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Know Your Enemy: Investing for Retirement

In today’s Saturday Selection, I’ve got a classic selection from The White Coat Investor.

It should come as no surprise to you that succesful investing requires you to vanquish several enemies. If you don’t know who they are, you’re unlikely to win, and you may have a tough time realizing the retirement you’ve envisioned and deserve.

While Dr. Jim Dahle alludes to a fourth enemy in a way, he deosn’t exactly call him or her out. Instead, he calls out “Bob,” the neighborhood chatterbox who always seems to be doing better than you.

The fourth enemy? It’s not Bob; it’s you. You must learn to overcome you and all the innate tendencies you were born with that can cause you to do the opposite of what’s optimal with your money. Best wishes in understanding and overcoming the numerous enemies you are facing!

This post first appeared on The White Coat Investor.


Know Your Enemy: Investing for Retirement


Investing your retirement savings wisely is not all that different from fighting a battle. Unfortunately, too many investors don’t actually know the enemy they’re fighting.

Financial advisors often reinforce these mistaken ideas by comparing portfolio performance to an index such as the S&P 500 Index composed of the stocks of the largest companies in America. Since that comparison seems important to the advisor, the investor assumes it is important.

Even worse, many investors compare the performance of their portfolios to that of Bob down the street, or more likely, Bob’s idle cocktail chatter. You see, it’s unlikely that Bob mentions anything other than his best investments at the cocktail party, and highly likely that Bob actually has no idea how to calculate an investment return.



ready for battle


You Decide What a Win Looks Like


When it comes to retirement investing, what matters is whether or not you reach your goal. The more specific your goal, the easier it is to design and monitor a plan to reach it. A good example of a specific goal is “Have a portfolio capable of supporting an income of $100,000, indexed to inflation, that will last throughout my retirement beginning Jan. 1, 2030.”

Notice how there is no comparison to the S&P 500 or Bob’s portfolio. It’s much easier to win the battle when you get to decide what a win looks like.


Three Enemies of Every Retirement Investor


Your opponent in this battle is not Bob. Unfortunately, your enemies are far more worthy. The three enemies of every retirement investor are inflation, taxes, and investment expenses.

Consider an investor whose investments achieve a gross return of 8% for the year. He may pay as much as 25% of that return in taxes, leaving him with a 6% return. Investment expenses may run as high as 2%, decreasing the return down to 4%.

If inflation is running at 3%, then the investor’s net return, after inflation, taxes, and expenses, is just 1% a year. At that rate, it will take over seven decades for compound interest to double his money.

In other words, he is going to have to do almost all of the heavy lifting through brute savings, rather than allowing his portfolio to do much of the work of building his retirement nest egg through compound interest.


#1 Beating Inflation


There is precious little an individual investor can do to actually control the rate of inflation of the goods and service he will purchase over the course of his life. Keep in mind that the rate of inflation that matters is your personal rate of inflation, not necessarily what the government says the overall inflation rate is.

For example, someone paying a great deal of money for health care and college tuition may have a much higher personal rate of inflation than someone who spends most of his money on technology and heating his home with natural gas.

The main error that investors make when combating inflation is worrying about the wrong risk. Too many investors think the main risk they’re running is the volatility of their investments. They remember that gut-churning feeling in late 2008 when a third of their nest egg disappeared.

While volatility is a risk because many investors cannot handle it and end up selling low, a far greater risk is not outpacing inflation and falling short of your retirement goal. In order to beat inflation, a significant percentage of the portfolio must be invested in asset classes that are likely to beat inflation over the long run.

At current low yields, nominal Treasury bonds (much less cash-like investments such as savings accounts and CDs) are unlikely to do this. Riskier investments such as stocks and real estate are much more likely to beat inflation over the long run.

Inflation-indexed bonds, such as Treasury Inflation Protected Securities (TIPS) and I-Bonds are unique in that they are relatively safe investments that hedge a portfolio against unexpected inflation. Although at current low yields they are unlikely to beat inflation by much, at least they’ll keep up if inflation spikes, unlike nominal bonds.


#2 Beating Taxes


Believe it or not, Uncle Sam wants you to have a nice retirement. There are many tax breaks available to investors. Long-term capital gains and dividends are taxed at lower rates than regular income. If you lose money in a taxable investment, the IRS will share your pain through tax-loss harvesting. When you die (or receive an inheritance), the investments receive a step-up in basis as of the date of death, allowing the heir to sell them tax-free.

There are also a plethora of tax-advantaged retirement savings accounts including 401(k)s, 403(b)s, 457(b)s, profit-sharing plans, defined benefit plans, IRAs, Roth IRAs, SEP-IRAs, solo 401(k)s, SIMPLE IRAs, HSAs, etc. The tax-drag on investment growth is eliminated insomuch as you invest inside these accounts.

