Investments
Thomas E. Nolan, MD, MBA
Abe Mickal Professor and Chair
of Obstetrics and Gynecology
Director, Women’s and Newborn
Services
LSU-Health Science Center
New Orleans
Objectives
– Understand the relationship of risk and reward
of different financial vehicles
– Have fundamental appreciation of why and
how to diversify a portfolio
– Considerations to take when saving for
college, retirement
– Taxation and estate planning (and impact of
divorce)
– Understand different investment vehicles
– Pitfalls
Starting Out
• Debt management
– School loans
– Automobiles
– House
• Cash reserves
– 3-6 months of net income in cash,
money market or short term bond fund
School Loans
• Consolidate high interest loans
– Most banks will provide the service
– Consider a 10 year time period to pay
off loans so that other funds can be
vested in retirement plans
– Make sure there is no penalty to prepay
the loans
• Look for “forgiveness” programs
– Rural and minority programs
Starting Out
• Level of debt that bankers and
lenders use as a benchmark
– Monthly housing costs (principal,
interest, taxes, fees and insurance)
should be no more than 28% of gross
income
– 20% of net income (after tax)
Starting Out
• The good old days of banks giving
doctors big breaks is essentially
gone, except in rural areas
• Debt pitfalls early in career
– Too much house (you may move!!!)
– Too much car (you don’t deserve it)
– Too much credit card debt (restaurant,
vacation, furniture)
Smart Debt
• Mortgage debt is tax deductible and
hopefully your home will appreciate
• Once the mortgage debt is established, then home equity debt, if available
in your state, (also tax deductible) can
be used for large ticket purchases
such as cars, furniture and
collectables
Percent Stock/Bond/Cash
0/90/10
10/80/10
20/70/10
30/60/10
40/50/10
50/40/10
60/30/10
70/20/10
80/10/10
90/0/10
Percent Return
Reward versus Risk
1926-1997
14
12
10
8
6
4
2
0
Investments
•
•
•
•
•
•
Equities
Bonds
Cash
Real Estate
Collectibles
Precious Metals
Investments
• Where doctors have traditionally
made mistakes
– Live off cash flow or “pay as you go”
rather than saving for goals
– Love tax schemes and limited
partnerships
– Recent trends—Offshore trusts—The
IRS never lets an American Dollar loose
Investments-Equities
Slide from 2/14/2000
• Primarily common stock
• In past 18 years, it has been the
place to be (especially in a low
inflationary environment)
• Dividends have become less
important
• Is the most volatile investment
(greatest risk, greatest rewards)
Investments-Equities
• Primarily common stock
• From 1982-2001 the market was
returning ~ 14.5% (Dow >11,000,
NASDAQ >5000), but after
bubble burst, returned to ~11%
• Delayed many retirements, need
consistent long term view
Investments-Equities
• Dividends have become more
important because of tax
consequences (15%)
• Is the most volatile investment
(greatest risk, greatest rewards)
Investments-Equities
• Is where the young physician should
be, because there is time to “ride
out” down markets
• Problem: the market has was too
good for too long. Remember 1929
1987 and 2001—They are real (and I
have very vivid memories of 1987
and 2001)
Investments-Equities
• Types of Stocks
– Growth—fast growing companies, may
have limited equity, but rapidly
increasing cash. Amazon, Google,
Sirius radio
– Value—older companies, may have
dividends, not currently in favor.
General Electric
– Equity income—Usually have good
dividends, stable companies. Altria (do
you know the company?), Utilities
Investments-Equities
• Mid cap funds: Primarily companies
found in the Fortune 100-500.
Definitions may change, but not at
the level of GE, Microsoft, Dell, etc.
• Small cap funds: Usually defined as
having market capitalization of < 2
billion dollars, usually more volatile,
but may have longer term growth
Investments-Equities
2/14/2000
• Best performance over the past
decade have been large capitalization
growth stocks (lagged since 2001)
• Historically they have returned ~11%
annually
• Overtime small caps have done better
~12.5%, but have done poorly last
decade (outperformed since 2001)
Investments-Equities
• Hedge funds: Use exotic instruments for
investments, tend to short markets and use
leverage to increase return
• Did very well during the bubble bursting,
but can be “squeezed” if markets turn
against them
• High net worth individuals that can afford
loss and expense (managers take first 20%
of profit)
Bonds
• Historically have returned ~5.5-6%
• May be more volatile than common stock if
less than investment grade or in rapidly
changing interest markets
• Credit grade affects price and return (i.e.,
Treasury have highest grade and
traditionally lower return, while start up
companies have low grade and highest
return—Junk bonds (i.e., risk)
Bonds
• Are affected by multiple risks
(interest rate risk, reinvestment rate
risk, default risk and purchasing
power risk, i.e., inflation risk)
• Trading bonds can be more risky
than stocks (remember, a stock
usually has a product or service, not
a promise to repay!)
Bonds
• Most bonds are in one of three
categories:
– Short term: 1 year or less
– Intermediate: 2-10 years
– Long term: > 10 years
• Common bond strategy is to “ladder
bonds,” a portfolio of bonds with
varying maturities or “duration”
3
Duration
30 year
25 year
20 year
15 year
10 year
5 year
3 year
1 year
6 month
3 month
Yield
Yield Curve (Appoximately 2000)
7
6.5
6
5.5
5
4.5
4
3.5
Bonds
• The higher yield for the longer bond
is because of default risk, inflation
risk and general time value of money
(TVM)
• TVM is the erosion of purchasing
power over time and is important in
rating bonds, considering retirement
and general money management
Effect of Martket Interest Rate on Bond Price
(6% coupon, 20 year bond)
$140.00
Bond Price
(as reported)
$120.00
$100.00
$80.00
Coupon
Prem/Discount
$60.00
$40.00
$20.00
$0.00
Actual Interest Rates (4.5-7.5%)
Municipal Bonds
• Primarily issued by local authorities
for projects
• Are tax free at the Federal Level
(except for individuals at the
Alternative Minimum Tax level)
• If you live in the state of issue, they
are probably tax free at state level.
