Steven Podnos, MD, CFP

I find it interesting when physicians I work with balk at paying the cost of certain types of insurance but not others. In particular, I encounter the most resistance to purchases of disability and long-term care policies.

The reasoning I hear is often, "That is too much money, and it will all be wasted if I stay healthy." But in fact, all insurance (except some annuities, discussed below) is a form of risk sharing, in which you likely are "wasting" dollars as long as things go well.

I don't encounter nearly the same hesitations when it comes to buying life insurance, which is indeed a waste if you live a long time (those dying early win the life insurance lottery so to speak). Similarly, we also usually don't hesitate to spend thousands of dollars a year to insure our homes against the very unlikely losses from fire and natural disasters.

I'm not sure that I can explain why some types of insurance elicit this different response. What I do emphasize is that the great basic tenet of insurance is to plan for the small possibility of a large loss.

Here are some of my other insurance tips:

Insurance coverage tips for physicians

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The great basic tenet of insurance is to plan for the small possibility of a large loss. Here are some of my other insurance tips for doctors.

Physicians cannot read a financial publication or watch financial TV without endless speculation on “When will the Fed raise interest rates again?”  What does this mean for practices and why will it happen?

Traditionally, the Federal Reserve (Fed) uses a number of mechanisms to influence banks to either lend money at a lower or higher interest rate.  When the economy is slowing and/or unemployment is high, the Federal Reserve will seek to make the banks loan cheaply in order to stir economic activity. Conversely, if the economy is heating up, and especially if prices are rising quickly, the Fed will seek to make borrowing more expensive by tightening up the money supply by increasing short term interest rates.

Up until recently, the Fed did not directly seek to influence long term rates, but this changed with the onset over the last few years (now over) of Quantitative Easing-in, which the Fed bought long-term debt on the markets (especially mortgages) in order to lower long term rates.

The US has had an almost “zero rate interest policy” for the six years since the great recession.  The economy is starting to recover, albeit very slowly.  The Fed is advertising that higher rates are coming, and actually boosted short-term rates by a quarter of one percent in December 2015.  Why?

First, almost free money is a distortion of market forces.  No rational individual would lend you money at a zero interest rate (unless we have significant deflation), so why should the government do so?  In addition, keeping interest rates artificially low is a terrible penalty for savers.

Second, the Fed worries about inflation.  Although government measures of inflation seem tame to date, there is a suggestion of wage inflation recently (Walmart, for example) and with unemployment dropping, the Fed is rational to expect more.   Raising short-term rates traditionally puts a brake on inflation.

Finally, the Fed needs to reload its tools for the next economic weakness.   If interest rates are zero and we have some economic slowing, there is little the Fed can do to stimulate.  They need higher baseline rates from which to make changes.

So, expect higher rates-but when is uncertain.   The effect on markets is also uncertain, and the most we can say is that a rapid move to markedly higher rates generally hurts both equity and fixed income markets.  Conversely, a gradual rise with a stronger economy can be well tolerated.

Interestingly, just as the Fed moved rates up in December, the U.S. markets suffered and global economic instability seemed to worse.  The Fed's response recently is to back off on its suggestion that higher rates were planned for this year.  We'll see.

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What would it mean physicians if the Fed raises interest rates again? Here is a guide that breaks down the scenario. 

Why Will the Federal Reserve Increase Interest Rates?

Despite the fact that we know some basics of investing, now is a perfect time to see how physicians can end up “mis-investing” and hurting their long term financial performance.

First, we know that the general investing population achieves investment returns from equities that are markedly below simply holding an index fund (just do an internet search for the Dalbar studies). 

Next, we know that holding a diversified portfolio with several asset classes that do not necessarily all move in the same direction at the same time has led to superior investment returns with lower risk (just do an internet search for Modern Portfolio Theory).

Next, we know that various asset classes move up and down relative to each other in cycles of years (search for Periodic Chart of Investment Return).   We know that there is no predicting which asset classes will do well or poorly in any given calendar period.  In the last twenty years, the S&P 500 has been the best performing asset class 30 percent of the time and the worst performing asset class 25 percent of the time.

Finally, we know that the U.S. stock market has outperformed just about every other world equity market for about four years. In fact, the large company stocks of the S&P 500 index have outperformed a diversified portfolio widely in four of the last five years-something that has not happened in over fifteen years.

Put this all together and the proper investing course seems clear, right? We should be overweighting non U.S. equities in our portfolios and just wait for the cycle.  But, that’s really hard to do.  It is hard for individual physician investors as the see their returns well below the numbers in the media.  It’s also hard for advisors, who must repeatedly explain the rationale for not being concentrated in the “best” performing market.

It pays to understand the cycles of investing whether you are an individual investor or rely on advice.  Chasing good returns is likely to hurt.

There are a lot of common sense facts about investing money, but despite this reality, physicians can still screw up and hurt personal finances.

How Physicians can 'Mis-Invest' Their Money 

When physicians begin to consider how much money they will need to retire on, they can start with a couple of broad factors.  First, how long do they expect to live while they are drawing on their investment portfolio?  Second, how much do they think they'll need annually to meet their lifestyle needs (or wants)?

We can generalize at the outset by stating that various distribution/withdrawal rates from a portfolio are historically likely to last certain periods of time in the worst case scenario.  For example, many studies suggest that a 4 percent withdrawal rate from a portfolio at least one half in equities should last for 30 years or more most of the time. 

