on this blog—or in the doctor’s lounge—FOMO can be real. And not just fear of missing out on the new cool investment vehicle but general fear of falling behind peers. This combined with a desire to become a “sophisticated” investor generates conditions ripe for undue risk. I have known for years that whole life insurance is a trap, and forums like this one have been integral in preventing dumb mistakes. Despite this, when my neighbor so sweetly extolled the ingenuity of a universal policy and my wisdom in discussing it, I gave the idea a moment’s pause. While I never seriously considered it, I left the conversation feeling wanted—and wanting something “exciting” in my portfolio. Thankfully, I am a boring creature, risk-averse, and milquetoast. Jack Bogle would be proud.

There are innumerable reasonable strategies for achieving financial goals that do not involve alternative investments. Knowing your goals, setting timelines for achieving them, and making a plan are foundational aspects of DIY investing. While there will always be schemes for achieving financial independence more quickly, the stark truth is simple: increasing savings rate, boosting income, and decreasing expenditures are far more important than what is done with a small portion of a portfolio.

For most Moderate-Income Physicians, alternative investing strategies are a fun academic exercise that are worth pursuing only with diligence and a hefty measure of enthusiastic indifference. For me, alternatives are just not the right choice.

As a Moderate-Income Physician, do you play around in the world of alternative investments? How much of your portfolio do you dedicate to those endeavors? Do you enjoy it? Ultimately, is it worth your time? Comment below!

The post A Moderate-Income Physician’s Approach to Alternative Investments appeared first on The White Coat Investor - Investing & Personal Finance for Doctors.

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By: Josh Katzowitz
Title: A Moderate-Income Physician’s Approach to Alternative Investments
Sourced From: www.whitecoatinvestor.com/a-moderate-income-physicians-approach-to-alternative-investments/
Published Date: Mon, 11 Dec 2023 07:30:15 +0000

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