How to build a reasonable long-term investment portfolio

Most investors, including physicians, are focused on the wrong things when it comes to their investing plan. They focus entirely too much on investment selection and not nearly enough on what matters most. What we all want is to own investments that never go down in value—and preferably always go up rapidly! However, the problem is that all of our crystal balls are cloudy about future investment performance. The data is very clear that you are highly unlikely to be able to choose outperforming stocks (or any other investment) over the long term. Unfortunately, the crystal balls of your investment advisor, mutual fund manager, hedge fund manager, and favorite guru are all cloudy, too. The truth is that you need an investment plan that does not require you to predict the future to be successful.

Once you have a reasonable investing plan that is highly likely to succeed no matter what happens in the future, there are two key behaviors that must be paired with it. The first is to fund it adequately. The key to having plenty of money in your investing accounts is to put plenty of money into them. When our investing accounts hit $1 million for the first time, I was not surprised to see that 80% of it represented nothing but brute force savings. It was simply money that I had earned but put into the investing accounts instead of spending it. Too many investors are relying on hope and dreaming about compound interest to make up for a late start and a low savings rate.

That’s a bad idea.

By starting early and maintaining a reasonable savings rate, you can maintain your accustomed standard of living during retirement without taking on a ridiculous amount of investment risk. Your savings rate is simply how much money you are putting toward retirement (including any employer matching dollars) and your total income (including any employer matching dollars). For a typical physician, that savings rate needs to be in the neighborhood of about 20% to maintain your standard of living after a career of typical length.

The second key behavior is sticking with the plan. Jack Bogle, the founder of Vanguard, famously said, “Stay the course. No matter what happens, stick to your program. I've said stay the course a thousand times, and I meant it every time. It is the most important single piece of investment wisdom I can give to you.” Without a knowledge of financial history and a fair amount of discipline, it is challenging for an investor to not panic in a market downturn and sell their stocks just before the market rebounds. A long-term perspective would reassure them that the market is highly likely to recover within just a few years, which is almost always a lot shorter time period than their investment horizon. Panic-selling late in your career just once or twice may implode an otherwise perfectly adequate investing plan. Repeatedly buying high and selling low is a recipe for financial disaster, but it is hardly uncommon among uninformed or undisciplined investors.

A reasonable investing plan takes on enough risk to reach your investing goals but not so much to result in panic-selling due to inadequate risk tolerance. For most investors, that means a majority of the portfolio needs to be invested in stocks, real estate, or similarly risky investments. You just need your portfolio to grow, and without investment returns significantly higher than the rate of inflation, after-tax, it isn’t going to do that. If you want to put all of your money into relatively safe investments like cash, bonds, certificates of deposit, and whole life insurance, you’ll need to save 50% (a whole lot more than 20%) of your gross income for retirement.

However, having some cash or bonds in your portfolio will reduce portfolio volatility and help you to stay the course in a market downturn. Thus, most successful investors have a stock-to-bond ratio somewhere between 50% and 90%. It is best to keep your ratio lower than you think you can handle in a market downturn until you have been through one or two of them and proven it to yourself.

A reasonable investment plan is also diversified, both between asset classes and within them. An asset class is simply a type of investment—like stocks, bonds, or real estate. Each of these asset classes can also be divided into subclasses, such as domestic and international stocks or nominal and inflation-protected bonds. By owning three to seven asset subclasses, some parts of your portfolio should be zigging while other parts are zagging. Diversification means always being unhappy with the performance of some part of your portfolio but only rarely being unhappy with the overall performance.

Even within an asset class, you want to diversify as much as you can. For example, there are approximately 4,000 stocks representing publicly traded companies based in the United States. Every year, a few of those companies go bankrupt, wiping out investor capital. Why only own one or two of them, such as Tesla or Walmart, when it is so easy to own thousands of them? By using a “total market” index fund, you can essentially own all of them. You will get the market return, and over the long run, the data is clear that this approach will beat 90%-95% of “active” investors—and that’s before tax. Once you include the tax costs inherent to active management, the data gets even worse.

A reasonable investment plan is also low-cost. Index funds these days charge 0%-0.1% per year as an expense ratio (fund expenses divided by total fund value), which is 1/10 or even 1/100 of what most mutual funds used to charge and some still do. Investing has become essentially free these days. By monitoring investment (including advisory) costs and knowing the going rate for these costs, you can minimize the drag of these costs on your investment returns and reach your financial goals as soon as possible without taking on undue risk.

A reasonable investing plan uses a static asset allocation, or mix of investments, over long time periods, and it’s rebalanced back to its designated percentages periodically. This maintains your selected risk level and forces you to sell high and buy low, rather than vice versa.

While choosing investments can be sexy and exciting, the truth is that investment success is typically much more dependent on the more boring aspects of investment management, such as savings rate, asset mix, diversification, and investor behavior. Investing isn’t supposed to be exciting, and good investing usually isn’t. But what good investing can do for your life and career absolutely is exciting.

James M. Dahle, MD, FACEP is a practicing emergency physician and the founder of The White Coat Investor. After multiple run-ins with unscrupulous financial professionals early in his career, he embarked on his own self-study process to become financially literate. After seeing the benefits of financial literacy in his own life, he was inspired to start The White Coat Investor in 2011 to assist his colleagues.