When is it time to say goodbye to your financial advisor and start DIY investing all on your own?
You’ve got a great job. You’re making your monthly debt payments to pay down student loans and the mortgage, perhaps making additional payments on the principal.
You’ve heard that fees can devour your gains and that a low-cost, fee-only fiduciary financial advisor can be hard to find. You decide to do it yourself (DIY). You were smart enough to land a great career and diligent enough to set money aside to invest.
You can do this. Here’s how to get started.
1. Read a book.
Or two or three. The internet is full of great information, but it can be difficult to know where to begin. A good basic personal finance book is organized into a cohesive package of well-written and professionally edited chapters designed to teach you what you need to know and understand to be comfortable managing your money.
- The Only Investment Guide You’ll Ever Need by Andrew Tobias. The first investing book I read. An updated edition was just published April 26, 2016.
- The Little Book of Common Sense Investing by John Bogle. It’s not a how-to guide, but it gives a good overview of how the markets work, with some fun parables and loads of wisdom from an investing hero.
- The Bogleheads’ Guide to Investing by Taylor Larimore, Michael LeBouf, and Mel Lindauer takes the logic and ideologies of ‘Saint’ Bogle and applies them to everyday investing for people like you and me.
- The White Coat Investor: A Doctor’s Guide To Personal Finance And Investing by James Dahle, MD. Read my book report here. This is probably the best book for financial advice specifically for physicians.
- For additional books on investing and retirement, see our list of Recommended Books.
2. Harness the power of the internet.
Once you have some baseline knowledge from reading a book or two, refine that knowledge with a little browsing. Read some articles and blog posts. Read the forums. When you’re ready, ask questions on the forums. You’ll be amazed at the quality information you’ll receive on a quality forum, two of which are listed below.
A few sites to get you started:
- Bogleheads. An extensive wiki and a great forum with a new Youtube channel in 2021.
- WhiteCoatInvestor: 10+ years of great posts plus an active forum, podcast, and Youtube channel.
- Passive Income MD: A blog and podcast on real estate investing and passive income.
- The Physician Philosopher: Finance for physicians with a focus on behavior and psychology.
- Physician on FIRE. Shameless self-promotion. Move along.
3. Estimate your net worth.
It’s hard to figure out how to get somewhere if you don’t know where you are starting from. Look up your balances and add them up. Add home equity if you’ve got any. Look up your debts and subtract them from the assets.
Anonymous people on some internet forums like to quibble about what to include and exclude in the calculation. What about jewelry? And art? The Beanie Baby collection?!? I like to stick with property, cash, and investments, but whatever you decide to use, be consistent.
I like to use Personal Capital to track all of my accounts in one place. The site / app gives you lots of different ways to view and analyze your investments. Mint is lighter on the investment side, but more robust on budgeting and expense tracking if you’re into that kind of thing.
4. Determine your risk tolerance.
Harnessing the power of the internet in a different way, take a quiz to determine how comfortable you are in taking calculated risks with your investment portfolio.
Here are a few resources to help you with this task:
- CalcXML: What is my risk tolerance?
- The Motley Fool: Risk-Tolerance Quiz
- Index Fund Advisors – Risk Capacity Survey
Use the answers to determine a ratio between stocks and bonds for your portfolio. The quizzes are a guide. Some people use a simple formula, such as “age in bonds” (70% stocks / 30% bonds for a 30-year old) or a more aggressive version, i.e. “age minus 10” in bonds or “age minus 20” in bonds.
When breaking down your portfolio into two broad categories, the “stocks” allocation includes US and International Stock funds, and alternatives such as REITs. The “bonds” portion can include fixed income vehicles including bonds, CDs, and perhaps cash.
I decided on 10% bonds with the remaining 90% in stocks and real estate. You do what helps you sleep best at night, which may be a more conservative allocation.
5. Decide if you want international stock and bond exposure.
The aforementioned John Bogle of Vanguard fame has stated that international funds are not a necessity in the average investor’s portfolio. Interestingly, Vanguard’s target date funds recently increased the international portion of its target date and all-in-one funds to 40% in 2015.
While it is true that many American companies do substantial business overseas, and owning them gives you some international exposure, there are some very large corporations based outside of the United States, particularly in developed markets throughout Europe and Asia.
Recommendations for international allocations range from 0% to 40% or more. I’ve decided to allocate 20% of my portfolio to international stocks, or 25% of my stock allocation.
6. Decide if you want Real Estate exposure.
There are a number of ways to own real estate that do not require hands-on management of rental properties. In the past five years, I’ve made numerous investments in passive real estate that take no ongoing efforts and just a bit of due diligence upfront.
