Physicians + Money Management

If you've been in medicine for even a little while, you know there are a number of taboo subjects that just aren't discussed.

One of the most important discussions that medical students do not have while in training is the subject of money and overall financial management.

Last, at our most recent Medical Fusion Conference I was able to sit down with Dr. Setu Mazumdar, an Emergency Medicine physician turned financial manager.  Setu gives his perspective of "financial independence" in this interview.  Check it out...it's worth watching.  Hopefully, by learning a bit about finances while in training you'll avoid some of the common pitfalls of physicians and money.

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How to Navigate Market Volatility

Here's a great interview with John Bogle, founder of Vanguard, on how you should navigate any market volatility. Get through the commercial and watch this video. It's definitely worth your while and will only take less than 4 minutes:

There are some great take home points that Bogle makes. I've added some of my thoughts on this as well:

1. You can think of the daily swings in the market as pure speculation. Speculators are trading with other speculators daily and causing wild swings in the market. In the long run, however, markets reflect the growth of economies around the world. If you're a long term investor, you participate in this long term growth.

2. I love it when he says that one day the markets act as if it's the apocalypse and the next day it's nirvana. Just scan the media headlines everyday. It seems like one day the markets plummet because they anticipate another recession and the very next day the markets soar because they anticipate higher economic growth. The point is, you just can't predict any of this.

3. Another timeless Bogle quote is to "Don't do something. Just stand there." Psychologically you're tempted to do something in investing--usually this means selling when the stock market goes down. But it's incredibly difficult to know when to get back in. And usually "doing something" causes more harm than good.

4. If you are going to do something, then rebalance your portfolio within reason. This means to buy stocks at lower prices. So if your target allocation is 70% stocks and 30% bonds, perhaps now you're at 65/35. That means you should rebalance back to 70/30 either with new cash flows or selling some bonds and buying stocks.

5. Is this a "new normal" in investing? I'll write more about this in future posts, but according to Bogle, the boring buy and hold strategy of investing still works if your time frame is long enough. Remember that the timeframe for your portfolio is your entire investing lifetime not just until the day you retire.

6. Finally a great point made here is that you have better things to do with your life than to look at the daily speculative swings in the market. Don't let it distract you from the truly important things in your life--your family, your health, and your career. A well structured portfolio--like the ones I create for my clients--frees up your time to focus on the truly important things in your life.



6 Simple Tips To Embrace Stock Market Panics

What should you do when the market panics? Embrace the opportunity!

The world seems to be coming to an end, markets around the world have had steep drops, and investors are racing for the exits. But if you've got a sound long term investment plan and you've created a well structured portfolio, you shouldn't be panicking at all. No, you should actually be taking advantage of the market panic.

When I worked in the ER, my colleagues called me a pessimist. Rising malpractice premiums, flat reimbursements, increasing workload…there really weren't any good trends in emergency medicine. Similarly, all you're hearing right now in the financial markets is a bunch of bad news: US debt losing it's AAA rating, Europe's debt crisis, high unemployment, slowing economic growth, and so on. There's almost nothing positive in the news right now. While the skies are covered with doom-and-gloom clouds, here are some great reasons to like (dare I say enjoy?) market panics:

Reason #1: Buy cheap stocks

I love Wal-Mart. I actually get a thrill from buying everything from groceries to jeans for some dirt cheap prices. When it comes to investing, however, it seems counterintuitive to buy when others are selling. “Buy low, sell high” seems so easy to say but so emotionally wrong to do. After all there is a cliché in investing which says that the best time to buy stocks is when there is “blood in the streets.”

When perceived risk is high, stock prices go down because investors need to be compensated more for taking on risk. This means that future expected returns are higher. The problem is that no one knows when those returns will happen. But the point is that market panics allow you to buy at lower prices.

Reason #2: Buy more shares

Suppose you bought 20 shares of a stock for $50 per share for a total outlay of $1000. Then, nine months later the share price is $40, a 20% drop (bear market territory). Assuming you still believe in the merits of the investment, you can now purchase 25 shares for the same outlay. This technique, known as dollar cost averaging, assures you that the average price per share is lower than the average of the two prices because you have bought more shares at the lower price. More aggressive investors can use a technique called value averaging, whereby you buy enough shares to obtain a desired dollar amount. In the example above, to end with an investment amount of $2000, you would actually buy 30 shares of stock at $40. These techniques do not assure you of any gain or avoid losses because the stock price can go even lower, but at least it does assure you of reducing your average purchase price.

Reason #3: Reduce your taxes

If my portfolio is tanking, I may as well let Uncle Sam feel some of the pain. If you sell a stock for a loss, you can deduct up to $3,000 of the loss against your ordinary income. If you're in the 35% federal tax bracket, the $3,000 deduction equates to a tax savings of $1,050. Also, if your losses exceed $3,000 you can actually use the excess losses as deductions in future tax years indefinitely. While tax deductions imply stock losses, they also act as cushions to soften the blow.

