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.

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?”

Toss Your Quarterly Investment Statements

Now that it’s a new year, you're about to receive your fourth quarter 2010 investment reports.

If you have a financial advisor he might send you his own quarterly report detailing your performance for the last 3 months down to the penny---every stock, mutual fund, and account he manages. Along with those reports you’ll probably get some sort of outlook for 2011 and a review of the significant events of the last 3 months of 2010.

The reports will say something like this:

“The last quarter of 2010 saw a surge in US equity markets driven by increased risk appetite by investors as they shrugged off stagnant unemployment reports and rising interest rates.”

“The bond market began to fall as investors feared rising interest rates, making short term debt relatively more attractive at current valuations.”

“Our outlook for 2011 remains cautiously optimistic. After a 20 month run up we think equities are probably overvalued and remain bearish in the near term but cautiously optimistic in the intermediate term. Therefore we recommend a more defensive stance and recommend more exposure to large blue chip stocks with stable growth such as consumer staples and healthcare industries.”

While all of that sounds impressive, what exactly do you or advisor do with that information?

How about this: ignore all of it because it’s a complete 100% waste of your time. Here’s why.

First anytime you read a review of economic events in the past quarter, those events have already happened so it’s too late to adjust your portfolio to those events. Yes, unemployment was 9%. Yes, interest rates rose. Yes, manufacturing was flat. The problem is that none of this predicts what will happen this quarter.  And even if it did, you and your financial advisor are not the only ones who know this information. None of this is a secret. Everyone else already knows. So prices have already adjusted for this information and by the time you know it, it’s too late to adjust your investment portfolio.

Second, you’ll read incredibly vague phrases like “cautiously optimistic.” What exactly does that mean? I have no idea, neither do you, and I can assure your advisor doesn’t either. But it creates the illusion of sophistication. Speaking of that, what does “near term” mean? Is it the next hour of trading, the next day, next week, next month? What about intermediate term? Investing is a LONG TERM process, so why all the talk about last quarter and the near term? But financial advisors purposefully use nebulous terms like this to make themselves look smarter than they really are. Think about it –if you don’t define exactly what these terms mean, then no matter what happens to the market or the economy, the advisor will tell you he’s right. If the market goes down, he’s right because he’s cautious. If the market goes up, he’s right because he’s optimistic.

Third, how can anyone or a group of people understand something as complex as the economy or the stock market and predict where they’re headed? The Fed can’t do it. Mutual fund managers can’t do it. How do you expect you or your financial advisor to do it?

Fourth, while last quarter’s performance was probably pretty good, there’s no predictive value for this quarter’s performance or even this year’s performance. What’s more important is figuring out your performance in relationship to meeting your future goals.

So when you receive your quarterly statements skip the economic outlook and summary. Instead focus on more meaningful things such as: do you have the portfolio that’s right for you? I’ll tackle that question soon.

Wealth Transfer: Preparing for the End

As a physician, getting your financial house in order is an organized process just like seeing and treating patients.

Let’s summarize what I’ve been discussing in previous posts:

1. Forget investment products. Your personal goals should be the primary driver of the rest of your financial life. 
2. Before you focus on investments, protect what you already have. 
3. After you’ve secured your assets, only then can you focus on building your wealth portfolio.

And that brings me to the final big area of your financial life you need to address in order to have a unified wealth management plan. And that’s wealth transfer, which is the efficient redistribution of your wealth after death and during life.

Notice that most people think of transferring their wealth after death via a will, but that’s only one aspect of wealth transfer. Wealth transfer encompasses 3 aspects of financial planning: estate planning, gifting, and education planning.