The tax advantage of being able to choose when you pay your taxes is also substantial. For example, a resident physician in the 15% bracket may choose to pay taxes now and invest in a Roth IRA. When he pulls that money out tax-free in retirement, he may be in the 25% bracket. A physician in his peak earning years may contribute to his retirement plan and save 40% in taxes on the contribution. The effective tax rate of his withdrawals after retirement may be closer to 15%.

Too many physicians complain about high tax bills without taking advantage of the easiest way to save on those taxes, ensure a comfortable retirement and protect the assets from creditors — contributing to retirement accounts and investing in a tax-efficient manner outside of retirement accounts.



#3 Minimizing Investment Expenses


I have seen physicians paying as much as 2% to 3% of their assets every year in investment expenses. 401(k) fees, mutual fund expense ratios, commissions, and advisory fees can add up rapidly. Many physician investors don’t realize the heavy impact that fees can have on their eventual nest egg size.

Consider two doctors, each saving $50,000 per year for 25 years in an investment earning 8% per year before expenses. The first pays 2% in investment expenses and the second pays 0.2%, or one-tenth as much. After 25 years, the difference in net worth will be nearly a million dollars! Every dollar you pay in fees comes directly out of your investment return.

The retirement investing battle is definitely worth fighting, and it becomes much easier when you realize what you’re fighting against. Having a plan to combat inflation, taxes, and investment expenses will give you peace of mind now and a comfortable retirement later.



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What other financial enemies sabotage your retirement plans? Comment below!

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9 thoughts on “Know Your Enemy: Investing for Retirement”

  1. Tips marginally protect against inflation at best. They almost never keep up with inflation.
    Especially when it spikes rapidly. One way to try to assess whether you are in such an environment if that Gold goes up quickly.
    Gold moves in 2 scenarios: rapid deflationary collapse and inverted real rates ( rates below real inflation).
    Which means that short of the middle of a depression, when Gold goes up, real rates are negative.
    And Tips in this environment lose purchasing power (despite the illusion of nominal gains), as well as the stock market.
    It’s a bit tricky but not knowing these things will get many retirees literally destroyed in terms of purchasing power (though their portfolios may look rosy).
    To counter this, and I’m assuming here that Docs won’t play sophisticated money games (and shouldn’t), one needs a big, long term fixed rate mortgage. The best nearly free (and legally robust) hedge, available to anybody.

    • Seems like a major contrarian view for those here. Most of the posts here are about buying a house you can afford. ideally under 2x your salary.
      I wonder if you are letting the desire to keep inflationary costs under control be the tail that wags the dog. If the goal is to have a growing portfolio that outpaces inflation, I would be happy to have a 30x portfolio in a 70/30 split, rather than a 30x portfolio in a 30/10 split and the remainder tied up in my McMansion.
      Talk me through your thought process a bit more and tell me more about this “inverted real rate”. I’ve never heard that term before.

  2. Subscribe to get more great content like this, an awesome spreadsheet, and more!
  3. I agree that investor behavior is the worst enemy of all.

    The amount of savings we do, rather than what the fine details of which asset allocation we chose, is the main determination of wealth. If that is the case than why does everyone have results all over the place?

    That’s where investor behavior comes in. Every individual has their own risk tolerance profile. Those that are quite nervous will sell at lows and lock in their losses. This can result in a huge loss of wealth over time as they buy high and sell low repeatedly (the reverse of what you want to do).

    Then you have those that are overconfident and feel they have the golden midas touch. I believe we have created a generation of investors like this as everyone looks like Warren Buffet with the long bull run we had. This may lead to taking riskier approaches which can lead to large downfalls.

    The financial industry is very smart in terms of minimizing the impact of fees. Basis points seem so miniscule in the grand scheme of things. Yet because those fees come out of your potential investment pool and don’t have the ability to be in the market, the effect can be quite high over decades of investing.

  4. For some odd reason the best investments for me were never suggested by a professional. The best investments for me were almost always accidental. I suspect I am alone in this respect, but for this reason any time anyone suggests an investment I look at it with disdain. This did result in a big lost opportunity however. When Google was a startup a patient told me he was doubling his investment every 6 months using options. He told me I should get in on it. I didn’t. He retired (on Maui) a long long time ago…

  5. Nice post. I especially like the reframe of having a personal goal versus trying to beat Bob or the S&P. The goal is to get our chips off the table for our retirement – or at least play less risky games the
    we accumulate. If we don’t have a goal, then we keep rolling the dice, taking on excess risk when we already have “enough.”

  6. I have been my own worst enemy. It’s me who effects all three of these issues. If I can control me, I can control these things.

    Dr. Cory S. Fawcett
    Prescription for Financial Success


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