Surgeon's Bulletin Board

May 25, 2007
Surgical Rounds®, March 2006, Volume 0, Issue 0

Recognize the risky business of Wall Street

By Carol Clark

In the wake of some of the most violent hurricane seasons on record, there has been a great deal of dialogue over Americans' ability to prepare for and respond to risk. The problem with many of these discussions, though, is that they begin from the premise that there is agreement as to what the standard set of risks is. In our personal financial affairs, there is no one-size-fits-all definition of risk. Every asset class, every portfolio decision, and every tax- and estate-planning maneuver has unique implications for the person considering it.

Further complicating the situation is the fact that a person's planning needs shift as their age and life circumstances change. Yet, Wall Street abounds with common misperceptions about risk. Some of the most widely held misperceptions in?clude the following:

Stocks are riskier than bonds?There are pros and cons to owning every asset class. One of the few hard and fast rules of the investment world is that you cannot generate excess return without attendant risk. With respect to your particular situation, the interplay among all of the variables is key. For example, stocks tend to go up over the long term, based on the fairly steady growth of the US economy since its founding hundreds of years ago. Despite this long-term trend, however, there is much variability over shorter time frames. If you are in your 30s, the growth attributes of stocks are critical to your long-term financial wherewithal, since the primary risk over your long-time horizon is the risk that your purchasing power and asset base will lose ground relative to inflation. On the other hand, if you are in your 70s, there is a far shorter time frame in which your assets must make up lost ground if their real value should drop significantly?which means that you may want to consider allocating a higher percentage of your portfolio to assets that have steady principal preservation characteristics.

A second nuance complicating the "stocks versus fixed income" argument is that your asset allocation depends upon the relative valuation and fundamental outlook for each asset class that you are considering. If the current valuation assumes a future that is too good to be true, future incremental returns may be limited, no matter how steady the reputation of the particular asset class. On the other hand, if the current valuation assumes a future that is too bad to be realistic, there may be opportunity relative to the capital you would have to invest in order to participate. The key variable is the cushion between the asset's intrinsic value and its current market price.

Last quarter's or the year's best performing stock/fund/asset class is a sure bet?Fads come and go on Wall Street. The prevalence of best and worst rankings makes what is "hot" readily apparent and often prompts an irresistible urge to want to jump on the bandwagon. But, as Yale University's noted CIO David Swensen points out in his latest book, Unconventional Success (Free Press; 2005), "Any excess returns that may have existed will be threatened by the influx of new capital and new participants. Be wary of the market's ability to eliminate sources of superior returns."

Carol M. Clark

is a principal of Lowry Hill, a private wealth management firm that serves the investment and financial needs of more than 300 client families in 38 states. She welcomes questions or comments at cclark@lowryhill.com.

You can never be too rich or too di?versified?After the traumatic stock market performance of 2000 to 2002, many investors opted to spread their assets across multiple managers or funds. As many have come to realize, however, too much of a "good thing" can lead to headaches. Lack of coordination, index-like performance (or worse, sub-par relative performance), lack of control over tax consequences, increased costs in a low return environment, and too much paper are just a few of the pitfalls of too much diversity.

Market timing works?The assumption that one can jump completely in or out of an entire asset class is the stuff of Wall Street legends. Yet, major shifts like this are very difficult to make, since they necessitate being right on two decisions?both in and out. These choices typically need to be made precisely when public sentiment runs counter to what is comfortable, making them exceedingly tough to execute. Scores of studies prove that very few investors are able to make sufficient profit from whole scale market timing to surmount the high tax and transaction costs of this strategy. The best advice is to admit that there is no way to accurately predict short-term market moves, choose a variety of solid asset classes in which to participate, set tactical ranges, and then move asset class weightings to one end or the other of these ranges to reflect both your current market assumptions and relative asset class performance.

Tips for saving gas and conserving money

All of us have felt the effects of in?creasing gasoline prices on our wallets. With consumers spending more than double of what is considered normal, the As?socia?tion of In?dependent Consumer Credit Coun?se?ling Agencies (AICCCA; www.aiccca.org) says consumers need to plan carefully to make up for the in?creased gas and oil prices, no matter what their income level. The AICCCA offers the following tips to help consumers curb their gas spending:

(1) Avoid charging gas at the pump. If possible, pay cash; otherwise, pay off your balance monthly.

(2) Explore alternative options of transportation. Ride-sharing, carpooling, or mass transit may provide better means for getting to work, and consider walking or riding your bike to run errands.

