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New Thoughts on MD Emergency Funds

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Physician Household Emergency Fund Size

[By Staff Writers]

It has been said that most ordinary people should have at least three months of living expenses (not including taxes) in a cash-equivalent reserve fund that is easily accessible (i.e., liquid).  The amount needed for a one-month reserve is equal to the amount of expenses for the month, rather than the amount of monthly income. This is because during no-income months there is no income tax.  

However, the situation might not be the same for physicians in today’s harsh economic climate. 

The New Realities

Now, some physician-focused financial advisors and Certified Medical Planners™ suggest even more reserve fund savings; up to two years. That’s because many factors come into play when determining how much a particular doctor’s family should have.

For example: 

  • Does the family have one income or two? If the doctor is in a dual-income family with stable incomes and they live on a single income, the need for a liquid reserve is less.  
  • How stable is the doctor’s income source? If a sole provider with an unstable income who spends all of the income each month, the need for a liquid cash reserve is high. 
  • Does the doctor own the practice, work in a clinic, medical group, hospital or healthcare system? In other words – employee (less control) or employer (more control). 
  • What is the doctor’s medical specialty and how has managed care penetrated his locale, or affected her focus? 
  • How does the family use its income each month; does it have a saver, spender, or investor mentality?  
  • Does the family anticipate the possibility of large expenses occurring in the future (medical practice start-up costs or practice purchase; children, medical school student debts; auto or home loans; and/or liability suits, etc)?  

The Past 

In the recent past, a doctor may have opted for a nine-twelve month reserve if the need for security was high – and a six-to-nine month reserve if the need for security was low. But today, even more may be needed.  So, the following questions may be helpful in determining the amount of reserve needed by the physician: 

1. How long would it take you to find another job in your medical specialty if you suddenly found yourself unemployed – same for your spouse?

2. Would you have to relocate – same for your spouse? 

3. How much do you spend each month on fixed or discretionary expenses and would you be willing to lower your monthly expenses if you were unemployed? 

***

Money

***

Assessment

Once the amount of reserve is determined, the doctor should use the appropriate investment vehicles for the funds. 

At minimum, the reserve should be invested in a money market fund. For larger reserves, an ultra-short-term bond fund might be appropriate for amounts over three-six months. While even larger reserves might be kept in a short term bond fund depending on interest rates and trends. 

So, what do the initials M.D. really mean? … more dough!

How much reserve do you have and where is it stashed?

Conclusion

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Revisiting EGTRRA-2001

Basic Estate Tax Law Changes from EGTRRA-2001

Staff Writers

 

For some doctors, estate taxes will decline under the Economic Growth and Tax Relief Reconciliation Act of 2001, and about 2% of all taxpayers will be able to bequeath more to their heirs on a tax-free basis, up to one million dollars.

The amount exempted from estate taxes rose to $1 million in 2002 and to $3.5 million by 2009. The estate tax will not expire completely until January 2010. After that, the estate tax repeal is scheduled to last only one year. Congress must then either repeal the tax by December 31st, 2010, or the tax will revert to present day rates.

Some economists opine that this is an accounting artifact designed to curb the cost of legislation.  

The law also gradually reduced the estate and gift tax rates to 45%, from 55%, by 2007.

 

How will EGTRRA-2001 affect you going forward?

Rent versus Buy

When is Renting a Home Less Expensive than Buying?

[By Staff Writers]

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It usually makes sense to rent a home – rather than purchase one – when the period of time you will stay in the home is short or undetermined.

Why? The reason for this is the high cost of purchasing and selling a home. 

When a physician purchases a home, he or she must pay an amount varying from the total price in cash to at least 0-3% down; and hopefully up to the traditional 20% or beyond to remove PMI – especially after the recent mortgage industry meltdown with today’s tight credit markets because of the sub-prime mortgage fiasco.

Recall, that about 13% of first mortgages that originated in 2005 and 2006 had down payments of less than 10%, according to the Mortgage Bankers Association. An additional 1% of the mortgages surpassed the value of the property.

And, if the home is purchased for cash, a majority of the expense of purchasing and selling comes in the selling via commissions and excise taxes.