Reason #4: Dump your losers

Have you gotten emotionally attached to your investments? Market panics should make you question why you bought a particular stock or mutual fund in the first place. Did you buy the stock because you researched the company’s balance sheets, quarterly reports, and financial ratios? Or did you buy the stock because you overheard a surgeon in the doctor’s lounge boasting about how he made a 50% return in just two months? (If this happens, I suggest you ask him why he’s still working 70 hours a week).

Even if you bought a stock or other investment which has positive returns, bear markets are good times to sell those investments if you should not have been purchased them in the first place. One strategy here is to sell these winning investments and avoid a taxable gain by offsetting those gains with losses from other losing investments.

Reason #5: Gauge your risk tolerance

For most investors risk tolerance is directly related to stock prices: in bull markets risk tolerance increases, and in bear markets risk tolerance plummets. One way to determine your willingness to take risk is to evaluate your emotional response to this year’s bear market. There's no better way to know your true risk tolerance than to lose a truckload of money in a short amount of time. Did you sell and invest in cash, or did you load up on Citigroup as it tanked almost 20% today? Another way is to quantify this risk by determining your maximum drawdown, which is the highest percentage loss you are willing to accept before selling an investment. Determining your maximum drawdown over one, three, and five year periods can help you build a more disciplined portfolio and stick with your investment strategy when the next bear market comes out of hibernation.

Reason #6: Appreciate your job

If you've got a job that's pretty stable, savor it. For example, while there are numerous challenges to practicing medicine today, one thing is certain—the demand for physicians and other health care providers and health care affiliates (pharmacists, PAs, nurse anesthetists, etc.) is strong. In effect, your income is similar to a bond in the sense that there is low risk of default (unemployment). If you're a physician, your period of extended “unemployment” occurs right at the beginning of your career (medical school and residency). If you consider your career as a bond, you can actually take a bit more risk with your stock portfolio. While other professions and industries layoff workers, it seems nearly every week my mailbox is flooded with emergency medicine job opportunities across the US. My investment portfolio may be struggling, but my value in terms of human capital is stable. Market panics should make you appreciate the stability of your career.

And finally remember that stock market panics are a normal part of investing. If you don't have a solid investment plan that's addressed potential losses you could suffer in your portfolio, then you need to get one...now! And that's one way I help my clients stay disciplined during market panics.

The Importance of Investment Benchmarks

I dare you to ask any of your colleagues, or even your financial advisor (if you have one), about how their investments are doing.

Most people will say something like, "I'm doing fine" or "I don't know."  Most advisors will simply print some standard brokerage report for the accounts they're managing and tell you the return number.

Either way it's wrong.

One problem is that most people and advisors don't look at the whole picture, which includes your and your spouse’s investment accounts, including your 401k accounts.

The second problem is that most people don't use the appropriate benchmark. A common mistake is that people compare their investment returns with the U.S. stock market averages. But if your overall portfolio contains some bonds and international stocks it is no longer valid to compare your portfolio to a benchmark that consists only of U.S. stocks.

So what you need to do is break down your entire portfolio into its components and then design an appropriate benchmark to evaluate investment performance.

For example, let's say that your portfolio has 50% in U.S. stocks, 20% in international stocks and 30% in bonds. The appropriate benchmark to use is a combination of a U.S. stock index, an international stock index and a bond index in the same proportions as your portfolio.

However, you must realize that your portfolio percentages will change as each asset class has different returns. This will throw off your comparisons to appropriate benchmarks, which will be static.

Finally, if you have an advisor who is trying to sell you a mutual fund that has "beaten" the market, one of the first things you should do is look at what benchmark the fund is using to make its claim of outperformance. If you do this, the outperformance goes away for the vast majority of funds that claim to have skillful money managers.

The bottom line is that when you look at your portfolio performance, look at the whole pie not just the pieces. And make sure you're comparing it to a relevant benchmark.

In future articles, I’ll discuss different ways of calculating investment performance. It looks deceptively simple, but in reality it’s more complex.
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Physician Investing: Why Indexing Works

Watch this short video from Vanguard to learn why index funds beat actively managed funds.

Here are a few highlights from the video:

1. Investing is not a zero sum game but active management is a zero sum game. What this means is that when you invest in the market you are expected to be rewarded over long periods of time with market returns. As a group active managers must have the same performance as index funds BEFORE fees. After fees, active managers as a group always underperform an index. This has to be the case because the market is made of active managers and passive investors. So if the passive investors are getting the market return then it has to be the case that active managers are also getting the market return.

2. There will always be active managers from one year to the next who outperform an index. The problem is that the active managers who outperform in one year are unlikely to repeatedly outperform in the next few years.

Remember that active managers are smart people. I'm not suggesting they are dumb or incompetent. What I'm saying is that the competition between active managers is so high that it's almost impossible to outperform an index consistently in the long run.

Do You Understand Your Investments?

Do you really understand all of your investments and wealth strategies as a physician.

I’m fairly certain that when I see patients, they have no clue what most of the medical terminology means, such as “cholecystectomy,” or “conjunctivitis,” or “myocardial infarction.”

