Higher returns are often correlated with higher risk when it comes to investing, but there are several ways to boost your investing returns without increasing risk in the short or long term.
Most investors, physician or otherwise, need relatively high returns in order to achieve their financial goals. However, many experts feel the returns of bonds, stocks, and even real estate are likely to be lower in the foreseeable future than they have been historically. Bond yields, in particular, are at 30-year lows. The stock market is nearly seven years into a bull market and good deals in real estate are becoming harder and harder to find as the economy recovers. Higher returns are often correlated with higher risk when it comes to investing, but there are several ways to boost your investing returns without increasing risk in the short or long term.
Achieve Market Returns
Despite decades of academic literature suggesting the need to change strategies, many investors are still unknowingly engaged in a vain pursuit to beat the market over the long run by selecting individual securities and engaging in market timing, or more commonly, hiring a mutual fund manager or financial advisor to engage in these same deleterious behaviors. Investors in the know, on the contrary, have realized that these behaviors are far more likely to result in underperforming the market than in beating it. The sophisticated solution is also the simple solution—guarantee yourself market returns by investing in low-cost index funds. It turns out that it is quite difficult to beat the market after the expense of trying to do so, but it is very easy and inexpensive to match market performance. Low-cost index funds, available through many companies such as Vanguard, Fidelity, Charles Schwab, and the Federal TSP, are available in many asset classes including stocks, bonds, and real estate of all flavors. Eliminating the likelihood of underperformance boosts your expected return while simultaneously reducing your investment-related risks and costs.
Another guaranteed way to boost your investing returns is to lower your investing-related fees. These include advisory fees, commissions, spreads, expense ratios, and wrap fees. It is not uncommon to see investors paying 2% or even 3% in total fees every year. Even if an investor managed a return of 8% a year before fees, if he is paying 3% a year in fees, he will end up with 43% less money (and retirement income) after 30 years. While most investors cannot reduce their fees by 3% a year, many investors who start paying attention to their fees are able to reduce them by 1% a year or more. Every dollar paid in investment expenses comes directly from your investment returns. Reduce the “drag” and your nest egg will grow much faster. Some easy ways to reduce fees include eliminating “churn” by engaging in fewer transactions and using the mutual funds in your 401(k) with your lowest expense ratio. Many investors can also lower advisory fees by negotiating with their current advisor, moving to a lower cost advisor, or even learning to manage their own portfolio. While individual investors often lack the knowledge of a professional, sophisticated investment management can be surprisingly simple, and if nothing else, the investor can rest assured that he won’t rip himself off!
One of the largest expenses for many investors is the taxes due on interest, dividends, and capital gains generated by investments. By investing in a tax-efficient manner, this expense can also usually be reduced significantly. This can be done by maximizing the use of retirement accounts such as 401(k)s and Roth IRAs. Using tax-efficient investments, such as index funds and municipal bonds in non-qualified (taxable) accounts also reduces the tax bill. Holding investments with capital gains for at least one year allows those gains to be taxed at the lower rate reserved for long-term gains. Tax loss harvesting any investments with capital losses can further reduce the tax bill. After applying the effects of investment expenses, taxes, and inflation, many investors don’t have any return at all. There isn’t much you can do about inflation (aside from taking sufficient investing risk that you can outpace it) but an investor can exert a surprising amount of control over his fees and taxes.
Another way to boost investing returns without taking on any additional risk is to diversify into other high-returning asset classes. For example, instead of simply investing in US stocks, an investor could add an investment in international stocks and one in real estate to his portfolio. Since each of these investments has similar, high returns over the long run, but varying returns over the short run, holding a fixed percentage of each of these assets and periodically rebalancing them reduces portfolio volatility, reducing risk and increasing returns. The lower the correlation between the returns of the various asset classes, the more effect this diversification will have. Bear in mind that diversifying into some lower-returning asset classes, such as bonds and precious metals, may reduce risk, but is also likely to reduce long-term portfolio returns.
Very few investors have the luxury of only needing low returns to meet their goals. Achieving acceptable returns in our current low-yield environment can be made much easier by achieving market returns, reducing investment expenses, decreasing taxes, and diversifying the portfolio. The sooner you take these steps with your portfolio, the larger your nest egg will become, allowing you more money in retirement, more time in retirement, or both.
Dr. Dahle is not an accountant, attorney, insurance agent, or financial advisor. He blogs as The White Coat Investor and is the author of the best-selling The White Coat Investor: A Doctor’s Guide to Personal Finance and Investing.