But, we have to take some unknowns into account.  One of the most important is how well the investments do in the first few years of retirement.  A significant bear market may cause forced sales at bargain prices, which cannot be recovered over time.  For this reason, we recommend several years of anticipated withdrawals be kept in safe short-term fixed income that is not exposed to traditional investment volatility.  This is a real drag on growth in the portfolio, but it is necessary insurance.

Another great unknown is unexpected longevity.  Remember that the “average” life expectancy for individuals reaching their sixties in decent health almost reaches the late eighties now (in the U.S.).  The average means that half of us will live even longer.  

Unexpected events and costs are always in the background.  What if there is a pill in 2040 that you can take daily and can actually regain health?  What if the pill costs $40 thousand a year in today’s dollars?  How do you budget for that?   We don’t know if we’ll suffer extraordinary bad luck, trauma and/or illness.

Unexpectedly high inflation is a concern.  If we had a period of double digit inflation, as in the 1970s, a portfolio that is not properly invested and adjusted could lose major value quickly.  The purchasing power of the withdrawals after such a period may be inadequate.

I’m not writing a doom and gloom article here.  Instead, I’d urge consideration of the many variables that go into planning for a multi-decade retirement.  These factors (and more) need to be considered well before you stop working.  I am increasingly encouraging families that I work with to keep working longer than planned.  This may be for mental health, but it always provides more financial security.

What should physicians be wary of when looking at their investment portfolio in retirement? Here are a few possible trouble spots. 

Risks in Retirement for Physicians

Whether self-investing, or using an advisor, the physician should have a basic understanding of what his money is being used to invest in.

In a prior column, I discussed the introduction and high level of success with the introduction of passive index mutual funds.   We reviewed the fact that buying an index outperforms active stock pickers (using that index) the vast majority of the time. 

However, about 20 years ago, academics in finance began to question why index funds should all be based on market capitalization (the size of the company in the index).  There was the belief that this type of index would over concentrate investments in those companies "doing the best" and being the largest, and at the same time relatively ignore smaller and value type companies.

This led to many trying other ways to organize stocks in various indexes.  Some of the early trials used company size, profitability, momentum (picking stocks that moved faster upwards than the general market), and low volatility.  The researchers were surprised to find that every one of these "factors" seemed to add performance over long periods of time against the traditional market cap index funds.

This information slowly percolated into the investment world, which was still concentrating on actively managed funds.  But with the rise of fee only planners and fee-based accounts, performance began to trump commissions. 

Over the last five years, we have seen a virtual explosion of investments using these and many other factors.  We are seeing funds (and exchange traded funds) that use combinations of the factors as well.

There is reason to believe that some of this type investing (if at reasonable cost) may reduce volatility and add to long term returns when compared to traditional market cap only index investing.

As one specific example, take a typical S&P 500 index fund.  As we noted, it is heavily weighted towards the largest and most expensive companies in the index. The biggest five companies (think Apple, Exxon) make up about 14 percent of the index and its movements.   So, $500 invested in the fund buys $70 of the largest five stocks with the rest spread out.  If instead you buy an “equal weight SP 500 fund," you put one dollar into each of the 500 component stocks-ending up with proportionally much more money in smaller companies and those with value type characteristics.

It is hard to go much further without getting into intricate details, but you may indeed notice these "smart beta" or "smart factor" type investments in your portfolios.  Know that there is some deep science and some history in using these vehicles and ask your investment advisor to tell you more about them.  What we don’t know yet is whether using a combination of these factors or just certain ones give the best outcome. 

What do physicians have to know about buying index funds? Here is a look into this type of financial investment.

Is There a Smarter Way for Docs to Buy Index Funds?

It is becoming common to see articles and recommendations in the financial press to include "alternatives" or "alts" in your investment portfolio.  Investment advisors are bombarded by recommendations in their journals to do the same.

What do physicians have to know about alternative investments? Alternative investments are legion, and are basically any investment in markets outside of widely traded stocks, bonds, or cash.  Technically even real estate is considered an alternative, but most professionals would consider publically traded REITs (real estate investment trusts) a form of stock investing within traditional bounds.

Non traded REITs, public placements, hedge funds, private equity, venture capital funds and more are all types of alternative investments.  Before I go further, the bottom line is that unless you have more than $100 million and team of professional investors working for you, these "investments" are usually bad news for physicians.  Actually, even if you do have $100 million and a team to help, these investments are not for you.

CALPERS (the California state pension system with 300 billion dollars in assets) recently concluded that much of its alternative investing in hedge funds was expensive and had terrible returns.  And they had a legion of analysts and "advisors" that the average physician does not.

Without going into detail on each type, they share common characteristics.  First, they have high fees. Second, they often are subject to high taxes.  Third, they are opaque, meaning physicians have little control or insight into what the vendors are doing with their money (rest assured, nothing you'd like).  Fourth, they are usually illiquid-you cannot have your money back easily without paying a high price (if at all).  Fifth, you are investing against much more sophisticated institutions who have a great deal of asymmetric knowledge. In other words, they know much more than you. 

As opposed to publically traded equity and fixed income markets, there is no efficiency or "random walk" here - there may in fact be a great deal of useful insider information (and you are no insider). Many of these investments also share the common characteristic of paying large fees to a long chain of salespeople (including your "advisor").

In contrast, investing in widely-traded stocks and bonds is transparent and inexpensive.  You can easily diversify, control taxes to a great extent, and have complete daily liquidity without much trouble.

I'll finish with the strong recommendation that you avoid these investment choices.  Furthermore, if you have an advisor recommending them, consider a change.

Are you interested in putting money into alternative investments? Stay away, warns physician financial planner, Steven Podnos. 