Let’s take a look at the relevant questions you need to answer to have an effective wealth transfer strategy:

1. When was the last time I reviewed my will with an estate planning attorney?
2. Alternatively, do I even have a will? (I know numerous physicians who don’t have a will, so if you don’t, then draft one…NOW!)
3. Who are the executors, trustees, and beneficiaries in my will and are they still accurate?
4. Do I have successor executors and trustees in my will?
5. Are appropriate provisions in place for minor children, such as naming guardians?
6. Have I titled my assets to minimize the chance of being subject to probate after I die?
7. Have I titled my assets to minimize the effect of estate taxes upon my death?
8. Will I or my spouse be subject to estate tax upon death?
9. Are the beneficiary designations on my life insurance policies as I wish? Do I have secondary beneficiaries on my life insurance policies?
10. Do I have a durable power of attorney, a living will, and a power of attorney for health care?
11. Do I need to buy permanent life insurance for liquidity purposes upon my death?
12. Do I need to start a gifting program during life to remove assets from my estate?
13. Am I giving to charity in the most income tax and estate tax efficient way?
14. Do I have provisions in my will to give my wealth to my favorite charities (for philanthropic reasons and for estate tax reasons)?
15. What types of trusts do I need to set up during life and after death for estate tax minimization, asset protection, and for appropriate distribution of my wealth?
16. What types of college funding vehicles are most tax efficient and how much do I need to save for my children’s education to meet their college funding requirements?

That rounds out a good list of questions that you need to address to get your entire financial life and wealth management plan in order—from wealth protection to wealth enhancement and ultimately to wealth transfer.

But, as they say, that’s just the beginning. Now it’s time to start implementing strategies to meet your goals. And that’s what I’m going to help you with from here on.

Wealth Enhancement: Build Your Portfolio

As a physician, is your wealth manager asking you the right questions to manage your investment portfolio?

In a previous post I discussed the most important step in getting your financial life in order—and that’s to determine exactly what your goals are. Everything you do falls into place and has a purpose based upon your financial goals.

Then, before actually building wealth you need to protect what you already have and proactively protect what you will have through appropriate asset protection and insurance planning. 

Only after you’ve done that can you focus on building your wealth to achieve the goals you’ve set.

Wealth enhancement can be broken down into 2 areas: investment portfolio management and retirement planning.

One of the things that irks me about most financial advisors is that they dump their clients money into a mishmash of investments without any sense of purpose or figuring out how much risk you really need to take in order to achieve your goals. They also typically look at investments in isolation to the rest of the wealth enhancement process, and that’s a mistake.

So what are the questions you or your advisor need to answer before implementing a wealth building strategy?

Here’s a start:

1. How much risk are you able to take in your investments?
2. How much risk are you willing to take in your investments?
3. How much risk do you NEED to take in your investments to achieve your retirement goals? (This is THE most important question)
4. What is the proper mix of investments (asset allocation) that meets your ability, willingness, and need to take to risk?
5. How will you change your asset allocation as your age and as your life circumstances change?
6. How do you properly diversify an investment portfolio?
7. What specific investment products do you need?
8. What specific investment products should you avoid? (This is just as important as determining what you need)
9. How do you minimize taxes in your portfolio?
10. How much do you need to save to meet your financial goals in retirement?
11. What are the chances that you will meet your retirement goals?
12. What options do you have if you cannot meet your ideal retirement goals?
13. How do minimize the chance of outliving your money? (This is THE ultimate goal of any financial plan)
14. How does inflation impact my future spending and how does that effect my savings rate and asset allocation?
15. How do I allocate investments across different accounts?
16. What is the role of annuities, and do you need an annuity?
17. Which type of retirement accounts are appropriate for me (IRA, SEP IRA, solo 401k, etc.)?
18. Should I invest money in Roth accounts or traditional accounts?
19. When should I take Social Security?
20. Do I need long term care insurance and if so how much and what type?

As you can see your financial plan is not just about investments It’s about integrating your investments with the other critical parts of wealth enhancement and ultimately your comprehensive wealth management plan.

First Things First: Handle Your Finances As A Physician

As a physician wanting to control your career, you're going to need to get your finances in order first.

