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Valuing the Quintessential Alternative Investment
By Dr. David Edward Marcinko MBA CMP™
[Editor-in-Chief] www.CertifiedMedicalPlanner.org
As all FAs, and informed physician investors know, the investment industry and Modern Portfolio Theory [MPT] strives to make optimal ‘allocations’ into different ‘asset classes’; according to some defined risk tolerance level or efficient frontier.
Equities, fixed income, property, private equity, emerging markets and so, are all ‘asset classes’, into which physician investors and mutual fund or portfolio managers will make an allocation of their total funds under management. It is quite proper for them to do this as they seek to balance the risk and potential returns for their own; ME, Inc., or other clients’ money.
But, by creating a “new” asset class, this concept opens the door to significant capital flows; advisory and management fees. Hence; the unrelenting innovation of Wall Street, and its’ commission driven and fee-seeking mavens, is unending.
Making an Impact
This secular and non-secular concept is broadly known as “impact investing”; and may be illustrated using Social Security as an example.
So, Wall Street opines, if you’re not counting on Social Security benefits as a part of an overall asset allocation strategy, you may be missing out on bigger gains in a retirement portfolio. Those of this ilk say that retirement investors should consider the value of their Social Security as a portion of their fixed-income investments. Others believe it may be too risky for some.
The Strategy
Generally, adopting such strategy would mean shifting a big portion of investible assets out of bonds and into stocks. And, into the hands of money managers, stock brokers, wealth and endowment fund for a fee; of course. This is akin to those financial advisors who rightly or wrongly goaded clients a decade ago, to not pay off a home mortgage and instead reposition the free cash flow into a rising; and then falling; market.
Of course, there are detractors, as well as proponents, of this emerging financial planning philosophy.
Vanguard Group
Jack Bogle, founder of the Vanguard Group, often cites his penchant for basing one’s asset allocation on age. (If you’re 40 years old, you have 40% of your investments in fixed income and 60% in equities. By the time you’re 60, you’ve got 60% in fixed income, 40% in equities).
Example:
So, let’s consider Social Security, citing a physician with $300,000 in an investment portfolio, and capitalizing the stream of future payments.
If the $300,000 is all in equity funds, even equity-index funds, and $300,000 in Social Security, you are already at 50/50″ fixed income versus equities. The next step is a conversation as a DIYer or ME Inc physician investor or advisory client. This is the nexus of where Social Security meets risk management.
Now, how will the doctor feel when market goes up and down? Some may believe the concept, but not enjoy the inevitable more fluctuating self-directed 401-k, or 403-b plan. So, one must be comfortable with taking on a larger stock position.
Source: Andrea Coombes; MarketWatch, September, 2013.
http://money.msn.com/mutual-fund/social-security-as-part-of-your-portfolio
The Negative
Others experts, like Paul Merriman, opine that Social Security is not an asset class and the idea is fundamentally flawed and should not be a part of anyone’s portfolio.
Why? As classically defined, a portfolio is composed of financial assets. A financial asset is something that can be sold. Social Security cannot be bought and sold. Because of that, it has a market value of zero.
Source: Paul Merriman, MarketWatch, November 2013
Assessment
Therefore, the definitional decision is left up to the informed reader, modern physician or enlightened advisor. Is a medical practice an asset class?
MORE: About iMBA Inc Expertise in Healthcare Valuation
MORE: Social Security as an Asset Class?
Conclusion
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Filed under: Alternative Investments, Investing |
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Dr. Marcinko;
Great points – Of course the main reason for asset diversification is because we are trying to minimize the risk to the entire holdings of the physician because we don’t really know how each asset class will perform in the future. It would be terrible to make a bet on one asset class with one’s entire holdings and be very wrong.
Having said that, and admitting that anything can happen in the future, the “asset class” of Social Security being around in the future as part our retirement income stream is pretty certain I believe. Details of the exact amount, the taxation of those benefits, the date that income will begin are certainly unpredictable. It is difficult to imagine we would totally abolish social security n a country in which almost half of all people retiring depend 100 % on Social Security for their retirement income.
Any physician will notice when looking at their projected cash flows in retirement that social security projected income is a very small part of their total income source, typically only 10% to 20% of their total need. So, even if we assume that Social Security will be around down the road, it is less significant than most other assets for providing the needed income in retirement that most physicians require.
Yes, I believe that a physician’s practice should be considered an asset in their total mix of investments.
Unfortunately a medical practice tends to be the most unpredictable of all assets when trying to project future value, especially looking out 10 or 20 years.
For these reasons a physician should be concerned about the diversification of all their other assets as well, which includes not just their 401k, 403[b], SIMPLE IRA, IRA, Roth IRA, brokerage account, muni bonds, and cash equivalents like money market, but also any real estate investments, apartment buildings, rental property.
For the sake of diversity you may decide to consider real estate holdings (and I am not referring to REITs) as a good investment addition to your entire portfolio, even if your financial advisor doesn’t recommend such investments.
A non-fiduciary financial advisor that is not compensated by a commission if you buy an investment property may see such an investment as “risky” or may believe that the REIT fund in your portfolio is the same type of asset. It is not.
As the great sage Warren Buffett has said, “Diversification is protection against ignorance. It makes little sense if you know what you are doing.” So, if you have a few billion you can lose because of a wrong bet on one asset class and still walk away from the table smiling, go ahead.
For the rest of us, I think diversification is a good policy.
David K. Luke MIM CMP™
http://www.CertifiedMedicalPlanner.org
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Yet – Another asset class?
Should dividend stocks be treated as a separate asset class?
http://www.financial-planning.com/news/are-dividend-stocks-a-separate-asset-class-2687617-1.html?ET=financialplanning:e15874:86235a:&st=email&utm_source=editorial&utm_medium=email&utm_campaign=fp_alert_121213
Is this getting silly; or what?
Ranaan
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Vanguard’s Bogle: Indexing Has ‘Gone Too Far’
“I can’t think of a worse way to invest,” Vanguard founder John Bogle says of the proliferation of index-based funds and ETFs.
See the whole interview here:
http://www.financial-planning.com/news/vanguards-bogle-indexing-has-gone-too-far-2687554-1.html?ET=financialplanning:e15882:86235a:&st=email&utm_source=editorial&utm_medium=email&utm_campaign=FP_Weekend__121313
I could not agree more.
Ester
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