DMD Staff

While we’re unlikely to see acid-washed jeans ever become a big thing again, you never know. I’d have said the same thing about bell-bottoms. But through all the fads, some of the basics stick, like Levi’s 5-pocket plain denim. 

For investors, the index fund has become kind of like the Levi’s 5-pocket plain denim. They’re here, they’re solid (but not always spectacular), and they’re unlikely to be completely toppled from relevance, no matter what new trends—

So let’s talk a little about index funds, including their strengths and limitations. Index offer a (mostly) low-cost way for investors to track popular stock and bond market indexes. They invest in securities to mirror a market index, such as the Dow Jones Industrial Average or the S&P 500. On behalf of investors, who purchase shares of the fund, the fund buys and sells securities in a manner that mirrors the composition of the selected index. 

Index funds are popular among dentists and other investors, and for good reason. These next three statements are all true: 1) In recent years, some index funds have outperformed actively managed funds. 2) Because they mirror an index, these funds ensure diversification. 3) Index funds are inexpensive in comparison to actively managed funds.  

While those “facts” about index funds can be true, they can sometimes be false as well. (I know, I know, but this is finance we’re talking about!) As with all investing strategies, you should consider the caveats, the relative nature of those statements, and the fact that the return of most investments changes over time. While those statements above are true, so are these next statements. 

If you’re investing in an index fund through a 401(k) or 403(b) plan, it may indeed have a very low expense ratio. Some firms offering their own “in-house” or proprietary funds may not be low-cost at all. Yes, they are still likely to be less expensive overall than other types of funds, but costs can still add up. Make sure you know how the fees associated with the fund are structured, exactly what they are, and how they compare to your other investment opportunities.

If you’re a regular reader of this site, the subhead above should look very familiar, but it’s worth mentioning again here. Just because several prominent index funds have outperformed managed fund accounts in recent years doesn’t mean they will continue to do so. There are also many types of index funds and exchange-traded funds that have under-performed the market. Yes, look at historical data of a fund’s performance as part of your due diligence, but understand that past performance is no guarantee and shouldn’t be the only factor in your investment decision. 

Index funds work quite well as part of an asset allocation plan, and they can be adjusted to match your risk profile and investment goals. Dentists generally find them of value because their income is relatively stable year over year; thus, their income cycle is a good fit for index funds. But because they track an index, and because many index track specific industries (such as technology, health care, real estate, etc.), the funds themselves are not necessarily diversified. They should be one component of a diversification strategy--not the whole enchilada. 

Index funds have other potential negatives as well, including the inability to control your holdings in individual securities and pursue securities that you think might represent a good value. Many still find them quite valuable, and for good reason. Just don’t think of them as some sort of cure-all for every portfolio.

Articles

Index funds have become popular of late. There's a good reason for that, but don't let their popularity cause you to get complacent.

Index Funds: Solid If Not Spectacular

, we covered the advantages of robo-advisors, the emerging technology that is changing the financial services industry. Robo-advisors are automated, algorithm-based wealth management service that uses large quantities of data to try and predict investments that will outperform the market. Chances are you’ve heard a little about them and their advantages, which can include lower fees, powerful computing algorithms, greater access to investment advice for many, and customization.

Of course, no financial services tool is without its drawbacks, and the same is true for robo-advisors.

How much does the human touch matter to you?

There are a few additional disadvantages we’ll mention, but the primary one is that while robo-advisors are 

. That is, the algorithms can be programmed for many variables, but they cannot take into account your personal situation. For the most part, they also won’t take into account your entire financial picture, though some of the more robust versions will seek a lot of input from you.

Perhaps more importantly, robo-advisors don’t provide the human touch. One won’t call you after a market down-turn to reassure you that your long-term buy and hold strategy still applies. The robo-advisor won’t sit across from you with a cup of coffee and detail why it made certain investment decisions, and it most likely won’t integrate your tax concerns, insurance concerns, estate plans, and other factors a human advisor is more likely to consider. For now, most robo-advisors are not equipped to handle more complicated transactions, like calls, puts, spreads, and straddles. (If you don’t know what those last four things are—they’re options transactions&mdash;chances are this won’t be a big obstacle for you.)