So I try to say these things in terms they understand, such as, “You have stones in your gallbladder and they need to be removed,” or “You have pink eye,” or “You’re having a heart attack.” Now those are concepts they can grasp.

It’s the same way in investing. If you’ve hired a financial advisor, you need to know what you are invested in and why. But I bet that you don’t know what you’re invested in, and I’m almost certain you don’t know why you’re invested in it.

I’ve got a theory about why financial advisors purposefully make investing far more complicated than it should be: Many want to confuse clients in order to justify their high fees -- either that, or they’re just plain incompetent.

Here are some things you need to understand and ask about your own investments, whether you do it yourself or hire an advisor:

Why do I own these particular individual stocks?

There are close to 15,000 publicly traded stocks in the world. If you own just 50 or 100 of them, then what about the other 14,000-plus stocks out there? How do you or your advisor know that those few that you have are the winning stocks? Think about it. If you have 50 individual stock in your portfolio, you’ve covered less than 1% of the number of publicly traded stocks in the world. Academic data show that only a small portion of stocks in each asset class drive most of the returns within an asset class. What if you choose the losers? That gets to another point: Excluding all these other stocks out there implies arrogance -- that you know more than the collective wisdom of millions of investors out there. What’s the chance of that?

Why do I own these mutual funds?

Just like individual stocks, there are thousands of mutual funds out there. You need to understand what role each fund is playing in your overall portfolio. Mutual funds are simply tools to fit your asset allocation, which is the mix of broad investments that is right for you. If the title of the mutual fund does not make sense, then you’ve seriously go to question the fund’s role in your portfolio. For example, if you own Oppenheimer Quest Opportunity Value Fund, what the heck does that invest in? The name makes no sense and I know you or your advisor don’t know what it does. Instead if you own Vanguard Large Cap Index you know that it’s an index fund that owns every U.S. large company.

In a future post, I’ll give you more thought-provoking questions you need to ask yourself about your investments.

The bottom line: Ask yourself, ‘Why do I invest in this but not that?”

Hey Doctor, What's Your Personal Rate Of Inflation?

I’ve noticed a disturbing trend over the past few years: my gross income has declined but my workload has increased.

I make less per patient and per hour now than I did over five years ago. Whether the reason is malpractice premiums, flat insurance payments, inability to increase fees and collect them, or corporate practice of medicine, one thing is certain: I’m not alone. According to the Medical Group Management Association, in 2006, physicians in my specialty reported a compensation increase of just 2.7%, compared with the inflation rate of 3.2%. We all know why we are feeling the squeeze but the question is, what can we do about it?

Inflation is a general rise in the price of goods and services in the economy. It results in a loss of purchasing power if income fails to keep up with inflation since each dollar of income will buy less of a good or service than it did previously. Inflation is usually measured by the Consumer Price Index (CPI), which reflects the weighted average price of a basket of goods and services consumed by the average household. From 1926-2010 inflation has increased at an average rate of about 3% annually. However, there have been periods such as the 1970s and early 1980s when inflation increased by over 10% annually.

Personal rate of inflation

It should be noted that these numbers deal with averages; a more appropriate measure of inflation for an individual is the personal rate of inflation. Inflation affects individuals differently depending on individual income, geographic location, consumption of specific goods and services, and allocation to various investments. For example, a married physician living in New York City with two college aged children may be more sensitive to inflation due to higher housing costs, heating costs, and education costs than a single physician living in the rural Midwest with no children. The only way to determine your personal rate of inflation is to accurately measure your yearly personal expenditures and compare that with your yearly income.

6 STRATEGIES FOR FIGHTING INFLATION

Work more, faster

Simply put, if your personal rate of inflation exceeds your rise in income, you can always work faster, see more patients, do more procedures, or work more shifts. For incentive-based physicians, seeing more patients per hour not only increases gross income but it also increases pay-per-hour. However, at some point you reach a limit to the number of patients you see per hour, and you increase the risk of making mistakes leading to possible malpractice lawsuits. Similarly, there comes a point where the number of days or shifts you work compromises your lifestyle.

Budget living

A second way to address the inflation gap is to reduce your personal expenses by adhering to a budget. After all, do you really need heated car seats when you live in Florida? Do you need to finish the basement on your 5000 square foot house when you have no children and face $100,000 in student loans? Of course some expenses are fixed, such as mortgage payments, insurance premiums, and child care expenses for which expense reduction is nearly impossible.

Real returns

The third option is to generate inflation-beating returns (known as real returns) from your investments. The goal is to preserve an investment portfolio’s purchasing power so that future liabilities, which increase at the rate of inflation, can be adequately met by an equal or greater increase in assets. Due to the compounding effects of inflation, there is a greater erosion of purchasing power as the time horizon lengthens. Assuming a 3% inflation rate, your purchasing power declines by over half in 25 years, which is well within an individual’s investment timeframe. With just a slight increase to 4%, it declines by nearly two-thirds. In other words, it would take twice as many dollars in 25 years to purchase the same goods and services as it would today assuming average inflation, and almost three times as many dollars assuming inflation rate is 4%.

Next time I’ll talk about some investment strategies to beat inflation.