The PMD Answerman Q & A

Physician's Money DigestFebruary15 2003
Volume 10
Issue 3


Financial Times,


Wall Street Journal

Nightly Business Report

You may have read about Richard C.Marston, professor of finance at the WhartonSchool, University of Pennsylvania, who hasbeen widely cited in , the and the or seenhim on CNBC and the .In an interview with the PMD Answerman,Marston shares his opinions on the economy, thestock markets, and what investors should bedoing during this turbulent period. He receivedhis BA from Yale University (summa cum laude),B Phil from Oxford University, and PhD fromMIT. He was also a recipient of a Rhodes scholarshipand a Fulbright fellowship.


You mentioned that the economy is in fullrecovery. Why doesn't the stock market recoveralong with the economy?


The stock market had been dropping up until theday before the terrorist attacks on September 11, 2001.The economy was weakening at that time, but now theeconomy seems to be in full recovery. The continuedweakness of the stock market can be traced to 3 factors.First, there are the accounting and corporatescandals, which go far beyond Enron. This type ofbehavior is upsetting investors. In recessions, we alwaysget the dirty linen aired and the scandals come out. Inthis country, for more than 200 years, we have hadsuch scandals. But then reform follows.

The second reason holding back the stock market isfear of further attacks paralyzing our economy and ourway of life. This fear is real, but its effect on the stockmarket has probably been exaggerated. We know thatAmericans are willing to bid up real estate prices, and,given the right conditions, namely rising corporateprofits, they will eagerly bid up stock prices.

The third reason is that investors want to see corporationsreport rising earnings and be able to believe thatthey are real. When this happens, I believe that we'll seea strong stock market rally. I think this will happen soonerrather than later, hopefully within 2003.


What should investors be doing during thisrecovery period?


I think we should reexamine our portfolios tomake sure that they are in shape for the long run. Thefact that the market has stalled for the moment gives usan opportunity to rethink our investment decisions.Some investors believe that a few years of poor stockmarket returns justify abandoning the stock market. Itotally disagree. I think this market is a much better placeto invest than in the late 1990s. The speculative excesseshave been purged. I admit that there are still many overvaluedstocks. But that's why good portfolio managersare needed—to pick and choose among stocks.

Realize that your mix of investments depends onyour age, circumstances, and risk tolerance. Structureyour portfolio so that you are well diversified amongdifferent asset groups to reduce downside volatility.


What recommendations do you have forinvestors in their 50s who do not have that muchtime left before retirement? What would be areasonable portfolio mix for this group?


We have to start out with a stock/bond decision—a key element of a sensible portfolio. We must ask ourselves,"How much should we put in stocks and bonds tohave a comfortable retirement?" We need to look atreturns over a long period of time, not just the past fewyears or the 1990s, because those were unreal. Let's useannual returns over the past 50 years to make long-rundecisions. The 50-year period includes periods of badeconomy and good economy, high inflation and lowinflation. It contains all types of circumstances and providesus with a long-run annual return of about 12% onstocks and about 6% on bonds. Some investors may say"12% on stocks is very good, but I know stocks can bevery risky, whereas 6% on bonds is not that bad, and I'llbe able to sleep well owning bonds."

A portfolio of bonds alone avoids the stock marketrisk but creates, in my opinion, an even greater risk ofoutliving your money because of inflation.


Many Americans in their 50s and 60s haveconverted their retirement assets out of stocksand are 100% in fixed-income or money funds.They plan to just live on the income and nottouch their principal. Any problems with thisretirement strategy?


Let's analyze this scenario by first examining aretired married couple in their early 60s with approximately$2 million in retirement assets. They decide toput everything in bonds and live off of the 6% annualcoupon. They will be modestly comfortable becausethey also will receive additional income from a smallfixed pension and Social Security payments. What iswrong with this retirement strategy?

We are talking about a 20-year or possibly a 25-yearretirement strategy, since this couple (based on mortalitytables) will probably live to their mid-80s and thesecond one of them to die will probably live past age90. The problem with the strategy is that it ignores theeffects of inflation. Over time, their portfolio shrinksrelative to the cost of living. Ten years later, when theyare in their 70s, let's assume that they still haven'ttouched their $2-million principal, but it is now onlyworth about $1,520,000, assuming the same annualinflation rate of the 1990s, which is a low 2.74%. Nowthis couple is in their early 70s and they are in seriousfinancial trouble. Their medical and living expenses arerising because of inflation,and they only have threefourths of what they had 10 years ago. How are theygoing to make it during the next 5, 10, or 15 years?

What we need to do in retirement is earn enoughon our portfolio to have sustainable spending to carryus through our retirement years.


How do we calculate how we can earnenough on our portfolio so that it will provide uswith sustainable spending throughout our retirementyears?


We need to understand the difference betweenreal and nominal returns so that we can adjust ourretirement portfolio accordingly. Nominal returns arewhat we receive before inflation. Real returns are theactual returns after the inflation rate is deducted.


You mentioned our investment time horizonshould be greater than 5 years if we want toinvest in stocks to protect our nest egg frominflation. If a 62 year old physician plans to retireat age 65, would you still recommend stocks ifthey will need to draw income from this nest eggduring their retirement?


Many retirees mistakenly believe that now thatthey are no longer working, everything must be investedin fixed accounts, especially after the past few yearsof negative returns from the stock market. This 62-year-old preretiree will probably live another 20 to 30years and needs to have some growth within theirportfolio to avoid outliving this money. Since womenoutlive men in the United States by 6 to 7 years, if thispreretiree were a woman, she would need even moregrowth, since this portfolio on the average would haveto sustain her 6 to 7 years longer.


Will fear of further terrorist attacks paralyzethe US economy and the stock market?


In the 1950s, Americans were afraid of the entireworld blowing up as a result of a nuclear war betweenRussia and America. Yet during the 1950s, the Americaneconomy enjoyed one of the best decades of growth,and the stock market was almost as good as in the 1990s.Since September 11, the American housing market hasthrived. So investors are perfectly willing to make long-terminvestments, at least in real estate. Fear of furtherterrorist attacks should not prevent investors from reenteringthe stock market once that market appears to beas attractive as the real estate market.

Steven C. Camp, a Certified Financial Planner™

practitioner in Fort Lauderdale, Fla, is a Wharton

graduate and author of 3 personal finance

books, including MONEY Rx for Physicians

(Trunkey Publishing; $14.95). He welcomes

questions or comments at 954-565-8608 or

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