Over the past few posts we've discussed the idea of taking responsibility for yourself and not waiting for others to come save you.  You've hopefully begun reading the blogs of a few of the adventurous souls who have found ways to live interesting lives, and learned about some of your career options here on Freelance MD.  In this post, we're going to discuss the first and primary means of addressing your confinement in a frustrating career.

If you want to begin living a different life, if you want a new career path and you want to branch out from the doldrums of your current career, the first and most important thing you will need to address is your inability to handle your personal finances.

How do I know you aren't handling your finances well?

Well, I don't mean to stereotype you, but let's face the facts: you're a Westerner living in a very materialistic culture that often defines itself by its material possessions, and you're in a profession that puts pressure on you to look and act in a successful manner.  

There are a few American physicians who have developed patterns of proper financial responsibility, but most have not, and one certainly doesn't develop these patterns by accident. These patterns and habits are developed through many deliberate choices day after day until they become second nature, but they are fought tooth and nail by the culture around us.  As physicians we feel the "need" to drive a certain car, have our kids in a certain school, have a certain type of house in a certain neighborhood, and be members of certain clubs.  The current of life in medicine carries us away from sensible financial decisions, and many, many physicians are drowning in their careers due to bad decisions regarding money.

This toxic financial culture in medicine was discussed in the popular book, The Millionaire Next Door .  In this text, authors Stanley and Danko discuss who the really rich in American society are, and usually it's not the professional class.  They note that there's a difference between looking rich and being rich.  Many physicians look wealthy, but when you scratch beneath the surface they're drowning in debt and working 80-100 hour weeks just to break even.  They overspend because they feel entitled to nice things due to their prior sacrifice of years in school and long hours at work (or are simply very foolish), never realizing until too late that they're boxing themselves in financially and completely undoing their financial future.

Of course, while physicians themselves are mostly to blame for this (remember, personal responsibility...you are not a victim), medical schools could do a lot more to help the situation.  It is appalling to me that we have a medical educational system that takes bright, idealistic students, trains them to be physicians, and then casts them out into this current healthcare world without any sort of training or discussions in financial management, various specialty salaries, billing and coding, practice management and the like.  It's more than appalling really, it's completely unethical, and those leading our nation's educational establishments should be embarrassed by what's happening.  

Dr. Robert Doroghazi, author of the book, The Physician's Guide to Investing: A Practical Guide to Building Wealth , said it this way: 

"I believe the position of the academic medical establishment to deny medical students financial instruction is naive, hypocritical, and indefensible.  They should acknowledge that money is important.  It is never as important as your patient.  It is never as important as your family, your health, your freedom, or your integrity.  But is is important."

Unfortunately, I do not believe this ridiculousness in our medical educational system will change any time soon.  As a matter of fact, I received a phone call recently from a medical student who is torn between a couple of different specialties and called to ask my opinion about his situation.  One of the things he said that stuck with me was, "Every time I try to ask questions of people at my medical school about salaries or financial issues, I'm either looked at in a weird way or people tell me not to worry about it. It's like they're wondering, 'Why would you even be asking that?'"

The naivete of our training coupled with a culture that pushes consumerism and materialism has undone the careers of many physicians.  It's a tragedy. 

The good news is that it doesn't have to be that way. You can make choices that alter your financial future and therefore alter your life.

Here's a project...

If you are serious about career modification and you're serious about making significant changes to your future, then sit down and take a good hard look at your finances.  If you're honest, what you'll find is that a lot of things your money goes towards are "wants" not "needs" and if you're ever going to be free, you need to take that "want" money and use it to pay down debt and increase savings so you can break free of the rat race you're in.  

This must be done.  

There's no other way.

If you cannot take this first step, then all the other steps are superfluous. 

