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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

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Investments l.jpg

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


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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


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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


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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


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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)


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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)


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Smart Debt

  • Mortgage debt is tax deductible and hopefully your home will appreciate

  • Once the mortgage debt is establish-ed, 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


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Investments

  • Equities

  • Bonds

  • Cash

  • Real Estate

  • Collectibles

  • Precious Metals


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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


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Investments-EquitiesSlide 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)


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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


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Investments-Equities

  • Dividends have become more important because of tax consequences (15%)

  • Is the most volatile investment (greatest risk, greatest rewards)


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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)


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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


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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


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Investments-Equities2/14/2000

  • 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)


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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)


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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)


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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!)


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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”


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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


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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”


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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


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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


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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


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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.)


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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.)


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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


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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.


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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.


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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


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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


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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


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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


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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


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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


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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


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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


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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


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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


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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


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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


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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!