(3) Combine your errands. Going to the grocery store, bank, and dry cleaners all in one trip saves gas and time.

(4) Brown bag your lunch. Bringing lunch to work or dining out less often saves more gas than you think: a 10-minute round trip to a deli or restaurant 5 days a week saves more than 4 hours of gas per month.

(5) Look for the best gas prices. Driving around, though, for the greatest discount can negate any savings, so keep your eyes open on regularly traveled routes.

(6) Consider a gas-friendly vehicle. The difference between filling up an SUV versus a smaller car could be more than $30. If you travel often or commute to work, you can save a lot of money with a more efficient vehicle.

Credit improvements enhance loan leveraging

It doesn't matter how much money you make or how successful you appear to friends and family. Without a clean credit report and a good FICO (Fair Isaac Credit Organization) score, your chances of obtaining a loan or credit card with a great rate will drastically diminish. In short, the higher your score, the better your chances are of securing whatever financial line of credit your heart desires. But if your score is below 620, considered fair on a scale of 375 to 900 and a credit risk to lenders, do not fret. According to FDIC Consumer News, even a moderate improvement in your credit, such as paying down high balances and correcting errors on your credit report, can increase your credit score enough to improve financial offers. For example, if a mortgage lender requires a credit score of 680 or higher, and you are teetering at around 660, taking the steps to improve your score even 20 points can potentially save you thousands of dollars over the course of a 30-year mortgage. Want to check your score? The Federal Trade Com?mission has decreed that every US consumer can request a free credit report from each of the three credit reporting agencies once every 12 months. To obtain your free report, contact Equifax (800-685-1111; www.equifax.com), Experian (888-397-3742; www.experian.com), or TransUnion (800-916-8800; www.transunion.com).

Sleuthing tips for prospective hedge funds

The recent fraud allegations and mis?management of the Bayou hedge fund have brought greater attention to the risks involved in this mostly unregulated investment vehicle. Because hedge funds do not disclose information very easily, surgeon investors have to put on their sleuthing caps to perform the background research themselves, ac?cording to the Wall Street Journal. Al?though professional firms can provide the service for you, the costs usually range from $1,000 for a basic manager check to more than $10,000 for checks of multiple managers. Do-it-yourself fact checkers should consider the following guidelines when researching a prospective hedge fund management firm:

Ask to see a firm's audits for the past 3 years.

Check that a firm's promotional materials are true.

Verify all references?past employers, colleges, and investors?and be wary of any discrepancy.

Do not commit money for at least 3 to 6 months and after several meetings at the firm's office.

Compare the firm's returns against competitive hedge funds through fund administrators and hedge fund databases.

Understand specifics involving trades, brokerages, and securities reports and prices. Be cautious of hedge funds that use their own brokerage firm.

Beware of side letters, which give preference to certain investors, and carve-outs, a means to exclude investments from performance numbers.

Generous taxpayers carefully plan charitable giving

Donating to your favorite charity is a wonderful way for surgeons to give back to their community. When it comes to tax planning, though, sometimes your best intentions can backfire, specifically if you happen to give more than 20% of your adjusted gross income (AGI) to charity. According to the National In?stitute of Business Management's Re?search Recommendations, tax laws limit the charitable donation deduction to 20% to 50% of your AGI annually, depending on the type of charity. A 50% limit applies to qualified public institutions such as hospitals, churches, and schools, and also some private organizations. A 30% limit applies to qualified organizations not included in the 50% category, such as veterans associations and fraternal societies. Plus, a special limit of 30% applies to capital gain donations gifted to 50% limit charities and a 20% limit applies to non-50% limit charities. The good news is that you can carry over any donations that exceed your AGI limits in the current year for the next 5 years or until the donation amount is gone. Confused? Ask your accountant to clarify the laws before you open your checkbook. For more information on charitable donation guidelines, you can access IRS Publication 526 at www.irs.gov/pub/irs-pdf/p526.pdf.

Sampling retirement communities now possible

Placing a parent into an assisted-living facility is never an easy transition, even for a surgeon used to caring for the frail and elderly. If you have an elderly parent who is reluctant to move from their home into an assisted living facility, perhaps you can convince them to take a retirement community test drive. According to the New York Times, most assisted-living communities offer the option of a short-term stay so your hesitant parent can test the waters to determine if staying there on a permanent basis is right for them. Short-term stays are also ideal for a frail parent following an illness or surgery so they can receive care from the staff as needed. They also may be persuaded to stay at the community after experiencing the care, attention, and activities the facility provides.