For many dentists looking for a simple savings and investment strategy, the services provided by a robo-advisor will be perfectly acceptable. For others, you know who you are. Also consider the following:

• All things equal, a robo-advisor will be cheaper to work with than a human financial advisor. 

But most robo-advisors do bring their own fees

. Advertising around robos tend to overestimate the cost of working with a financial advisor, so buyer beware.

. While the algorithms are robust and the principles behind robo-advisors are sound, there can’t yet be longitudinal studies of their performance versus human advisors, simply because robos haven’t been around long enough.

• Some people use meetings with their advisors as a system of regular check-ups—and perhaps encouragement&mdash;to save and invest more. Using a robo-advisor will not work for this purpose.

The drawbacks of working with a robo-advisor may not seem that substantial, but they really boil down to what kind of investor you are and how much hand-holding you’ll need. This is a very personal question, and the answer has to be right for you. Just be sure you understand the advantages and disadvantages before changing your approach.

Robo-advisors are a relatively new phenomenon, and one that many people are excited about. But don't jump on the bandwagon without some careful thought.

Rise of the Robo-Advisor: Things to Consider Before Embracing an Algorithm

All things financial interest me (excuse the pun), but I am particularly piqued by financial concepts that interact with psychology. This is, perhaps, because I have dealt with many of these issues myself as an investor, and I often wonder why I do the things that I do. In previous columns, our sister site has covered the 

 trap, and here we’ve covered the concept of 

There’s another intersection between finance and psychology that I think a lot about, in part because it derails the long-term strategy of many investors: the sunk cost trap.

Have you ever driven through hideous traffic to a football game, grilled some burgers and brats in the parking lot, gone through security, spent $10 for a thimble full of beer, and then, in the first quarter, your team is getting trounced 21-0? If you sat through the next three quarters, even though your team had no chance of coming back, you’ve fallen victim to the sunk cost trap. You stayed until the end because of the time and effort you had invested to get that far.

A financial sunk cost is an expense that has already been incurred and thus cannot be recovered. Good investors take emotions out of their decisions and make choices independent of what has come before. Why? Because the past costs won’t ever change. A good investor should consider only what may possibly change: the future cost and return of the investment.

This concept makes logical sense, but it can be hard to separate emotion from logic. That’s because your purchase of that “little stock that could” involved more than your dollar investment. Chance are, you invested emotionally in it, too. You saw the profits and stock price of Snake Oil Ventures (SOV) slowly rise from nothing, and you began to feel pride of ownership and validation of your investing strategy. Perhaps you ran that pride all the way to worthlessness as SOV’s stock withered and died.

Consider every future financial investment based only on its current and future benefit to your portfolio. Costs you have already incurred will never change, but they really are immaterial to the future benefit or loss. This will mean taking—and accepting&mdash;some losses. Take solace in the fact that every single investor takes losses. If you’re ever having lunch with iconic investors Carl Icahn or Warren Buffett, ask them for a brief overview of their losses, and you’ll have enough conversation to last through breakfast the next morning.

They’ll also tell you, though, that leaving those sunk costs behind was among their favorite and most important investing decisions. Sometimes our biggest wins aren’t the investments with the biggest net gains. They are missteps avoided, bad paths not taken even though they looked tempting at the time. 

Sometimes our biggest wins aren't the investments with the biggest net gains.

That Sinking Feeling: How to Pull Yourself Out of the Sunk Cost Trap

The recent Brexit vote and many other factors have combined to create an environment ripe for market volatility. This is a concept that frightens many investors—particularly those who may be a little closer to retirement. The old adage is that younger investors with a long window before they’ll need to spend their investments can ride out market volatility, while the near-retiree who may soon be cashing in stocks and bonds to live off of can’t necessarily do that.

There’s truth to the old adage, of course, but as with all things financial, it’s a little more complicated than that. Let’s take a fresh look at types of risk and how they play into strategies you can use during market fluctuation.

In a word, no. Volatility means significant upswings along with some potential downswings, and it can also mean increases in interest rates for some bonds and other investment vehicles, because of the inverse nature of risk and reward. Every retirement investor—in fact, every investor&mdash;faces risk.

Even the most conservative investing approach ever taken includes risk, because that approach may yield so little return that the original investment doesn’t keep up with inflation. That’s called 

, and it’s a very real thing that can damage portfolios.

 is the type of risk most often associated with market volatility. It’s the risk that your investment will decline in value. Generally, the higher investment risk you are willing to take on, the greater the opportunity for both increasing and decreasing the value of your portfolio.

