It has often been said that if youdon't know where you're going,you're never going to get there.Seems obvious, doesn't it? Yet manypeople start out on journeys of one sortor another without determining theirmeans of reaching their final destination.
For example, who among us hasn'tgotten into their car and driven offwithout first checking a road map? Orwandered aimlessly around a largedepartment store without first lookingat a directory? The result is often a lotof wasted time and energy. Fortunately,that's all that is usually wastedin those situations.
Stock investing, however, is a differentstory. Losing your way during thisendeavor could be costly, especially now.According to most analysts, there ismuch uncertainty in the stock marketheading into 2004. Interest rates are atthe lowest level in decades, so the slightestpercentage increase could have a dramaticimpact on the market. Understandingand observing sound investingfundamentals, as well as following a detailedroad map, could help you avoiddriving around in circles.
Before physician-investors can developa sound stock investing plan, it'simportant for them to first understandthemselves. Everyone has different needs,objectives, and comfort levels. Determiningto what extent you should be inthe stock market and what kind ofstocks you should be buying will be afunction of assessing where you are,where you hope to be, and what type ofinvestor you are.
"I had an investor tell me that heunderstood that he was developing ahigh-risk strategy," explains Tim Swanson,chief investment officer for NationalCity Wealth Management (www.nationalcity.com/wealth). "He just didnot think that meant he was going tolose money. And he was serious whenhe said that."
Swanson believes that the stock market'sbumpy ride of the past several yearshas changed investors' perceptions andmade them more aware of the importanceof understanding risk. But formany, it was a painful experience. Part ofthe reason, says Bryan Olson, vice presidentof Charles Schwab, is that investorsdon't fully understand risk.
"Too often, investors start their planningprocess and think that in order toearn more money they need to take onmore risk," Olson explains. "But youcan't assume that blindly taking on morerisk will ensure that you reach yourgoals. You have to understand the riskyou're taking on, and how that fits withyour overall risk tolerance."
Swanson points out that differentasset classes have different characteristics,explaining, "Stocks do have higher ratesof return over time, but they also experiencehigher volatility. And we just livedthrough a period of time where we sawthat can be distressing, particularly if youhave a short-term time horizon."
If you're like most investors, youprobably have multiple time horizonsâ€”short-term as well as long-term plans.In effect, you're not dealing with onesingle point in time. There are severalpoints along the way, and it's importantto sketch out those goals to see if youcan accomplish everything.
"You may have, or plan on having,three children, and you might want themeducated in certain schools," says TomTaulli, with Bridgewater Capital, and theauthor of several investing books."That's one track right there. You maywant a vacation home, or to expand yourpractice. So it's important to take a comprehensivelook at your situation."
That's because even a conservativeinvestor needs to have some risk in theirportfolio. "You might own some smallcap stocks or some international stocksthat, on their own, might be consideredrisky," Olson says. "But combining themin an overall plan with some large capstocks and bonds provides balance.That's why understanding your overallrisk tolerance and your time horizons arethe first two things you want to know."
Importance of Diversification
Like most investors, you probablyhave some sort of stock investing planalready in motion. But once you fully analyzeyour risk tolerance and time horizons,it's time to put the brakes on that planâ€”at least temporarilyâ€”and assess itsstrengths and weaknesses. What you'llprobably find is that your investments arenot as diversified as they ought to be.
The reason is that most investors use ashopping cart approach to picking theirinvestments, according to Sheila Moriarty,a director of Cohn Wealth Management(www.cohnwm.com). "People tend toinvest in what they can afford at certainstages in their lives," Moriarty explains,"and they accumulate this bag of stuff."Usually, that "stuff" does not equate to awell-diversified portfolio.
Swanson explains that the first level ofdiversification is the asset class level,determining how much you should haveinvested in stocks vs bonds, cash, andother investment options. Then you workyour way through the portfolio to makecertain you are diversified at each level.
"Within the equity portfolio, youshould be diversified by sector, andwithin a sector, diversified by company,"Swanson says. "The reason forthat is that we live in an uncertainworld. We spend a lot of time and energytrying to determine what the futurewill look like, but none of us has a perfectview. And it's because of that uncertaintythat you want to diversify."
Olson echoes those thoughts. He suggeststhat once you determine what percentageof your portfolio is going to be instocks, consider what the split will bebetween large and small cap stocks.Then, within each of those areas, determinewhat your level of diversificationwill be across different sectors, and thenindustries, and finally, companies.
"The problem comes when peoplestart out at the bottom rung and just lookat the companies," Olson says. "Thenthey put a bunch of companies togetherand realize they have seven tech stocks.And I don't care how you pick thecompany, that's a fair amount of risk.Investors have to start at the top andwork their way down."
Olson adds that it's important towork the same procedure where internationalstocks are concerned, but with anadditional consideration: geographic diversification.With international stocks,it's not only important to diversify byindustry, but also by region. Considerincluding some European and Asian companiesand maybe some emerging marketswithin your portfolio.
One additional suggestion from Taulliis that when you think about diversification,consider your entire financial portfolio.For example, you may own a homeand your practice. Together they could beworth several million dollars, or a largepart of your overall net worth. "That hasto be included in your diversificationplan," Taulli says. "You should probablyput available cash into areas that don'tcorrelate as much with your business orreal estate investments."
Stock Selection Criteria
Most consumers invest significanttime and effort researching differentmodel cars before they make a purchase.It's fair to say that the same should beused regarding the companies whosestocks you're considering purchasing.
"You really need to understand thecompanies you invest in," Swansonexplains. "That's why I employ a staff ofanalysts to dig through financial statementsand talk with company managementto determine that they are credibleand have a good vision. There are somethat espouse investment approacheswhere you don't have to know anythingabout a company. But I believe that overtime, understanding the company youbuy gives you a leg up."
Swanson also believes that the priceyou pay for a stock is an important criterion.He draws a comparison to horseracing, where he says the best strategiesare not built around which horse youthink is most likely to win the race, butaround which horse is more likely to winagainst the odds.
"That's really what the stock marketis all about," Swanson says. "It's notwhat companies you think will do well,although that's an important factor. Whatyou really care about is which companiesare going to do better than their marketprice currently reflects."
Swanson states that it's also not a badidea to be a bit of a contrarian when makinga stock selection. Be willing to digdeeper and look at companies in differentways. Information that is broadly knownwill already be reflected in the price of astock. When everyone is talking about thecurrent hot stock or a certain area as theplace to be from an investing standpoint,it means that pretty optimistic assumptionsare already imbedded in the price.
"It's important not to drive solelylooking in the rearview mirror," Swansonsays. "If you go with what has been hotand what everyone else is talking about,over time, you're going to lose." In otherwords, if you drive while looking in therearview mirror, you're liable to hit what'sin front of you. "That strategy only workswhen the road is straight. And in this business,the road is seldom straight."
Taulli adds that doctors should usetheir knowledge to their advantage. Anyedge you can get in the stock market, hesays, can go a long way.
"At the convention you attend, youmay spot a company that has a greatproduct, and they're publicly traded,"Taulli explains. "Keep in mind that thesesmaller stocks are risky, but it can also begood to speculate here and there with discretionarymoney, especially if you knowthe industry and have a good feel for thecompany. Just remember to stay awayfrom the junk. There's no quick way tobecome rich, just as there's no quick wayto become a doctor."