Through my years of following the markets, I’ve identified many mistakes that investors make again and again. Even experienced investors are prone to some of these common errors. How many of these investing mistakes are you making?
Not Investing Enough
It takes money to make money, and many physicians are simply not putting enough of their earnings into the markets. Aim to save at least 20% of gross income and invest it (this includes 401(k)s, IRAs, 529s, taxable accounts, etc.)
Investing in high-cost actively-managed mutual funds
It is common for many physicians to have been guided towards high-cost actively-managed mutual funds. Maybe you read about some star fund manager in a popular finance magazine, or you had a financial advisor who selected these funds for you. Investment fees add up, and academic studies have repeatedly shown that the majority of actively managed mutual funds underperform the market in the long-run. Stick to low-cost, passively-managed index funds.
Not diversifying your investments
Diversification is one of the few free lunches in investing. You are able to maintain your expected return while reducing your risk. Diversification is so easy these days: just invest in a broad-based index fund and you now own hundreds or thousands of stocks with a single trade. It’s also beneficial to diversify between asset classes as well. Adding bonds to your portfolio helps you weather difficult market conditions, and there are some years where bonds actually outperform stocks.
Taking too much or too little risk
I see many physicians, especially young physicians, taking too much risk with their investments. As in life, they feel invincible, and inevitably they’ll talk about having a “high risk tolerance.” Like your patients who say that have a “high pain tolerance,” many physicians overestimate how much money they’re willing to lose before they sell their investments in a panic. On the other end of the spectrum, there are some physicians who take too little risk with their investments. Maybe they were scarred by the financial crisis, or are generally suspicious about the stock market. By taking too little risk, it becomes much more difficult to achieve your financial goals, since the stock market has much higher expected returns than bonds or CDs.
Trading in their taxable accounts
I discourage physicians from trading, because they are unlikely to consistently beat the market and trading incurs a lot of fees through commissions and bid-ask spreads. But if you must trade, do not trade in your taxable account. Any trading gains you do make in a taxable account is subject to short-term capital gains taxes, which is the same rate as your regular income. On the other hand, gains from investments held for more than a year are subject to a much lower long-term capital gains tax. If you must trade, trade in a tax-protected account like an IRA, and stick to long-term investments in your taxable account.
Not taking advantage of tax-loss harvesting opportunities
While no one wants their investments to lose money, you should take advantage of market downturns by using tax-loss harvesting techniques. You can take up to $3,000 in investment losses as a tax deduction. If you have more than $3,000 in losses, you can rollover the difference to the next year. For physicians in the higher tax brackets, you can save a lot of money with tax-loss harvesting. However, be careful of wash sale rules — you cannot buy a substantially identical investment 30 days before or after you take your loss.
Mixing insurance with investing
Insurance is good, and investing is good, but products that combine insurance and investing are almost always bad. I encourage physicians to buy term life and own-occupation disability insurance as a resident or shortly after starting their first attending job, and to avoid all of the other insurance products out there that make a lot of money for the insurance broker but don’t make sense for the typical physician.
Timing the market / Not sticking to a defined asset allocation
Many investors will fall into the trap of trying to time the market. They will try to call the end of the bull market and sell their shares, missing out on years of potential market gains. In addition, many people will bounce around between asset allocations based on what’s been doing well lately. One of the keys to investment success is discipline, and sticking to your defined asset allocation is a major part of staying disciplined.
Reading the Daily Market Headlines
Most of the time, the market is pretty boring. As a result, CNBC needs to fill the time with screaming talking heads and catchy headlines to keep viewers interested. Keeping track of the stock market on a daily basis will give you a constant temptation to trade or tweak your portfolio. I rarely check my portfolio, and there’s no need for a physician to be checking their investment accounts on a daily (or intraday) basis.
Investing in index mutual funds instead of ETFs in their taxable accounts
This is a common mistake that even some experienced investors make (read: me). When investing in index funds in your taxable accounts with Fidelity or Schwab, you should use the ETF version of the index fund, not the mutual fund version. The reason is that ETFs are more tax-efficient than mutual funds, and the after-tax returns of ETFs are slightly higher as a result. This advice does not apply to retirement accounts (where the tax treatment of ETFs and mutual funds are essentially the same) or Vanguard investments (where they have structured their mutual fund to act like an ETF from a tax perspective).
I hope this article has helped you identify some potential mistakes in your investment strategy. Because of the power of compound interest, small mistakes can add up to a lot of money over time. By avoiding these ten common investing mistakes, you are doing way better than the vast majority of physicians out there.
What do you think? How many of these investment mistakes did you make in the past (or perhaps are still making)? How common do you think some of these mistakes are among the general investing public?