Understanding basic investment concepts and vehicles is helpful
Recent news stories have focused on the failure of various investment vehicles, reinforcing the importance of having a personal understanding of risk and a trusted advisor. The most important investment concept is to “get started!” The earlier you begin to invest, the longer your money is working for you. Compound interest and dollar cost averaging can help increase the value of your retirement fund.
Stocks and bonds, bulls and bears
Direct investments in the stock market are one option. Most financial advisors recommend a “well-diversified portfolio” of stocks and bonds that you select on your own or with the help of a professional.
Diversification simply means that you should own as many different types of stocks as possible—from large companies (“large cap stocks”), smaller companies (“small cap stocks”), international companies, and domestic companies. You should also have stocks in different industries, such as utilities, consumer goods, health care, and financial services. Finally, you should have investments in vehicles other than stocks. This helps spread your risk and is a much safer way to invest over the long term.
If you are passionate about a particular company, individual stock ownership may be the way to go. To build a portfolio based on individual stocks, you will need to consider allocating your assets among large cap, small cap, and international stocks, as well as bonds. Although large cap companies are generally considered safer investments than small cap companies, over time, small cap companies as a group may outperform large cap companies. One resource to help you assess small cap stocks is the Russell 2000 (www.russell.com).
Long-term investors who are also infrequent traders might consider an exchange traded fund (ETF) to help diversify their portfolios. ETFs make it easy and potentially less expensive to achieve diversification goals. Independent research firms such as Morningstar, Inc. (www.morningstar.com) have information on a number of ETFs.
One issue many investors overlook is the impact of fees associated with investments. Frequent trading or use of “full-service brokerage” services will require significantly higher returns to offset the added costs.
Allocating your assets
Asset allocation is a critical way to manage the risk associated with stock and bond ownership. Generally speaking, if stocks go up, bonds go down and vice versa. Therefore, a good mixture of stocks and bonds helps ensure some stability despite market fluctuations. An asset allocation model may be useful in determining what percentage of your investment should be in stocks, bonds, or other vehicles.
Simplified asset allocation models are often included in financial planning software products. These products may classify assets as large cap stocks, small cap stocks, international stocks, domestic bonds, cash, and money market funds. A more complex asset allocation model would also include Treasury bonds, mid-cap stocks (which could be further divided into value versus growth stocks), real estate, and other options. Financial planning software generally projects returns that are more realistic and significantly lower than the returns brokers project when they are promoting their services.
An aggressive, high-risk portfolio might have the majority of funds in large cap stocks, with the remainder split between small cap and international stocks (Fig. 1). This portfolio, although it doesn’t include any cash or bonds to help offset stock market risk, would have an expected return of about 9 percent. A medium-risk portfolio (Fig. 2), with funds in various types of stocks as well as in bonds and cash, could be expected to generate about a 6 percent return.
The younger you are, the easier it is to take more risks because you have time to make up for any losses. Investing primarily in stocks while you are in your 30s and early 40s may be reasonable. As you begin to approach retirement, your portfolio may need to shift more toward bonds. Even in retirement, however, a mix of stocks and bonds may be needed to meet your goals. Simply rolling all your funds into annuities or very low risk investments may not generate a sufficient return.
Two other investments that should be considered as part of your retirement planning are your home and your practice. You should decide whether you plan to stay in—and how you plan to maintain—your home after retirement. Although a house with a large yard and a pool that your children can help maintain may be fine while they’re growing up, mowing the lawn and cleaning the pool may not be chores you want to assume in your retirement.
Do you plan to sell your current home and move into a smaller place? If you plan to sell, do you expect to have substantial equity in the home that will be a windfall to you or will you still owe money on the house? Do you have a second home? In many places, appreciation on a second home may result in an additional “nest egg,” if you decide to sell once you retire.
Another asset that may be available to you at retirement will be your practice. Although you may not be able to “sell” your practice, you do have fixed assets such as the building (if you own it), the furnishings, and the radiographic equipment. A hired appraiser can assess the value of these assets, but be aware that significant differences of opinion are common. The actual value of a practice is usually lower than most physicians would like to believe and is usually closely associated with the actual value of the fixed assets associated with the practice. In addition, the value of any outstanding accounts receivable can be determined by an appraiser if you plan to sell them, or you can hire someone to continue to collect those accounts for you.
Frank M. Griffin, MD, has served as a member of the Practice Management Committee and is in private practice in Van Buren, Ark. He can be reached at firstname.lastname@example.org