Are there ways to mitigate investment risk?

Yes. One of the most important and commonly used is diversification. We’ve covered this topic in depth 

, but let’s sum up:  Diversification can be defined as 

managing risk by using a wide variety of investments within a portfolio, thereby minimizing the risk of a shortfall in any given investment on your overall investment portfolio.

 There are many types of diversification—including by investment vehicle, by industry, by geographic location, and more&mdash;and being truly diversified means incorporating one or more of those types. Diversification allows you to be more aggressive with some investments, knowing that if the market takes a tumble, your portfolio won’t completely crumble along with it.

Beyond diversification, you’ll want to consider asset allocation during volatile times. When you first start investing or saving for retirement, you select a mix of investments to diversify your portfolio, with some diversity of stocks, bonds, short- and long-term investments, index funds, and perhaps some international equities. But investments change all the time, particularly during a period of market volatility. As some asset classes grow and others sink, the weighting of each asset class in your portfolio will change. Rebalancing is the process of buying and selling portions of your portfolio in order to set the weight of each asset class back to its original state.

Rebalancing sounds simple, but it can actually be confusing for all but the savviest of investors. Financial statements, even when they come in the handy form of “easy to read” pie charts, can be confusing, and they may tell you your current mix of assets but not how that compares to the mix you want. Transaction costs and tax considerations will be part of the mix as well. If you have a trusted advisor, talk to him or her about whether or not you need to rebalance, how often you might need to do so, and exactly how to go about doing so. 

The recent Brexit vote and many other factors have combined to create an environment ripe for market volatility. Follow these tips to steady your financial ship when the market is anything but stable.

Market Volatility Doesn't Have to Derail Your Investment Strategy

Casual (and terrible) golfers such as myself often miss makeable putts. Even when the putt goes in, it is considered bad form if the putt “dies at the hole.” That’s a putt that, with just one less revolution, would have been left short. Professional golfers almost always aim to have the putt go a few feet past the hole if it doesn’t fall in, on the logically correct theory that a putt that never gets to the hole doesn’t even give itself a chance to go in.

I thought about this (daydreaming of golf?) while reading a fascinating 

 by popular financial blogger Michael Kitces. The column isn’t about golf, but it does raise some really interesting points about the terrifying possibility of retirees running out of money long before they die, and why so few retirees ever come even close to doing so.

Kitces, linking to a related study, notes:

a recent study entitled ‘Spending In Retirement: Determining The Consumption Gap’ by Browning, Guo, Cheng, and Finke

 in the Journal of Financial Planning, researchers showed that affluent retirees relying on their portfolios in retirement are failing to even spend their annual income in their retirement years (and the more affluent they are, the worse the trend tends to be). In fact, not only are retirees not fully spending their available income, but 

. As a result, from the beginning of 2000 to the end of 2008 — a very challenging time of mediocre returns for retirement portfolios, when in theory account balances would have dipped with ongoing withdrawals – the average financial assets of wealthy retirees 

continued to increase in retirement. Thus, the researchers identified a ‘consumption gap’ between what spending the retirement portfolios could support, and the lesser amount that was actually getting spent (which in turn left room for the portfolios to continue to grow).”

We might think of the optimal result for a retiree as spending her last dollar on the day of her death—hopefully doing something that brings her joy, perhaps buying a gift for a great-grandchild. The likelihood of that happening, of course, is effectively zero. And it’s a sobering thought that our “optimal result” immediately becomes a terrifying result if our retiree lives one more day, just like our hypothetical putt that dies at the hole. It’s encouraging, then, that retirees continue to seek income and keep their expenses down, thus ensuring that a longer life won’t be a destitute one.

But there’s a concern in this trend, too; namely, that retirees, having worked their adult life and prepared well for their sunset years, now deprive themselves of some material things—be they good and services, travel, or gifts to charities or family members&mdash;to prolong their income well beyond what they’ll actually need. It’s not that the money will go to waste, of course, as they can be directed to charities or family members through wills and trusts, but rather that the freedom to use that money at their discretion is what the retiree may have lost.

