As a financial advisor, it can beawfully tough getting physician-investors to heed the lessonsof history, especially when itinvolves shedding portfolio winnersbefore they become losers.
A few years back, I advised myclients in dot-com businesses to movesome of their 401(k) assets out of companystock. The idea was to offset theinherent risk of having their money tiedup in a single asset, much less a singleasset class. But when I suggested theyreplace some of their high-flying equitywith more conservative investments,the typical response was, "I'm making250% a year on my stock options.Three or 4 more years like this and Ican retire. Why should I pull moneyout of that for the sake of balance?"
Happily, I was able to convincesome of them to reinvest 20% to 25%into a defensive strategy. Many losteverything on the 75% they retained indot-com stock.
I can't help but be reminded of thatinsanity when I see what is happeningtoday with real estate. I wonder ifinvestors really learned anything fromthe dot-com madness. While we havenot yet experienced the same meltdownin real estate, the undeniable omenshave surfaced. Many investors refuse toacknowledge them. Realtors will tellyou the signs are evident: more propertieson the market, unsold longer, withfew overbid prices.
Perhaps that information has not filtereddown to individual investors ordoctors who are busy with their practices.A doctor friend of mine recentlybought a property in Lake Tahoe,planning to generate cash flow withseasonal rentals. I advised against thepurchase, citing the short 3-monthrental season and that he was likelybuying at the peak of the market, buthe was undaunted. Mind you, this fellowis no neophyte, but a seasoned realestate investor. His thinking is, "Surethe market has slowed down, but realestate is always a good investment."The bigger problem here is that he isapproaching retirement and plans tosell the property in a few years to helpfund his golden years lifestyle. Buyingat the top of the market and relying onappreciation is a seriously flawed strategy.He simply doesn't have enoughtime before retirement to recover fromthe impending selloff.
As with every other asset class thatoverheats and attracts a flood ofinvestor money, the herd's love affairwith real estate continues, virtuallyunabated. No one wants to get off theride if there's a chance it will makeanother loop. Meanwhile, long-termrates are inevitably headed upward,triggering spiraling payments for all thewacky mortgages created during theboom—negative amortization, interest-onlyloans, and such. Stretched homebuyersquickly run out of options whenincreasing supply overruns decreasingdemand. Refinancing is no longer feasibleonce prices flatten, bringing equitygains to a halt. All of this translates intolower prices. Those least able to affordit will be the first to lose their homes.
I believe the real estate snowballpeaked sometime last autumn and isnow slowly but surely gathering downwardmomentum, threatening to engulfanyone who fails to get off the mountainin time. Just as with the dot-comcraze, the real estate landslide is coming,and I think it will get ugly.
The point is, we all know the markets,if anything, are cyclical. Retirementportfolios require asset class balance,which calls for tempering enthusiasmfor any single asset class, realestate included. But industry salespeopleand the media fuel excitement forthe current hot asset class. Moneypours in from all over, diluting valueand investment returns. Savvy investorsget out ahead of the stampede withsome profits. Those who delay, risk losingwhat they have gained. The rest,stubbornly hanging on, may see theircore principal decimated, and lackingsufficient time to recover before retirement,suffer a needless disaster.
Real estate is just another exampleof a single asset class euphoria overwhelmingcommon sense. The heavyinflow of money currently into emergingmarkets is another example. Doyou remember the late-night TV adsabout how to trade stocks and options?A few years ago, stay-at-home momswere becoming day traders; now thosesame moms are real estate agents. It's amirror of 1999 to 2000. Today, TVshows tout how to make big moneyflipping real estate. It's a repetition ofthe same conversations, just a differentinvestment vehicle.
I don't mean to sound like theprophet of doom. Despite the weakenedmarket, there is still time to pull moneyoff the table that could otherwise suffergreater damage. The time for hesitationis over, however, particularly for physiciansnear retirement with real estateassets in their retirement portfolios.Real estate can be a useful diversifier ina long-term retirement portfolio, sometimesas an alternative to bonds. Butwhen interest rates are rising, you mustbe especially cautious about yourweighting. A physician at age 35 or 40has time to ride out market cycles. Aphysician at age 50 or 55 does not.
My suggestion is to balance—andperiodically rebalance—your retirementportfolio by diversifying yourasset class mix and adopt an investmentstrategy designed to avoid sustainedlosses.
Balance and Rebalance
It's hard to balance your portfolioby moving out of an asset class youperceive as still being a winner. Youcan't help thinking you may be missingout on some meat still left on thatbone. What you should be thinking,however, is how to protect your retirementportfolio against a downturn, thehistorically inevitable return to thenorm experienced by every asset class:real estate, emerging markets, hightech—all of them.
By rebalancing your portfolio, Imean sell your winners and buy yourlosers. I know the idea of selling what'smaking you money and buying what'slosing you money is a difficult conceptto embrace, but it's how many of theworld's smartest—and most successful—investors have consistently mademore money. It's the time-tested adageto "buy low and sell high." Everyoneagrees with the concept; few people havethe discipline to convert it into action.
Avoid Sustained Losses
If I was limited to offering a singlepiece of investment guidance, I wouldcounsel you to avoid sustained losses. Ittakes much, much longer to recoverfrom even modest losses than mostinvestors imagine. Investors chasereturns and ignore the risks associatedwith an aggressive portfolio strategy.When they sustain losses, they risk losingthe capital they need to take part inmarket recoveries. Worse, they risk losingthe principal they rely on for theirretirement plans. Dedicated financialadvisors never want to see that happento any of their clients.
Jonathan DeYoe of DeYoe Wealth Management
in Berkeley, Calif, is a registered
principal with and offers securities through
Linsco/Private Ledger, Member NASD/SIPC.
His background includes investment management
responsibilities at Morgan Stanley, UBS Paine-Webber, and Salomon Smith Barney. Mr. DeYoe is heavily
involved in community activities, serving on Boards for the
Berkeley Food and Housing Project and the Berkeley Opera.
He also serves on the Executive Board of the Berkeley
Chamber of Commerce.