Did you know?

$237,932?Estimated annual sal?ary of Dr. Heathcliff Huxtable, OBY/GYN, from CBS's The Cosby Show, adjusted for inflation and the character's location and seniority. (Salary.com, 2005)

$65,000?Estimated annual salary of Homer Simpson, nuclear safety in?spector, from Fox's The Simpsons. (Salary.com, 2005)

140%?Percentage increase in the median US home price since 1990. (National Association of Realtors, 2005)

76%?Percentage of college undergraduates who have a credit card. (Allstate Foundation, 2005)

16%?Percentage of shoppers who don't spend any money during a mall visit. (United States Depart?ment of Commerce, 2005)

Replace your bond ladder with a barbell

By Barry H. Zucker

A traditional laddered bond portfolio is a passive investment strategy that follows a simple, established system. For example, to structure a 10-year laddered $100,000 portfolio, an investor purchases $10,000 worth of bonds that are due each year over the next 10 years. Each year, the proceeds from maturing bonds are used to purchase a 10-year bond for the portfolio. This strategy requires very little management skill and reduces volatility by accepting lower yields in the process. The principal from maturing short-term (low-yielding) bonds is reinvested into new longer term (higher yielding) bonds.

Investment professionals who recommend bond laddering argue that short and intermediate bonds capture most of the return of longer bonds, but with less volatility and regardless of which direction interest rates move; however, most individual surgeon investors are left unaware of the potential shortcomings of this investment strategy.

Laddering limitations?Laddered bond portfolios are typically structured with 5- to 10-year time horizons, and the realities of the yield curve (the shorter the maturity, the lower the yield) suggest that investors will rarely have an opportunity to lock in higher yields associated with longer maturity bonds. To maximize the overall yield in any bond portfolio, investors must take advantage of changes in interest rates by capturing positively sloping yield curves and benefiting from higher yields in longer term maturities. Despite the media buzz regarding the inverted yield curve on US Treasury Bonds, municipal bonds nearly always have a positive yield curve and can represent significant opportunities for higher returns.

Barry H. Zucker is president and CEO of J.B. Hanauer & Co., a full-service financial services firm founded in 1931, specializing in building and preserving wealth for affluent investors and recognized for its expertise in fixed-income investment. He welcomes questions or comments at (800) 631-1094 or bzucker@jbhanauer.com. For more in?formation, visit www.bondsearch123.com.

Apart from their inherent financial shortcomings, bond ladders can also have built-in structural liabilities, which surgeon investors may be unaware of. For example, many bank trust departments and an increasing number of financial advisors charge investors a fee for "managing" a laddered portfolio, though this is largely an automated transaction. These unwarranted fees reduce the over?all return of a laddered portfolio.

Build portfolio muscle?One alternative to a laddered bond portfolio is to purchase specific fixed-income instruments that represent the best values in the market, regardless of maturity. Sim?ilar to the selection of equities, this strategy provides investors with opportunities to buy and sell assets as their values change over time. Some investors, however, are uncomfortable with market risks related to this approach.

An effective bond investment compromise?combining the protection of a ladder with the higher yields of individual long maturity bonds?is called a "barbell" strategy. Barbells can be structured in a number of ways, perhaps with half the portfolio laddered from 1 to 5 years and the balance in long-term, higher yielding bonds. Rather than long-term bonds, half the portfolio might be in bonds that represent the best value at that time, regardless of maturity. Consult with your financial advisor to determine the best strategy for your investing needs.

Microcaps are no small potatoes

Microcaps aren't the little sibling of small-, mid-, and large-cap funds, but provide an opportunity to reap high re?turns. Companies in a microcap fund generally have a market capitalization of $500 million or less. Warning: Microcaps are volatile, and the short-term outlook could be dreary. According to Market?Watch, investing in these small com-panies is basically boom or bust. If you're not afraid of the rollercoaster ride, then microcap funds have the potential to signficantly reward your bravery. The recent opening of the Bridgeway Ultra-Small Company Market Fund has advisors excited because it is a positive microcap opportunity that is priced lower than most microcap funds, reducing the inherent risk. But experts caution that surgeon investors should not invest large amounts of money in microcaps. Although they have been out??performing recently, the hazard of their instability is too extreme to bet the farm on them.