There are no easy answers. It may be that, in a wide range of possible outcomes, the one most often taking place is the least damaging. My point, simply, is that we shouldn’t ignore that there is a downside to that approach as well. Perhaps it cannot be avoided, but it’s there nonetheless.

We’ll return to this idea in a future column. 

Fear of running out of money means many retirees may live too cautiously.


How the Greatest Fear Impacts Retirees

This is the first of a two-part series on "robo-advising." Check back next week for Part 2.

The machines are coming, and like Terminator 2’s terrifying, shape-shifting T-1,000, they use complicated technology. They’re called robo-advisors, and while they aren’t looking for Sarah Connor, they do use advanced programming to manage and administer investment portfolios. An industry shaken by a new 

Department of Labor “conflict of interest” rule

 and some recent market volatility is turning to them to redefine—and automate&mdash;financial advice.

First, what is a robo-advisor? It’s an automated, algorithm-based wealth management service that uses large quantities of data to try and predict investments that will outperform the market. Think of it like playing chess against the computer. Wait, on second thought, don’t think of it like that. Chess, though it has millions of variations, is ultimately a finite series of moves. Stock performance, though typically associated with less variation than chess, has the potential for infinite variation. Think of robo-advisors, instead, like meteorological models; using past and current data to predict future performance.

For now, robo-advisors are being used only in predicting investment performance, and not in more personal avenues of financial advice, such as tax planning, assessing insurance needs, or estate planning. Like almost anything else, the use of robo-advisors has its pros and cons. (Bacon is the exception; it has only pros!) Here’s a quick look.

 Fees eat away at investment performance, so the lower they are, the better off you generally are as an investor. Because the algorithms used by robo-advisors can be developed and then customized, they are cheaper than human labor, and the fees range from practically free (Charles Schwab’s innovative service) to a fraction of professional investment assistance.

Legitimate—and powerful&mdash;algorithms: 

The move to robo-advisors isn’t about replacing human labor like the shift from bank tellers to ATMs. It’s about algorithms that have literally 

 for the economists who invented them. If the idea of a machine picking stocks seems impersonal, consider that robo-advisors are built to control for both market randomness and human emotion. It’s a little scary.

 Investors of lower net worth can rarely work with the top advisors, who work mostly with high net-worth investors. Robo-advisors even the playing field, allowing easy access and lower fees for investors at all levels.

 You might think the algorithm by its nature means robo-advisors are limited in the kinds of investors they work for and the kinds of investment advice they offer. That’s not the case at all. You can customize investment planning for certain sectors of interest, and even set some limitations. For example, some investors prefer to steer clear of “sin” stocks such as tobacco and liquor companies. Robo-advisors are customizable in many ways for many different tastes.

While robo-advisors have substantial and positive attributes, you won’t be at all surprised that 

 They include the fact that robo-advisors, unless they are truly advanced, won’t consider your overall long-term financial goals in accordance with your circumstances and other issues that may influence your investment decisions.

We’ll cover this in more depth, along with some common misconceptions about robo-advice, in Part 2.

Algorithms can process huge amounts of data in order to come up with predictions about future market trends. Does this mean they can replace human financial advisors?

Rise of the Robo-Advisor: 4 Advantages to Automated Advising

If you don’t have HBO, I can’t fathom where you’ve been or how you arrived at the decision not to watch 

. But you don’t need HBO to watch John Oliver’s withering takedown of the financial services industry. The full segment is 

, and an excellent write-up by Jared Kaltwasser is 

Although the segment aired some time ago, I thought it was worth revisiting. That is, in part, because much of my writing for 

 discusses the utility of working with financial advisors as part of developing and implementing your savings strategy. Watching the Oliver clip—and, let’s be clear, everything he says in the clip is accurate—you’d be forgiven if you decided never to work with an advisor again.

I happen to think that would be a case of burning down the house because you fund a snake in the garage. Better to deal with the snake, and any of its kin, than eliminate a structure that can add value to the financial well-being of many. So, what can you do as an investor to protect yourself?

Beware the “altruistic” financial services company.

Besides being a writer for this esteemed website, I have worked for four different financial services companies—all of which you’ve probably heard of. I have worked alongside many good people with laudable values, and all of those companies did indeed include “corporate responsibility” and “helping clients prepare for retirement” among their stated goals. But each was also primarily interested in building its own revenue—a staple of pretty much every business everywhere.

