– Investing is a key part of any overall financial plan.
– Your investment strategy should revolve around your goals and sensibilities.
– Holding a diversified portfolio can help you reduce risk while maintaining returns.
– Taxation plays an integral role in your investment decision making process.
– As a physician you have particular investment opportunities that can be evaluated with the help of a professional advisor.
Physicians spend decades educating themselves and preparing for a future of caring for society. What physicians do not prepare for during their education is the often intimidating world of investing. Most physicians do not plan on working forever and know that investing plays a crucial role in reaching financial independence; but with a massive amount of information, water-cooler talk and technical lingo, what is the right approach to help you reach your goals?
Cutting through the jargon: What you need to know about investing.
It needs to work for you.
First, your investment choices should be tailored to your financial circumstances. Everyone has a different situation, different goals and different risk tolerances that all need to be considered before making a decision on what type of investor you will be. It is always advisable to create a comprehensive financial plan with your advisors before carrying out investment decisions. A goal-oriented approach to investing is the best way to ensure that you meet the targets that are important to you.
It’s not gambling.
There is risk associated with almost every facet of investing but it should be a calculated risk, designed to suit your particular set of circumstances and risk tolerance. Stereotypical stock-picking based on a “hot-tip” is not an attractive strategy to the majority of professionals. Physician investors want to know that the money that they have worked hard to earn is not being gambled away on an investment portfolio that does not fit their needs.
Use compounding to your advantage.
The sooner that you can begin to invest, the better off you will be. Due to of the nature of compounding, if your money earns a positive return year-over-year, your savings will grow at an exponential rate. Most physicians have spent 7 – 15 more years educating themselves than a peer who began working right out of school. This means that physicians are behind before they have even begun. Although outside of the scope of this article, many physicians find the effects of compounding paired with the current low-interest-rate environment encouragement to pay off student debt more slowly and begin investing immediately.
The basic investment vehicles.
To know what type of investments you may want to hold, you need to know the characteristics of each:
1. Bonds: Bonds fall under the umbrella of “fixed-income” investments. When you buy a bond you are lending money to a government or company. In return you receive the promise of being paid interest on that money, then having the money returned to you at the end of the bond’s term.
The attraction of fixed-income securities like bonds or GICs are the relative safety that they provide. Historically, bonds have been less volatile than stock markets. As such, the relative returns have also been less. The interest from bonds can also be appealing to retirees who require a regular, dependable income from their investments.
2. Stocks: When you buy a stock (or “equity”), you are buying a piece of a company. To make money from this stock, an investor looks for one of two things:
a) Price Increase: If the price of the stock increases, this means that the market believes that the underlying company is worth more than what it was previously valued at. If you were to sell that stock when the price is higher, then you will have earned a return equal to the difference between the selling price and the original purchase price.
b) Dividends: If the company that you own stock in is profitable, it may choose to return some of those profits to the investors that own it. Typically mature, established companies pay regular dividends, versus small growing companies who reinvest those profits to help themselves grow larger.
Compared to bonds, stocks have a higher potential reward, the price paid for that potential? Greater risk of loss.
3. Mutual Funds: Mutual funds are collections of stocks and/or bonds. A number of investors pool their money and allow a professional money manager to make investment decisions on their behalf. By pooling their money together, investors are able to gain access to dedicated professional management and diversification that can be difficult to achieve as an individual investor (discussed in “Building a portfolio” below).
4. ETF’s (Exchange Traded Funds): Like mutual funds, ETF’s are a way for investors to pool their money to achieve greater diversification. Unlike mutual funds however, ETFs are usually “passive” in nature. This means that instead of the portfolio manager seeking investment opportunities, the fund is designed to mimic another asset or index, such as the S&P 500, gold stocks or the energy sector.
5. Alternative Investments: In addition to the above traditional investments, investors also have the ability to buy into real estate, foreign exchange, gold & other commodities and a number of other investment vehicles that may hold a place in a portfolio.
Building a portfolio
The next step is to use the investment vehicles mentioned above to your advantage. By pairing your overall goals with different investment instruments, an optimal allocation can be made to each asset class in an attempt to realize the best return given the amount of risk you are willing to take.
Another key component of building a portfolio is what is known as diversification. By adding a wide variety of assets to your portfolio, you will on average receive a higher return with a lower amount of risk. Imagine a portfolio of only 5 stocks equally weighted at 20% each. If one of those stocks price was cut in half, the portfolio’s value would drop by 10%. If the portfolio held 30 stocks however, the effect of that stock price drop would be significantly dampened, with only a 1.67% drop in overall portfolio value. Now imagine if that portfolio of 30 stocks held investments that tended to move differently than each other. The stock that dropped in value might be completely offset by one that increased in value. By investing in a diverse portfolio, much of the risk associated with holding an individual company’s stock usually borne by an investor can be mitigated.
Investors need to be aware of the fees that they are paying to invest their money, as fees are a key determinant in investment performance over time. There are many different fee structures for the management of stocks, bonds, mutual funds and ETF’s. The important thing for investors to ensure is that they are receiving value for the fees that they pay to have their funds invested. Fees should not dominate the investment decision making process, but investors should work to ensure their fees are reasonable within the portfolios that they construct.
Physicians have the huge advantage of being able to invest their savings within their professional corporations (PC’s), which helps physicians further tap into the magic of compounding, since they do not have to pay personal tax before investing the funds. These PC-held investments need to be carefully monitored for taxation however, as any income will be fully-taxable at the highest marginal rate. Taxation of different investments is beyond the scope of this reading, but should be discussed with your advisor.
Although it may seem overwhelming, once the scary mask has been taken off of investing, we hope that physicians see it for what it is: an effective tool that can be used to help them achieve their overall financial plan.
Sitting down with a professional advisor can help you articulate your goals and plot out a clear roadmap to successfully reaching them.