By Steven Holt Abernathy
Many physician-investors tend to ask the question: What will my investment returns be? Instead, they should be asking: How much risk does my portfolio have?
No one can control returns, but anyone can control risk. Institutional investors have always known that the key to savvy investing is avoiding losses. They keep their capital safe and intact during down markets so they can take advantage of market recoveries.
Physicians—and every other busy business professional—tend to miss this point. They make hurried, emotional decisions, often chasing unrealistic returns. They suffer losses to their capital during down markets and are unable to participate when the recoveries come.
Use Reason, Not Emotion Two thirds of the time markets will be upbeat and portfolios will do well, but investors must protect against the other one third. The first step is creating a strategy that guards against losses and preserves investment capital, even if it means accepting somewhat lower investment returns.
A popular way to hedge against losses is by shorting an index. Indexes historically increase in value an average of about 8% per year. Shorting something that produces an 8% positive annual return costs 8% per year. Using an asset with a zero return, but with perfect negative correlation to the other assets in the portfolio reduces loss risk and provides greater planning flexibility.
Find Balance, Gain Returns
Institutional investors know that achieving any amount of return by adding an uncorrelated asset to the portfolio mix creates "opposing sign waves." When one wave troughs, the other peaks. This creates a zero effect, lowering risk without cost. In recent years, they have increasingly converted their large cap equity funds to less risky funds that are hedged, less correlated, and can produce positive returns in both up and down markets, albeit at a somewhat lower rate of return.
It's easier for physicians to plan a retirement portfolio at 6% consistent annual growth than one subject to erratic annual performance—up 15% one year, down 10% the next. Nobody plans to suffer losses in 3 or 4 of the next 10 years. We don't think in terms of up 2 years, down 1; we think linearly. Using average investment returns over a given period helps us understand that averaging 6% per year over an extended period may be less than what we hope for but at least we know we won't lose money and we can rely on a projected amount for retirement.
Mr. Abernathy is principal and chairman of The Abernathy Group in New York, NY. The firm specializes in asset protection and wealth management. He welcomes questions or comments at 800-342-0956 or email@example.com. For more information, visit Abernathy Financial Services.