I’ve invested in real estate funds with minimums as low as $10 and as much as $100,000. I’ve also made a number of investments in individual projects via crowdfunding platforms. Completed deals have given me returns ranging from 2% to 50% annualized.
Ownership in a REIT or a fund of REITs is another way to profit from real estate without the hassles of managing rental property yourself. While there is some correlation with the overall stock market, over the long term, it tends to be rather low, at least according to this article from Financial Advisor Magazine.
At this point, you should have your target asset allocation nailed down. You’ve got mine, too (50% US stock, 20% international stock, 20% real estate and alternatives, 10% bond/cash).
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7. Learn about tax efficiency.
Hooray! you’ve got your very own tailor made asset allocation. Now keep in mind that you will have multiple retirement and non-retirement (taxable / brokerage) accounts. You aren’t going to try to recreate your desired allocation in each account. You will apply the asset allocation across all accounts.
Tax-efficient fund placement describes a manner in which your assets are placed in the accounts which will provide the best (or least deleterious) tax consequence. Tax-inefficient assets that would be taxed the most are sheltered in a tax-deferred or tax-free (Roth) retirement account.
Tax-inefficient funds include REIT funds, actively managed mutual funds with high turnover, and high-yield bond funds.
The most tax-efficient funds will be ideal choices for a taxable account. These include municipal bond funds, passive stock index mutual funds, and international stock funds with low turnover (index funds).
Owning tax managed funds such as municipal bonds in a tax sheltered account can be counterproductive. You are sacrificing yield for a tax benefit that won’t be fully realized.
International funds will generate a foreign tax credit that you can report to the IRS and typically subtract dollar for dollar on your 1040. Growth funds tend to be more tax efficient than value funds, due to lower dividend payments.
8. Explore your work-related retirement savings options.
If you are employed, you likely have access to a 401(k) or a similar account which could be a 403(b) or 401(a). You may also have access to a deferred compensation plan such as a 457(b), or a cash-balance plan.
If you are self-employed, a solo 401(k) is an attractive option. Others exist, such as SEP-IRA, SIMPLE IRA. To learn more about these investment accounts and the rules that govern them, see my post on investing basics for professionals.
Ideally, you’ll have quality, low cost funds available to you (because fees wil cost you millions). Unfortunately, some 401(k) and similar plans have no good options. If you’re forced to choose from a list of crummy funds, WCI has written a guide to assist you. If the funds are really bad, and you have no match (as is typical with a 457(b)), you may consider not contributing to the account at all. Always contribute enough to get the match where one exists. Never turn down free money.
9. Decide Roth versus Traditional for your work-related plans.
Some plans will allow you to make traditional (tax deferred) contributions to your 401(k) and similar plans, or Roth (taxed now, not later) contributions, or a combination of the two. If you are unsure of your options, check with your plan administrator or human resources department.
I love Roth money. I love it so much I slashed my net worth by nearly $300,000 to have more. But if you are earning a physician’s salary, you’re probably better off with traditional contributions, taking a tax deduction now while you are in a high tax bracket.
The future is uncertain, but most of us can expect to be in a lower tax bracket in retirement. This is especially true if early retirement is potentially in your future. It’s not unreasonable to plan to live quite comfortably and pay zero federal income tax as an early retiree.
If you plan to work for 30+ years, maxing out all your tax-deferred space, you could easily end up a millionaire. Your impressive balance will ensure that you remain in a high tax bracket starting the year after you turn 72 and Required Minimum Distributions are mandated. If this is going to be you, Roth contributions would be a reasonable consideration, despite your lofty current tax bracket.
10. Consider Investing in an HSA
If you have a high-deductible healthcare plan (health insurance), it may be paired with a Health Savings Account, or HSA. This is a wonderful “triple tax free” retirement account.
You’ll get a tax deduction when money is contributed (up to $7,300 for a family annually, $3,600 for an individual in 2021). The money in an HSA can be (and should be) invested where it will benefit from tax-free growth.
Finally, when used for eligible out-of-pocket healthcare expenses, the money can be withdrawn tax-free. If you somehow end up with more in the account than you could ever spend on healthcare (seems unlikely, but you never know), you can withdraw the money for any reason at age 65 but it will be taxed as income if not used to pay for healthcare. In that case, it will have worked just like a 401(k) or traditional IRA.