These are called “double tax free”
Municipal Bonds
• Tax effective yield:
– Divide the yield of the bond by 1 minus
your marginal (highest tax rate) tax rate
– 6% / (1-.28) = 6% / .72 = 8.34%
– 6% / (1-.35) = 6% / .61 = 9.23%
• Primarily used by investors in high
tax brackets
Money Markets
• Return is low (currently ~2.2%) but
the risk is negligible
• Most funds consist of U.S. treasury
issues and AAA corporate securities
• Have a maturity < 270 days
• Considered as liquid as cash
Real Estate
• Your home (usually a first investment)
• Rental property (can be a real
headache unless professionally
managed)
• Limited partnerships (watch out
unless you know the market well)
• REIT (Real estate investment trusts)
– May be equity or mortgage based
Real Estate
• REIT can be used to diversify a portfolio
• By definition, they must pay out 90% of
the annual income
• Can be a dividend play (current cash) or
capital gain (long term appreciation)
• Vanguard and others have indexes and
mutual fund options (the mutual funds,
however, may be in common stock, etc.)
Collectibles
• Limited market, hence “spread”
(difference between what you pay
and what it cost to dealer)
• Markets can be extremely volatile
• Requires special knowledge
(antiques, art, coins, etc.)
• Probably should be a hobby and not
retirement planning (barred from
401 (k)’s etc.)
Precious Metals
• Prior to 1974 (Brenton Woods
agreement), gold was a significant factor
in international currency stability
• Free global markets have replaced the
gold standard. Many countries have
been dumping their gold in response
• Other metals (platinum and silver) are
commodities rather investment vehicles
How to Invest?
• Depends on the level of involvement
and level of sophistication
– Internet has changed investing forever
– Individual accounts (on-line investors)
– Stock brokers (individual funds, family
of load mutual funds)
– Mutual funds, self directed
– Trust companies, banks, etc.
How to invest
• Level of involvement is key concept
– Individual stocks, bonds, etc.
– ETF (baskets of fixed stocks) that can
be traded
– Broker—family of vehicles
– On line trading, etc.
Mutual Funds
• Have professional full time managers
• Professional diversification
• Have numerous vehicles for
investment (stock, bonds, money
market, international, emerging
market, REITs and annuities)
• Low cost to get started
Mutual Funds
• Evaluating funds:
– Morningstar, New York Times, Forbes
– Consider companies that have mutual
ownership rather than company
– Look at families of funds (able to
transfer to different funds easily)
– Consider long term returns rather than
the hottest at the moment
Mutual Funds
• Different types:
– Load funds: charge a “load” or
expense when buying (front load or A
class), selling (back load or B class,
usually decreases by 1% annually,
starting at 6%) and 12-1(b) (C Class)
which is assessed annually
– Mostly sold by stock brokers, a source
of income for them. Average load is
5.75%, decreases with amount invested
Mutual Funds
• B funds have come under very close
scrutiny because brokers make the
most money on them (SEC consider
eliminating them as vehicle)
• Make sure you know the “break”
points (load drops to 0 at 1,000,000)
• Also evaluate turnover, expenses
Mutual Funds
• Low load funds:
– Usually front loads and average 3%.
– Also sold by brokers
– May be used by certain mutual fund
companies for “hot funds”—Fidelity
• No load funds: no up front costs,
usually distributed by mail or internet,
have become increasingly popular
Mutual Funds
• Load versus no load:
– Arguments abound on this issue—may
depend on investor comfort level
– Management fees for some no loads
may be as high as 2% annually, while
load funds may be <1%
– Most experts prefer no load funds, but
there are some sound arguments on
both sides
Mutual Funds
• Probably the most important aspect of
investing is to have a reasonable mix of
funds (index, large cap, mid cap, small
cap, growth, international and bonds) and
to invest for the long term. Stay away
from trends, and keep your discipline
• The sun don’t shine on the same dog all
day long
Mutual Funds
• Young investor
– Invest primarily in growth and small cap
stocks and if closely involved consider
speculative areas—sector funds
– Income generation is not important, but
long term growth of capital
– Key concept: Keep the long view!!!!
– Don’t over react
Mutual Funds
• After a good base is funded
– Add other investments such as large
cap value, mid-caps, international
stocks and bonds
– The concept is that not all markets
move together and diversification
decreases overall volatility
Mutual Funds
• Older investor: usually defined as 5
or less years to retirement
– Increase fixed income such as bonds
and mortgage backed securities
– Lots of controversy to “equity risk”
– 100 – age = Equity exposure
– Does not factor in risk tolerance,
income needs
Mutual Funds
• Latest products are so-called lifestyle
funds
• You select either an age or year of
retirement and the fund company will alter
the mix as you get older (stock: bond:
international stock: money markets)
• Companies vary greatly on the mix and
investment vehicles
Exchange Traded Funds (ETF)
• Similar to mutual funds—basket of
securities, but traded on exchanges
• Bundled into a single “stock” that is
traded on an exchange as any equity
• Maybe wave of the future—debates
rage in WSJ, etc. on suitability for
long term investing vs. mutual funds
Summary
• Know your risk tolerance and needs
• Investment advice and advisors
come in all flavors
• Recognize the limitations that any
one group have to offer
• Do something!! And monitor results!