Investment Alternatives to Reduce Portfolio Risk
Aug 09, 2011 |
If you are like most Americans, you feel less secure about the U.S. economy. Certainly, this is justified. While we may be technically out of the recession, our dependence on foreign oil, behemoth deficits and the weak dollar are all fundamental threats to our national fiscal health and investment marketplace that are not going away anytime soon. For this reason, it is crucial that savvy investors, including physicians, learn from the past two years and adjust their investment behaviors accordingly.
Investment theory for doctors
Most savvy doctor investors understand that portfolio diversification is a key consideration to reducing some of the risk of loss in a portfolio. In historically volatile markets, mitigation of loss is not a luxury — it is a necessity.
Though most savvy investors who thought they were “adequately diversified” also lost almost half of their portfolio value in 2008 and 2009, there is an explanation. Most investors were diversified “within” the stock market with holdings in various sectors. What these investors suffered was “market risk.” As the entire market came crashing down, so did all investors within the market.
What many experienced investors don’t understand is that diversification need not be limited to securities like traditional stock and bond investments or bank deposits. Proper diversification — especially in a highly volatile market like the one we are experiencing today — must also be across investment classes and not just within a class (such as securities or real estate). A balance of domestic and foreign securities, real estate, small businesses, commodities and other alternative investments would prove to be much less risky than holding the majority of your investments in real estate and securities (which is what most doctors do).
Since most doctors who contact us are either very successful already and want to fine tune their planning or want to know the secrets of the more financially successful, it may not come as a surprise that many of our physician clients have taken a more active interest in surgery centers, medical office buildings and other health care-related real estate. This strategy apparently contradicts the idea of achieving portfolio diversification by avoiding any investments within the health care arena.
One strategy of portfolio diversification for doctors is to avoid all health care-related investments. The theory is that doctors already have so much of their income related to health care that they should not invest in health care-related investments. Unless a doctor has a very good reason to think that a particular company will excel in its arena, this theory suggests that doctors typically avoid health care stocks. For doctors who have the ability to personally influence the success of a surgery center or MediSpa, this is obviously an attractive investment.
For those doctors who can’t build or participate in surgery centers or other profitable health care investments, a popular investment strategy is to take advantage of different investment programs that are not traded on a public exchange like the New York Stock Exchange. Non-Traded Real Estate Investment Trusts, Leasing Funds and Oil & Gas Drilling programs are a few examples. As with any investment, there are pros and cons for each type of offering.
Given recent market conditions, many physician investors have been attracted to non-traded programs because they offer a certain level of stability. Most of these programs are sold to investors at a flat price, for example $10 per share, during the offering period.
An advantage to these programs is that their performances are not correlated with any particular market or index, making them an additional form of diversification. Holding non-correlated offerings can help reduce the “volatility rollercoaster” of a traditional portfolio. They should be an additional allocation in your portfolio, not a substitute for proper allocation.
Another significant benefit for physicians in the higher income tax brackets (which are sure to increase as government bailouts and the upcoming budget ranges in the multiple trillions) is the potential tax benefit an alternative program can offer. Some programs offer tax deductions on the initial investment. Others pay tax efficient dividends. Some programs offer both.
There are Oil & Gas Drilling programs that offer tax deductions on the initial investment due to intangible drilling costs and tax deductions on the program’s cash flow due to depreciation and depletion allowances. Real Estate Investment Trusts’ & Leasing Funds’ dividends are often only partly taxable to the investor. These tax efficiencies vary by program and from year to year.
Word of caution
It is important to note that one of the advantages of a non-traded offering is also a disadvantage. There is typically no market for shares of these programs. As an investor, you are expected to hang on to the security for the life of the investment — which can be as long as four to 10 years. This can make your investment relatively illiquid.
In addition, these programs are not without risk. You could invest in an oil and gas drilling program that finds no oil. Sure you will get a deduction, but you may not get much of the initial money back. Like any other investment class, some offerings are more aggressive than others, and none make any guarantee about future performance.
The time is now
There has never been a better time to focus on investment risk management and tax reduction planning. For physician investors seeking ways to diversify traditional stock and bond portfolios and reduce portfolio volatility while possibly reducing unnecessary taxes, non-traded investments are an attractive alternative.
David Mandell is an attorney, lecturer and author of five books for physicians. Jason O’Dell is a financial consultant, lecturer and author of two books for physicians. They are both principals of the financial consulting firm O’Dell Jarvis Mandell LLC. All readers are entitled to a free copy (pay just $5 shipping and handling) of the authors’ book For Doctors Only: A Guide to Working Less and Building More. Call (877) 656-4362 or email email@example.com.
This article contains general information that is not suitable for everyone. The information contained herein should not be construed as personalized investment, legal or tax advice. There is no guarantee that the views and opinions expressed in this article will come to pass or be appropriate for your particular circumstances. U.S tax and state corporate law changes frequently, accordingly information presented herein is subject to change without notice. You should seek professional tax, employee benefit and legal advice before implementing any strategy discussed herein. For additional information about the OJM Group, including fees and services, send for our disclosure statement as set forth on Form ADV using the contact information herein.