Sound too much like a Pollyanna? Well, one must understand that mortgage securities are now so complex that it’s often hard to know who actually owns the underling property. If the doctor finances a home, he or she has to pay closing costs on the mortgage as well as the back-end commissions and excise taxes.  

So, it’s obvious that owning a home for a short period of time can be very costly unless the home experiences a dramatic rise in appraised value during the (short) ownership period. And, it surely did in some areas, in the past.  But, because each situation will vary, it is important to build a spreadsheet model that encompasses all of the important information when analyzing the situation. 

The Contemporary Scene for Homes

Currently, more doctors should probably concentrate on debt reduction and establishing their careers – and rent their homes. Of course, this strategy does drive up rental fees in the short term. But, home “flipping” did the same thing to prices and resulted in our current mortgage mess. 

Current Theme for Apartments 

Apartment asking rents posted their biggest increase of 2007 in the third quarter, jumping 4.2% from a year ago, to an average of $1,015 per unit, according to industry sources. And vacancy, which had edged up slightly earlier in the year because of apartment construction, tightened up in the last quarter to an average of 5.6% from 5.7% the same time a year ago. Thus, the outlook is rosy for landlords in 2008, but murky for homeowners.

Row Homes

Assessment

Hopefully in the future, home prices may shrink – and physician economic stability increase – to the point that home ownership becomes the delight it should be; rather than the burden it has become for many doctors. 

Do you rent or own? How has your strategy worked for you? Do you view your home as a place to live – or an investment? Why, or why not?

Conclusion

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Understanding Active Asset Allocation

The Two Types of Active Allocation

[By Jeffrey S. Coons; PhD, CFA]

[By Christopher J. Cummings; CFA, CFP™]

ACASometimes, physician investors feel that the markets either overreact or under react to a given piece of news – related to a specific security – and are generally willing to commit their time and resources to find mispriced securities.  

For example, a young physician with a long time horizon may feel that the financial markets are too focused on the near-term following a decline in a pharmaceutical company’s stock from a disappointing FDA report.  Or, the recent banking industry debacle is a good sector wide example of abrupt depression. 

And so, if active asset allocation makes sense based upon the limitations of passive asset allocation in managing risk over even long periods of time, how do physician investors – and their advisors – make active asset allocation decisions?   

The Approaches 

There are two distinct active asset allocation approaches used to build an investment portfolio.   They are the top-down method and the bottom-up method, and they differ based on how important economic and industry variables are to the decision-making process relative to individual security variables.  

Top-Down Approach

Advocates of the top-down approach generally begin their investment process by formulating an outlook for the domestic economy, and in certain circumstances the outlook is constructed for the global economy.  This may be a direct result of a quantitative model using various market and economic data as input to reach a conclusion regarding the best asset mix on a tactical basis, or it may be a more subjective process resulting from a qualitative assessment of the market and economic outlook.

In developing an economic overview for qualitative top-down asset allocation decisions, the medical professional and/or his advisors typically consider factors such as monetary policy, fiscal policy, trade relations, and inflation. Clearly, macroeconomic factors such as those listed above are likely to have a significant impact on the performance of a wide range of investment alternatives.

After a thorough analysis of the overall economy has been completed, top-down investors will either buy broad baskets of stocks representing an asset class or perform an analysis of industries that they believe will benefit from the economic overview that has been developed. 

Factors that may influence the attractiveness of particular industries include regulatory environment, supply and demand of resources, taxes, and import/export quotas. 

The top-down approach generally views the best company in a weak industry as being unlikely to provide satisfactory returns.  

The final step in the top-down process involves analyzing individual companies in industries that are expected to benefit from the forecasted economic environment.  

Stock_Market

Bottom-Up Approach

In contrast, investors employing a bottom-up approach will focus their attention on identifying securities that are priced below the investor’s estimate of their value.

Physicians and investors using the bottom-up approach to asset allocation and portfolio construction will only purchase securities deemed attractive according to their basic pricing and security selection criteria, thus adjusting the overall mix of investments by the limit of securities considered attractive at current valuations.

A truly bottom-up approach will consider economic and industry factors as clearly secondary in identifying investment opportunities. Investors using this approach will focus solely on company analysis.   However, they must recognize that investment decisions cannot be made in a vacuum.  Macroeconomic factors, as well as industry characteristics and traits are likely to be key elements in identifying attractive investment opportunities even on a security-by-security basis.