11. Start a Roth IRA
This Roth contribution is different than the potential Roth contributions we talked about in Step 9. In that case, the alternative was a desirable tax deferred contribution to a retirement account. In this case, we’re assuming you’ve maxed out your retirement accounts, and have money left over. The alternative to this Roth contribution is a contribution to your taxable account (See step 12).
Many physicians will be ineligible for a direct contribution to a Roth IRA due to income restrictions.
Do you have the fortunate problem of earning too much? There is good news for you and it’s referred to as a backdoor Roth IRA. It’s a sort of loophole, but it’s a poorly kept secret.
- Make a $6,000 non-deductible after-tax contribution to a traditional IRA account ($7,000 if you’re 50 or older). Your spouse, if you’ve got one, can do the same, even without earned income.
- On a later date, convert the contribution to Roth.
- Be sure to submit Form 8606 with your 1040 to report the after-tax IRA contribution.
- The net result is the equivalent of a $6,000 or $7,000 Roth IRA contribution (or two), and it can be done no matter how high your income.
For detailed instructions with screenshots, see:
- Backdoor Roth IRA 2021: A Step by Step Guide with Vanguard
- Backdoor Roth IRA 2021: A Step by Step Guide with Fidelity
- The Backdoor Roth FAQ
Bonus reading: You may have heard of the Mega Backdoor Roth IRA. Not every 401(k) is set up to all for it, but if yours is, it can be a sweet deal.
12. Start a taxable account.
A taxable account sounds like a bad idea, much like spinal anesthesia, but like spinal anesthesia, it is a good option associated with a scary word.
Also referred to as a brokerage account, or after-tax account, this is simply a collection of investments you buy with money left over after you’ve exhausted your tax-advantaged options.
Although dividends and capital gains in this account can be subject to taxes, there are good ways (keep taxable income low) and bad ways (death) to minimize or completely avoid those taxes.
If you were paying attention in Step 7, you will fill your taxable account with passive index funds, including international funds if you chose to include them in your portfolio. Municipal bond funds can be a good option too, especially if you can find one that is also tax-free in your state.
When invested in a tax-efficient manner, a taxable account can actually be as good or better than a Roth IRA, especially when you engage in tax loss harvesting to eliminate taxes on $3,000 of ordinary income per year.
13. Create a spreadsheet to track the money in different accounts.
Personal Capital will give you all the balance and allocation information you can ask for, but nothing will be as flexible as a well-designed spreadsheet. I’ve created one that use to track my own investments, and the template is available to download. The sheet does a great job helping me allocate my desired asset allocation across different accounts in a reasonably tax-efficient manner.
Enter your email below, and I’ll send you a copy of the sheet where you can enter your own investments. When you add the free add-on Stock Connector, the spreadsheet will automatically update based on the current value of the ticker symbols you’ve entered.
14. Sweat the Details
If you’ve followed the first 13 steps, you’ve probably come across some recommendations in your reading that you’d like to implement in your portfolio. You’ve got a plan that will allow you to be a successful DIY investor, but there is some fine-tuning you’d like to enact.
Weigh the merits of various fixed income options like CDs, TIPS, I Bonds, and bond index funds. These details aren’t going to make or break you, but you want to have a plan, and this is your opportunity to make it your own.
If you’re someone who likes to optimize and maximize, you can spend plenty of time fine-tuning things. Conversely, if you’re comfortable with “good enough,” and a believer in the Pareto Principle, you don’t need to get into the thick weeds here.
15. Allocate up to 5% of your portfolio to “play money”
Index investing is boring. You’re not going to hit any home runs or beat the indexes. Of course, you will get market returns, which is better than most active managers do, as Boglehead Larry Swedrroe demonstrates in Swedroe: Active Funds Whiff Again.
But you want a home run. You want to pick stocks; you want to invest in the healthcare sector because you work in the healthcare sector. You want to invest in promising startups before the IPO. You want to be like me and own part of a microbrewery. Or a restaurant or distillery. The guy in Blindside owned Taco Bells and had a proper mansion.
These investments may offer a higher reward, but the potential reward is often paired with a side of equal or higher risk. A common recommendation is to limit these investments to 5% of your portfolio. Once you’re financially independent, you can comfortably increase that percentage as long as you keep a portion of your portfolio equal to the 25x to 33x annual spending invested in a reasonable manner.
If you have a basket of many individual stocks that is reasonably diversified, you don’t have to count that as part of your play money. Doubling down on biotech is another story. Have fun but don’t bet the microbe farm.
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16. Insure yourself
A good investing plan can be thwarted if your assets are not protected from loss.
- Insure against loss of life with term life insurance.
- Insure against loss of the ability to work with disability insurance.
