Many physician-investors tendto ask the question: Whatwill my investment returnsbe? Instead, they should be asking: Howmuch risk does my portfolio have?
No one can control returns, but anyonecan control risk. Institutional investorshave always known that the keyto savvy investing is avoiding losses.They keep their capital safe and intactduring down markets so they can takeadvantage of market recoveries.
Physiciansâ€”and every other busybusiness professionalâ€”tend to miss thispoint. They make hurried, emotionaldecisions, often chasing unrealisticreturns. They suffer losses to their capitalduring down markets and are unableto participate when the recoveries come.
Use Reason, Not Emotion
Two thirds of the time markets willbe upbeat and portfolios will do well,but investors must protect against theother one third. The first step is creatinga strategy that guards against lossesand preserves investment capital, evenif it means accepting somewhat lowerinvestment returns.
A popular way to hedge against lossesis by shorting an index. Indexes historicallyincrease in value an average ofabout 8% per year. Shorting somethingthat produces an 8% positive annualreturn costs 8% per year. Using an assetwith a zero return, but with perfect negativecorrelation to the other assets in theportfolio reduces loss risk and providesgreater planning flexibility.
Find Balance, Gain Returns
Institutional investors know thatachieving any amount of return byadding an uncorrelated asset to the portfoliomix creates "opposing signwaves." When one wave troughs, theother peaks. This creates a zero effect,lowering risk without cost. In recentyears, they have increasingly convertedtheir large cap equity funds to less riskyfunds that are hedged, less correlated,and can produce positive returns in bothup and down markets, albeit at a somewhatlower rate of return.
It's easier for physicians to plan aretirement portfolio at 6% consistentannual growth than one subject toerratic annual performanceâ€”up 15%one year, down 10% the next. Nobodyplans to suffer losses in 3 or 4 of thenext 10 years. We don't think in termsof up 2 years, down 1; we think linearly.Using average investment returnsover a given period helps us understandthat averaging 6% per year over anextended period may be less than whatwe hope for but at least we know wewon't lose money and we can rely on aprojected amount for retirement.
Steven Holt Abernathy is principal and chairmanof The Abernathy Group in New York,NY. The firm specializes in asset protectionand wealth management. He welcomesquestions or comments at 800-342-0956or firstname.lastname@example.org. For more information, visitwww.abernathyfinancial.com.