Helping people achieve a good retirement outcome and making money for the company don’t have to be mutually exclusive goals; this isn’t a zero-sum game. Just make sure you are constantly aware that someone who is selling you something is, well, selling you something. That’s worth keeping in mind no matter how much trust you place in the institution—or the individual—working to help you meet your financial goals.

Consider the short- and long-term impact of fees and commissions.

One point Oliver hammers home, very effectively, is that fees and commissions, which often seem like negligible percentages of an overall investment portfolio, have an insidious way of adding up over the life of an investor. While many investigative reports can cherry-pick data that makes their point, the numbers Oliver uses and scenarios he describes are both accurate and germane to most investors.

The key to protecting yourself as an investor is making sure you’re aware not just of the amount of fees and commissions any investment vehicle carries, but two much more important considerations:

1. The true long-term cost of that fee, over the life of the investment, and

2. Comparable expenses from competing firms and different investment vehicles.

As an investor—really, as a consumer of anything—you’re rarely if ever going to get a product or service without any cost whatsoever. When those costs truly add up is when you could have gotten a similar return or result at a much lower cost.

The main issue I have with Oliver’s piece is that, while hilarious and mostly very accurate, it does (intentionally) ignore the simple fact that working with an advisor, even when it comes with commissions and fees, has proven to be more than worth it for millions of investors. As with any transaction, buyer beware. 

John Oliver skewered the financial advising industry in a video that went viral earlier this year. Does the bad behavior Oliver described mean you ought to go it alone when it comes to investing?

In the Aftermath of a John Oliver Takedown

Part 1 of our “Beyond Cash” retirement checklist

, we looked at your plans for your practice, health insurance needs, and some lifestyle considerations. Here in part 2, we’ll tackle estate planning, insurance considerations, additional income sources, and one big factor that sneaks up on some retirees.

How much you will withdraw from your retirement accounts depends on too many factors to list here. In fact, there are so many variables involved, it’s almost impossible to suggest a way to tackle withdrawals. But…some decisions will be made for you, like those associated with required minimum distributions. In short, by age 70 ½ (with some exceptions), you’ll need to start taking distributions from your tax-deferred retirement accounts, even if you’re still a working dentist. While you can still save, invest, and earn on the bulk of your retirement savings, amounts you must withdraw will start to impact the growth of your ongoing retirement investments. In a way, this requirement—in place because Uncle Sam can’t wait to get his taxes&mdash;can provide structure around what else you’ll take out and when. Talk to your financial advisor about distributions and finding a roadmap that’s right for you.

A few years before you consider retiring, review all of your existing insurance policies, including life, property, casualty, practice, and liability insurance. Make sure you’re covered for what you need, of course, but this is also a good time to eliminate any kinds of insurance you may still be carrying but no longer need. Also, consider where you’ll turn to health insurance after you retire.

Planning too far in advance may limit how much you can estimate retirement from other income sources, most notably Social Security. But once you get within a few years of your retirement date, you should have a pretty clear picture of what you can expect to receive. Note that you’ll have to file for Social Security a few months before you start to receive benefits. Also take into account all other retirement savings, including any from individual retirement accounts, 403(b) plans, pension plans, and other income strategies, such as annuities or reverse mortgages. (In a future column, we’ll discuss the more favorable view of reverse mortgages from many financial experts.)

This is another topic too large to cover for our purposes here, but the key is to make sure you have a will, living trust, or other legal documentation of how your assets will be distributed in the event that your retirement is cut shorter than you would like.

No plans are set in stone, and this goes double for retirement. Many retirees are caught off guard when a changing family situation or an evolving viewpoint from a spouse, partner, or other family member suddenly changes and can impact your retirement. For example, what if you miss your practice too much and decide you want to continue to see patients part time? What kind of impact would this have on your also-retired partner?

While you can’t prepare for a sudden change of heart or living situation, you can make sure you initiate regular communication with all those who may be affected by your retirement decisions. These conversations can be all the difference.

In Part 2 of our series, we look at the decisions you'll need to make and strategies you'll want to formulate as you approach retirement.

