Practice Management Toolkit

Coping with Today’s Stock Market

If you’re like most individual investors, you’ve seen the remarkable returns of the 1990s fall flat on their face. Suddenly, the markets, and possibly your portfolio, have been turned upside down. No longer are you comparing hot stocks or stock mutual funds to determine which one will make you the most money or rushing home after work to watch the Nightly Business Report or CNBC on television. Nor are you eager to open your brokerage mailings each month, because the statements are depressing. You’ve probably heard the joke where someone says that their 401(k) is now a 201(k). There’s no real humor in that statement, but it is telling of how times have changed, and lives have been impacted.

You may now find yourself more focused on uncovering ways to protect your investments while still retaining some measure of market exposure for long-term growth. After three years of declines, the major indices are again trending upward thus far in 2003. However, when market rallies occur they are often short lived and unsustainable compared to what occurred during bull market of the 1990s.

So what’s the average, hard-working dentist to do? Is it business as usual (you keep putting money into those stock mutual funds or continue buying individual stocks) or should you rethink your investment strategy? One of the first things you may want to consider is just what is your investment strategy? Or better yet, do you have an actual strategy?

These are some complex questions and the answers are not always simple. So we’ll use the Personal Finance section of the Crest Learning Center to address a number of very tough issues, interesting topics, and put forth suggestions to help you shape your own answers. Let’s start at the beginning. Do you have an investment strategy? Yes or no? If we were together in the same room, and I asked you that question directly, how would you respond? Would your answer be “yes,” or would it be “no”? A “maybe” counts as a “no.”

If You Answered “Yes!”

If your answer was “yes”, then you are one step ahead of most folks. Now take a moment to analyze what that strategy is, and if it is one that is still suitable for today’s market. Or, was the plan you created developed in the previous bull market? And ask yourself if your current investment strategy needs to be adjusted to be more successful in today’s market environment.

If You Answered “No!”

On the other hand, if your answer to the question was “no,” then the task before you is to come up with a game plan that will work in the current market yet afford you the flexibility to make changes in the future.

Establish an Asset Allocation

Confused? Then look at the situation this way. First, take a moment to determine your time horizon to continue investing and your tolerance for risk. With that information in mind, you can work toward establishing what is referred to as an “asset allocation.” In general terms, asset allocation is a way of spreading your investment dollars across multiple categories of investments. In other words, you decide how much of your portfolio you want to be invested in the stock market through stock mutual funds and/or individual stocks and how much of that portfolio should be in cash and fixed income investments.

You might find that a brokerage house recommending an asset allocation of 65%/35%. This means they are currently advising clients to create or adjust their portfolio so it contains no more than 65% stocks and/or stock mutual funds and no less than 35% cash and fixed income instruments. Financial firms or investment professionals who take a more aggressive (bullish) stance may suggest an asset allocation of 75%/25% or higher. Obviously, the higher the percentage allocated to equities (stocks and stock mutual funds), the greater the exposure to market fluctuations be they up or down. Conversely, if you decide to raise the amount of cash and fixed income in your portfolio to say 50%/50%, you tend to create a more conservative asset allocation. Generally, a higher percentage of equities (stocks/stock mutual funds) is more appropriate for investors with long investment time horizons and a greater tolerance for risk and market volatility.

Bear in mind that these are generalizations, and risk is not solely defined by your asset allocation. There are conservative stocks and stock mutual funds for your equity allocation just as there are aggressive junk bonds that could be put in fixed income category. So two investors with a 65%/35% asset allocation may own vastly different individual investments in their respective accounts. One person may prefer to purchase aggressive mutual funds while another opts to put more conservative mutual fund into that same 65% equity allocation.

As an individual investor yourself, you have to determine how much of your money you’d like to protect, and how much you’re will to put at risk. Then the task at hand is to find specific investments that fit your financial objectives, risk tolerance, and time horizon. You may prefer a mix of balanced funds, total return funds, broad index funds, a blend of value and growth, and so on. Someone else may choose a mix of small capitalization (small cap), micro cap, aggressive growth and sector mutual funds, or some other higher risk combination in their same 65% equity allocation.

