Investments

1. 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

2. 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

3. 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

4. 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

5. 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)

6. 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)

7. 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

9. Investments • Equities • Bonds • Cash • Real Estate • Collectibles • Precious Metals

10. 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

11. 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)

12. 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

13. Investments-Equities • Dividends have become more important because of tax consequences (15%) • Is the most volatile investment (greatest risk, greatest rewards)

14. 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)

15. 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

16. 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

17. 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)

18. 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)

19. 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)

20. 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!)

21. 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”

23. 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

25. 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”

26. 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

27. 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

28. 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

29. 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.)

30. 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.)

31. 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

32. 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.

33. 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.

34. 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

35. 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

36. 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

37. 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

38. 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

39. 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

40. 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

41. 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

42. 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

43. 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

44. 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

45. 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

46. 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!