We're going to be talking more about this concept in the future, and we're pleased that Dr. Setu Mazumdar is one of our authors.  In addition to being a board certified Emergency Medicine physician, Dr Mazumdar is a financial planner and the founder of Lotus Wealth Solutions where he counsels physicians on money issues.  Be sure to check out his posts here on Freelance MD and watch for more good counsel from him in the near future.  

For those of you who want to go ahead and begin getting control of your finances, a good place to start is the Money 101 website from CNNMoney.com .  No website is perfect, of course, and we're not unequivocally endorsing any site or any person (please use your head), but the Money 101 site does have a lot of tools to get you started if you need someone to simply help point the way.

So there you go, your first homework assignment on your road to freedom: handle your finances.

It can be really tough at first, but in the end it is absolutely necessary if you want to modify your career and begin living a better life.  

Keep checking back here on Freelance MD since in future posts we're going to be discussing specific things you can do to improve your financial lot and how to move forward with your plan to develop a new, more exciting future.

2011 Tax Law Changes Every Physician Needs To Know

The tax laws are changing in 2011. Here's how that will apply to you as a physician.

Recently I sent the following information to my clients regarding the 2011 tax law changes which are almost a done deal. Hope this helps you

You may have heard that a deal for 2011 tax laws is almost a done deal. I'd like to point out several things which will apply to you.

1. Federal income tax rates

Will remain the same as they are now for 2011 and 2012. However, we don't know what the cutoffs for the tax brackets are yet. It's unclear whether phaseouts for deductions on Schedule A of your income tax return will remain as is or will get worse next year. It looks like they will remain the same as now for the next 2 years. Obviously this is good news for high income taxpayers such as all of you.

2. Dividend and capital gains tax rates

Before this deal dividends in taxable accounts were going to be taxed at your highest rate, which was going to be 39.6% as of next month. However even the current dividend tax rate of 15% will stay on for 2 more year. This is also true for capital gains taxes, which were supposed to go up to 20% and instead will remain at 15% for 2 more years. If you have a taxable investment account, this will make it easier for me to rebalance portfolios since the cap gains rate will remain low.

3. Roth IRA conversions

I've already discussed and converted several of your traditional IRAs to Roth IRAs already this year. If you have not converted your traditional IRA to a Roth yet but are considering it, you may be OK doing it next year in order to defer paying taxes on the conversion. However, realize that by converting this year there is an option to spread out the income over 2011 and 2012 and that option is good ONLY for converting in 2010.

The other issue is that for those of you whom we've converted in 2010 already, it is probably more advantageous for you to spread out the income over 2011 and 2012 since tax rates will remain the same. Please discuss this option with your CPA when tax time comes. In other words instead of reporting the income on the conversion for 2010 only (this would be more advantageous if tax rates are going up next year) you may be better off reporting it in 2011 and 2012 in order to defer taxes to those years.

That brings up another issue—estimated tax payments. If your CPA plans on reporting this all in 2010, then adjust your 2010 Q4 estimated tax payment. However, if the plan is to split the income from the conversion in 2011 and 2012, then there may not be a need to adjust your Q4 estimated tax. Instead, you will have to adjust estimated taxes for 2011 and 2012.

And finally if you have nondeductible IRA contributions, remember that portion is not taxed on the conversion.

4. Estate tax

It looks like the estate tax exemption will be $5 million for 2011 and 2012. This changes things like whether to set up life insurance trusts. However, realize that this is once again a temporary rule and eventually this will change again in 2 years. So it may still be better to proactively address these issues rather than to address them later. But at least this might buy some more time.

5. Medicare investment tax is coming

For taxable investment accounts starting in 2013 there will be an additional Medicare investment tax on investments sold for a gain in addition to capital gains tax. This tax will be 3.8% on "high income" earners and will apply to both capital gains and dividends. This was part of the health care law passed earlier this year. Of course the details on this still have to be worked out.

Hope that helps put some of this in perspective. If you have any questions about this, please ask them as a comment and I'll do my best to answer them.