Unite Growth and Income in Investments

Physician's Money Digest, July31 2004, Volume 11, Issue 14

Most of us think of "growth"when we think of investing.The more we take advantageof a rising stock market,the sooner we'll achieve our retirementgoals. Unfortunately, investing forgrowth also means taking risks. Thegreater the potential for growth, the moremoney you're likely to lose when the marketfalls. Think of "safety and income,"and you probably think of bonds—thefixed-income investments that, alone, areunlikely to meet your retirement needs.And they're not always safe.

Financial advisors typically suggestthat investors should compromise, balancinggrowth-producing stocks withincome-producing bonds. But physician-investorsdon't have to compromise.There are ways to achieve both growthand income within a single investment,which include the following:

  • Convertible securities
  • Real estate investment trusts (REITs)
  • Dividend-paying stocks

These options, especially convertiblesecurities, give investors something extra.They provide dividend or interest income,along with the potential for growth. Ablended portfolio of these securities canreduce risk by providing diversification.

Example:

Note:

Dividend or interest income can giveyour returns an extra boost, but it alsoreduces downside risk. You receiveannual interest income or a dividendworth 5% of your investment. Ifthat investment gains 10%, you earn theequivalent of 15%. But if your investmentdrops 10%, you lose only 5%. Inthe long term, this extra income can contributesignificantly to the total return ofyour portfolio. Past performance isno guarantee of future return.

Convertible Securities

Convertible securities are corporatebonds or preferred stocks that can be convertedinto common stocks. Companiesissue them to make their securities moreattractive to investors. Convertibles combinethe income features of bonds with thegrowth features of stock. Other advantagesinclude the following:

  • High current income—Convertiblestypically provide high current income,regardless of whether the price of theunderlying common stock rises or falls.
  • Equity participation—If the valueof the common stock rises, the value ofthe convertible often rises as well.
  • Downside protection—In a downmarket, convertibles typically decline, atmost, to the level of their value as a fixedincomeinvestment.
  • Diversification—Convertibles provideinvestments in a broad mix of sectorswith a wide range of credit quality, contributingto a portfolio's diversity.
  • Total return—Like stocks, convertiblescan achieve growth, but theyalso produce income, which adds to theinvestor's total return.

Real Estate Trusts

REITs enable investors to pool theircapital to invest in commercial real estate.The managers of these trusts handleinvestors' REITs just as professionalmoney managers handle mutual funds.REITs have the dual benefit of offeringboth capital gains and income. Capitalgains are generated through increases inrental income, real estate market value, orREIT popularity among investors. Thetrusts earn income from rent and intereston loans. REITs typically pass on at least90% of their income as dividends toshareholders. When they do, they avoidtaxes on the income.

Other advantages found in REITsinclude the following:

  • Liquidity—Shares are traded dailyon a national exchange, so, unlike actualreal estate, they can be bought andsold at any time.
  • Diversification—They add diversifi-cation to portfolios with stocks andbonds, which can improve returns anddecrease risk.
  • Deferral of income taxes—No tax ispayable on the shares until they are sold.At that point, profits are taxed as capitalgains, not ordinary income. Some REITsdistribute more than 100% of their netincome. In that case, the amount over100% is reported as a return of capital,which is not taxable to the investor.
  • Inflation hedge—As an investmentin tangible, hard assets, REITs can providea hedge against the uncertain and oftendamaging effects of inflation.

Dividend-Paying Stocks

In the past 30 years, dividends haveaccounted for nearly a third of the S&P500's total return, according to Standard& Poor's. In addition to being highly profitable,dividends reduce downside risk.

Note again:

Dividends can produce regular income,or, if reinvested, significantly increasetotal returns. If $10,000 wereinvested in the S&P 500 in 1972, today itwould be worth $208,972 if all dividendswere reinvested and only $74,547 if dividendswere not reinvested. Past performance is not necessarily aguarantee of future return.

Also, because of recent changes in thefederal tax code, instead of paying taxeson dividends at their income tax rate,most investors can now pay at a rate ofonly 15%. As a result, stocks with dividendsare more attractive and more companiesare offering dividends.

Risk and Reward Balance

There are no guarantees when itcomes to investing. No matter what anyphysician-investor would like to think,risk simply can't be avoided without sacrificingreturn. The key is to find anacceptable level of risk that, in the longterm, also provides a level of return that ishigh enough to allow you to achieve yourfinancial goals.

A carefully chosen portfolio of convertiblesecurities, REITs, and dividendpayingstocks can provide the balance ofrisk and reward that most investors areseeking. They can provide growth in goodtimes and income in tough times. Longterm, they can help physician-investorsachieve financial well-being.

David N. Grenier is president ofCutler Capital Management inWorcester, Mass. He welcomesquestions or comments from readersat 508-757-4455 ext 318 ordgrenier@cutlercapital.com.