The key to bottom-up asset allocation and portfolio management is to realize that the decision variables driving the basic mix of assets in the portfolio are more related to the availability of attractive individual investments than to a general top-down market or economic overview.

Are you an active or passive investor?

If an active investor; what type are you?

Conclusion

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  Risk Management, Liability Insurance, and Asset Protection Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™8Comprehensive Financial Planning Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™

[Dr. Cappiello PhD MBA] *** [Foreword Dr. Krieger MD MBA]

Front Matter with Foreword by Jason Dyken MD MBA

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The Arbitrage Pricing Theory [APT]

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A Multi-Faceted Representation of Systematic Risk

  • By Jeffrey S. Coons; PhD, CFA
  • By Christopher J. Cummings; CFA, CFP™

fp-book2Introduction 

Did you know that the economist Stephen Ross PhD developed a more generalized Modern Portfolio Theory [MPT] model called Arbitrage Pricing Theory (APT)? 

Definition

APT is based upon somewhat less restrictive assumptions than the Capital Asset Pricing Model [CAP-M] and results in the conclusion that there are multiple factors representing systematic risk.  The APT incorporates the fact that different securities react in varying degrees to unexpected changes in systematic factors other than just beta to the market portfolio.

The risk-free return plus the expected return for exposure to each source of systematic risk times the beta coefficient to that risk is what determines the expected rate of return for a given security.

Physician-Investors

An important point for physicians to keep in mind is that the APT focuses on unexpected changes for its systematic risk factors. The financial markets are viewed as a discounting mechanism, with prices established for various securities reflecting investors’ expectations about the future, so any excess return for an expected change will be arbitraged away (i.e., the price of that risk will be bid down to zero). 

For example, market prices already reflect physician and other investors’ expectations about GNP growth, so prices of assets should only react to the extent that GNP growth either exceeds or falls short of expectations (i.e., an unexpected change in GNP growth).

A Rhetorical Interrogative?

And so – we can ask – why do lay investors, medical professionals and their advisors go wrong in making passive asset allocation decisions using MPT?   The problem has less to do with the limitations of CAPM or APT as theories and more to do with how these theories are applied in the real world.

The basic premise behind the various MPT models is that both return and risk measures are the expectations assessed by the investor.   Too often, however, decisions are made based on what investors see in their rear view mirror rather than what lies on the road ahead of them.

Theoretical?

In other words, while modern portfolio theory is geared towards assessing expected future returns and risk, investors and financial professionals all too often simply rely on historical data rather than develop a forecast of expected future returns and risks.

While it is clearly difficult for physicians and all investors to accurately forecast future returns or betas, whether they are for the market as a whole or an individual security, there is no reason to believe that simply using historical data will be any more accurate.  

MPT Shortcomings

One major shortcoming of modern portfolio theory as it is commonly applied today is the fact that historical relationships between different securities are unstable.  And, it would seem that a physician or other healthcare provider should not rely on historical averages to establish a passive asset allocation.  

Of course, the use of unstable historical returns in modern portfolio theories clearly violates the rule-of-thumb related to the dangers of projecting forward historical averages; MPT is nonetheless an important concept for medical professionals to understand as a result of its frequent use by investment professionals. 

Critical Elements of Investing

Furthermore, MPT has helped focus investors on two extremely critical elements of investing that are central to successful investment strategies: 

  1. First, MPT offers the first framework for investors to build a diversified portfolio.   
  2. Second, the important conclusion that can be drawn from MPT is that diversification does in fact help reduce portfolio risk.

Assessment

MPT approaches are generally consistent with the first investment rule of thumb, “understand and diversify risk to the extent possible.”  

Additionally, the risk/return tradeoff (i.e., higher returns are generally consistent with higher risk) central to MPT based strategies has helped investors recognize that if it looks too good to be true, it probably is. 

Conclusion

Your thoughts and comments on this ME-P are appreciated. Feel free to review our top-left column, and top-right sidebar materials, links, URLs and related websites, too. Then, subscribe to the ME-P. It is fast, free and secure.

Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com

OUR OTHER PRINT BOOKS AND RELATED INFORMATION SOURCES:

Risk Management, Liability Insurance, and Asset Protection Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™8Comprehensive Financial Planning Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™

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