The important point to remember is that money put into stocks and stock mutual funds takes on a measure of stock market risk. Conversely, you can protect your cash/fixed income dollars by choosing instruments that are safe, insured, and guarantee protection of your principal. Be advised that some fixed income investments, namely bonds, can and do have price fluctuations. In fact, bond prices have an inverse relationship to interest rates. As interest rates do down, bond prices increase, and vice versa. If one were to guess the direction of interest rates over the long term, the likelihood is greater that rates will go up in the future rather than be lowered further. Translation – bond prices will go down, not up. Over the near term, bond prices may rise (and rates/yields will decline) particularly if the Federal Reserve lowers interest rates even more. However, if you purchase individual bonds (rather than bond mutual funds), hold them to maturity, then the principal is returned to you in full. What’s more, you get to keep the income those bonds generated. Sell the bonds prior to maturity, and you may get more or less than face value depending on interest rates and prevailing bond prices. With interest rates at historical lows, chances are bond yields eventually will rise (driving bond prices down). If you suspect interest rate changes over the near term, then buy bonds with short maturities. When those bonds mature you can reassess where that principal might best be reinvested – into higher yielding bonds or moved into stocks or stock mutual funds.

That said, there is also the risk of being too conservative. If you are young, have a long time horizon, and don’t have sufficient exposure to equities in your portfolio, you run the risk of underperforming the markets over time. In other words, you can play it too safe. The net result is that your portfolio barely keeps pace with inflation and taxes and fails to provide sufficient growth to support you throughout retirement. In other words, you run the risk of not having amassed sufficient wealth by the time you plan to retire. And we all know that people are living better and longer in retirement. So you very well may have to work beyond your own projected retirement date and/or put more money into your investment accounts now. The choice is yours to make. And it is always better to plan for your future when you’re young rather than be forced to react to adverse circumstances late in life when you find that you can no longer retire as planned.

Consequently, there has to be some balance in your investment strategy and your asset allocation. Both these elements are dynamic. You will want to change your asset allocation and strategy as you approach retirement age to protect the principal and any gains you’ve accumulated. Otherwise, you risk losing part of your portfolio simply from being too aggressive too long or not aggressive enough.

In Review

Just to recap. Set aside some time to go over your account statements to determine if you have an investment strategy. Are you still comfortable with that strategy in today’s stock market? If you don’t have a strategy, or cannot determine if you have one or not, then analyze what you do have. And ask yourself what is the current asset allocation in each of your accounts as well as your overall investment portfolio?

Are you 100% invested in the market through stock mutual funds and individual stocks? Are you invested entirely in growth-style mutual funds, value-style mutual funds, or do you have a mix of both styles? Are you comfortable with your present asset allocation and the performance of the investments you now own? Do you feel the need to increase the cash/fixed income portion of your portfolio for greater safety?

Addressing questions such as these should get you started in assessing where you are and where you might be headed.

About the Author

W. Patrick Naylor, D.D.S., M.P.H., M.S. is an adjunct professor at the Loma Linda University School of Dentistry where he lectures on personal finance and investing. He is author of the book, 10 Steps to Financial Success, A Beginner’s Guide to Saving and Investing (John Wiley & Sons, Inc.). Dr. Naylor also wrote a dental text, Introduction to Metal Ceramic Technology (Quintessence Publishing Co.).

Together with Loma Linda University he created a self-paced personal finance CD-ROM entitled “Personal Finance Series for Health Professionals” based on 16 hours of lecture. The CD-ROM consists of four parts: Series #1 - Savings and Investment Basics, Series #2 - Investment Selection I – Mutual Funds, Series #3 - Investment Selection II – Stock Selection and Investment Tracking, and Series #4 - Investing in Tax-Deferred Accounts. The topics in all four of the series are of general interest, but Series #4 contains a section devoted to retirement plans for the dental office.

The personal finance CD-ROM can be purchased from the Loma Linda University School of Dentistry for $35.00 (including shipping in the continental U.S.) by calling (909) 558 - 4685 or sending a check for $35.00 to Continuing Education, Loma Linda University, School of Dentistry, Loma Linda, CA 92350. Loma Linda School of Dentistry also has several dental CD-ROM programs available for sale.

Dr. Naylor’s personal finance book can be obtained from any of the large, online book retailers, such as www.Amazon.com, or ordered by a local bookstore. His dental textbook is available through the Quintessence Publishing (800-621-0387 or 630-682-3223).