Beyond Cash: Your Pre-Retirement Checklist, Part 2

As we plan for retirement, many of us are understandably focused on income needs and sources. How much money you’ll have—and how much you’ll need&mdash;is obviously critical to a successful retirement. But focusing only on income and expenses can blind you to other essential considerations, including some that may end up having a truly significant impact on when you can retire and what your quality of life will be when you head for the sailboat, the Winnebago, or the beach, or the golf course.

With that in mind, let’s take a look at an oversimplified list of major decision categories you’ll want to consider as you near the big day, in two parts.

Our first item up for consideration is a bit of a cheat, because the eventual sale of your practice may be the single biggest factor in what your retirement income will ultimately be for some dentists, despite the risks to relying on the sale of the practice as your sole source of retirement income. For others, however, who may be leaving the practice to a family member or a group of partners, what happens with the practice may not necessarily be your biggest consideration. Make it one. No matter your situation, you’ll want to ensure that you answer the big questions about your practice long before the siren call of retirement lures you in.

This should be obvious to all, much less someone who works in the healthcare industry. But you’d be surprised how often even dentists fail to consider future health considerations and the impact they may have on your retirement income and quality of life. Before you retire, thoroughly and honestly assess the health of yourself and your immediate family members, consider items such as long-term care insurance, and don’t take it for granted that good health now will continue to eternity. Father Time is remarkably consistent in his ability to mess with people’s health as they age.

Estimating how much income you’ll need involves projecting out the kind of life you envision for yourself and your family when you retire. That lifestyle may involve traveling Europe, the going on safari, and wiggling your toes in the black sand beaches of the Caribbean. But it could also involve a lot of lower-cost activities like gardening, cooking, and reading. They key in anticipating your lifestyle in retirement is including flexibility. You may find that extra free time didn’t motivate you to become the homebody you expected to be. In that case, you’ll want to have the flexibility to increase your monthly spending without the very real and disturbing threat of running out of retirement money before that sudden desire to travel has been satiated.

Unless you plan to go back to work post-retirement, you’ll have much more leeway in your expenses than you will in your income. While you have a higher income now, consider whether building in that additional flexibility, even if it comes in the form of sacrifice now, might be wise.

In part 2, we’ll look at estate planning decisions, life insurance needs, and an unexpected factor that retirees often fail to consider.

Most of the words written about retirement focus on building a nest egg, but those who hope to retire someday must also plan for non-monetary considerations.

Beyond Cash: Your Pre-Retirement Checklist, Part 1

A new survey reveals that when it comes to financial matters, millennials are ready to step out of the shadow of the Baby Boomers and take control of their financial futures. The survey, from life insurance and financial services company Securian, found that 71% of millennial investors predict a bull market in the next one to three years, compared to only half of boomers who share that confidence.

In addition, the survey of 2,000 investors, evenly split between millennials and boomers, revealed that millennials are surpassing the previous generation in terms of investing with confidence. Forty-two percent of millennial investors say they are “very knowledgeable” about investments, compared to only 17% of boomers.

The findings are particularly interesting in these times of market volatility. The Brexit decision, financial concerns in Asia, and many other factors have contributed to significant concerns from investors and major swings in the key market indices. But survey respondents appear ready to ride the wave: only 12% of millennials say they are not very knowledgeable about investments, compared to 25% of baby boomers.

Interestingly, the familiar target number of $1 million needed for retirement still seems to be the benchmark number, even for a new generation. But while boomers are unsure if they’ll meet that goal (45% think it’s likely), more than half of millennials believe they’ll reach the goal. Perhaps they should aim higher; there is nothing magical about the $1 million figure. While that goal is a worthy one and is much more productive than having no goal at all, with growing life spans and increasing costs for healthcare and other goods, millennials and the generations after will be well-served to set higher goals.

A few other noteworthy findings from the survey:

• As investors, millennials buck the trend you might expect: they’re generally more conservative in their investing strategy than boomers are.

• Both groups seek advice from financial advisors at the same rate, 65%. Boomers are more apt to also use news outlets for advice, while millennials turn to family more often. (Good thing Mom and Dad are reading the news!)

• Millennials do use money management websites at much higher rates than do boomers.

• More millennials than boomers (42% to 29%) expressed high levels of concern about market volatility and its impact on them reaching their retirement goals. They also project confidence about their understanding of the volatility, and are more likely to take action to mitigate volatility.

 for more information on the survey, which was conducted late last year.

Survey sheds light on differences between millennial and baby boomer investors.