- Insure your homes and cars with home and auto insurance.
- Insure against malpractice lawsuits with appropriate malpractice insurance.
- Insure against most anything else with umbrella insurance.
Don’t spend money insuring things you can afford to replace yourself, like your cell phone and other electronics. Insure against catastrophes, not inconveniences.
If you’re completely Financially Independent, you can afford to live without some of these, notably life insurance, and costly disability insurance.
Pete Adeney, a.k.a. Mr. Money Mustache has the audacity to forego home insurance. That’s not a bet I’m ready to make, although I have raised my deductible to $10,000 to lower my annual rate.
17. Rebalance at pre-determined intervals
As time goes on, your investments in different asset classes will grow and shrink at different rates. Eventually, your tidy 50 / 20 / 20 / 10 split will look something like a disheveled 52 / 19 / 21 / 8. This is where rebalancing comes into play to right the ship.
There are different approaches to rebalancing as outlined in the Bogleheads wiki. Choose one and stick with it. Your options are to rebalance with new additions (or withdrawals in retirement), at set time intervals (quarterly, semi-annually, annually), or when the balance is off by a certain relative or absolute percentage.
The beauty of rebalancing is that it forces you to buy low and sell high. When one asset class has performed well, you will have more of it. You sell some, capturing the gains, and buy more of an underperforming class that is priced low. Rebalancing too often tends to minimize this effect.
18. Decide if a Donor Advised Fund is right for your charitable giving.
You’ve made it through the first 17 steps. If you’ve got a decent income and savings rate, you’re on a path to real wealth. It’s time to think about how to share the wealth (and I’m not talking about taxes this time).
I like to do things optimally, and my charitable giving strategy is no exception. I’ve written about the benefits of utilizing a donor advised fund (DAF), and I donate a good chunk of this website’s profits to charity via our donor advised funds. The balance of our DAFs has grown by about $200,000 since we celebrated the quarter-million-dollar milestone, all the while granting tens of thousands of dollars from them annually.
I have used several companies’ DAFs, but find Fidelity’s to be my favorite, thanks to low costs and the lowest minimum grant of $50, as compared to Vanguard’s minimum of $500.
When you give to a donor advised fund, you receive an immediate tax deduction when you contribute, and you can donate the money at any time in the future. The tax treatment of your donation can be further optimized by contributing appreciated funds from your taxable account rather than cash. Capital gains will not be incurred by either the giver (you) or the recipient. A win win.
19. Consider your drawdown plan
As you build up your assets, keep in mind you’ll eventually be tapping into them to live a good life in retirement. Knowing which trees to tap and when to tap them can affect your overall harvest. If you’re planning to retire early, and all your assets are in a 401(k), you’re going to have to be a little more creative than your colleague with a sizable taxable account.
Knowing where your money is, how it can be accessed, and what the tax consequences are will allow you to come up with a sensible drawdown strategy to allow for retirement spending.
Which accounts you draw from and when will depend on how old you are, where the bulk of your assets are located, and what sources of passive income you have. A well-thought-out strategy will be
Come up with your own and incorporate it into your Investor Policy Statement. “Wait, my what?”
20. Write a simple Investor Policy Statement.
This step might scare you off. It shouldn’t. Keep it simple. I’ve written about my IPS a couple of times now. It started out simple, and has grown with me as my knowledge base has expanded, and my plan has become more finely honed.
University of Chicago professor Harold Pollack wrote his on an index card, and it went viral. The card’s popularity spawned a co-authored 256-page book entitled The index Card: Why Personal Finance Doesn’t Have to Be Complicated. I’ll add this to the list of books I haven’t read, but would love to when I find the time. With a 4.5 star rating on Amazon, it might be good enough to land itself in the list of go-to resources in Step 1.
You’re almost done. Write down 5 to 10 sentences based on the knowledge you’ve gathered so far. Set it aside for now, and revisit annually. Expand it and modify it occasionally as your investing acumen grows and your situation changes.
That’s it! From zero to DIY investing hero in 20 steps. I’m rather proud of this one… please consider leaving it up on the screen in the lounge or share with a friend who could benefit from learning a thing or two.
What did I leave out? Things that are optional or don’t apply to everyone, like college savings and student loan repayment strategies. Asset protection and estate planning are further steps a DIY investor can explore once the basics are covered, but again, are beyond the scope of this 3,700 word post. You wouldn’t want this to go on any longer, would you? Me neither.
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Have you made the transition to DIY investing? Have you always been a DIY investor or do you prefer professional help with your investments? Why or why not?