Self Portfolio Management

By Clifton McIntire; CIMA, CFP®

By Lisa McIntire; CIMA, CFP®

Most individual investment portfolios are simply a list of stocks.  Doctors with such lists usually know the cost of each position and when they acquired it. It is not unusual to find inherited low cost stocks in the account that have been held for many years. But, this list is not an investment portfolio. 

Introduction 

In order to self create and monitor an investment portfolio for personal, office, or medical foundation use, the physician investor should ask himself three questions: 

1. How much do I have invested?
2. How much did I make on my investments?
3. How much risk did I take to get that rate of return?

Most doctors and health care professionals know how much money they have invested.  If they don’t, they can add a few statements together to obtain a total. Few actually know the rate of return achieved last year – or so far this year.  Everyone can get this number by simply subtracting the ending balance from the beginning balance and dividing the difference.  But few take the time to do it.  

Why? A typical response to the question is, “We’re doing fine.” But ask how much risk is in the portfolio and help is needed. Nobel laureate Harry Markowitz, Ph.D. said, “If you take more risk, you deserve more return.”  Using standard deviation, he referred to the “variability of returns;” in other words, how much the portfolio goes up and down; its volatility. How – and even whether or not – to create and manage your own portfolio is the topic of this essay. 

Creating the Portfolio 

First, you must determine what to do with your investments.  How much risk can be taken and what is the time frame?  You must understand the concept of risk vs. reward and write an investment policy statement [IPS].  Next, the assets that will be used for investment must be selected.  This involves asset allocation and mixing different styles of investment management to achieve the desired results, and is the point where you go it alone, or professional investment managers are selected.  Be sure to review expenses, like account and service fees, commissions and compares mutual funds with private money management. 

Once the initial portfolio is in place, the performance must be monitored to assure compliance with the investment policy.  Here’s where you consider 401k and 403b plans, pension plans, retirement accounts, as well as how to change doctor trustees or managers when necessary. 

Finally, consider the role of professional consultants. Now after all of this, if you still want to do it yourself rather than be a doctor, the entire process will be professionally outlined along with the steps taken to improve returns and reduce risk. 

The Investment Policy Statement

You would not think of starting to build a house without a set of construction drawings and detailed written specifications. An Investment Policy Statement (IPS) sets forth plans and specifications for the portfolio just like construction drawings and detailed written specifications tell the contractor how to build a house. The physician who writes the IPS is like the architect who draws up plans for a building.  Both must ask many questions to determine the wishes of the owner.  The same is true with a portfolio.   

Fred Rice, a Senior Vice President of Carolinas Physicians Network in Charlotte, North Carolina who writes medical institutional and foundation IPS documents explains,  “To me, the Investment Policy Statement is the most important investment document.  It must be a clear statement of precisely what you want your money to do for you.  Everyone involved; physicians, board members, money managers, administrators, investment consultants and beneficiaries of the trust must have a single clear statement of investment parameters.  There should be no misunderstanding of who is to do what and how they are supposed to do it with a properly written Investment Policy Statement.” 

Investment Policy Statements written for institutions or individuals has several component parts:                                               

• Statement of Purpose
• Statement of Responsibilities
• Objectives and Goals
• Guidelines
• Performance Review
• Communication

IPS Components 

First, discuss why you are writing the document and what you are trying to accomplish.  This is the Statement of Purpose. The Statement of Responsibilities identifies the parties associated with the portfolio and the functions, responsibilities and activities of each with respect to management of the assets. Then, establish some Objectives and Goals for risk tolerance and expected returns. Which assets (stocks, bonds, cash, international, emerging markets, etc) will you use?  What return do you desire net after inflation? Net after taxes?  Net after fees and commissions? Now, what direction can you give to the selection of securities? In the Guidelines section, you need to identify specific securities or types of securities that you want to use in the portfolio and which are to be excluded. Discuss benchmarks, the use of margin, foreign stocks, short selling, futures trading, etc. The Performance Review section involves how to measure performance, what benchmark we will use and how we will critique management performance. 

Finally, you want to deal with procedures for Reporting and Communications. Quarterly reports are usually required. You will need to make a complete performance measurement and analysis. In reality, the solo dentist’s written IPS can be as simple as a single page. For a hospital, it can be an elaborate, detailed and multi-paged tome. 

Stock Purchases and Inheritance 

Purchased stocks have a definite cost basis; it is what it is. But, when you inherit securities, a new cost basis is established (the price of the stock on the date of death or six months later—the executor of the estate makes this determination). Even though there would be no capital gain liability if the stock were sold immediately after date of death, most people simply don’t do anything, just hold the stock.  

Taxes

Of course taxes should be considered when selling securities but the investment merit should be the overriding factor. 

Mr. L. Eddie Dutton, CPA says, “First make an investment decision and if it fits into the tax plan, so much the better.  Doctors often wonder where they will get the money to pay the taxes.  We say to get it from the sale of the appreciated stock.  Cry all the way to the bank with your profit.” 

Dr. Ernest Duty, a very successful private investor advises “Ask yourself this question: If you had the money instead of the stock, would you buy the stock?  If your answer is ‘Yes’ then, hold on to the stock but if you say ‘No, I wouldn’t buy that stock today, then sell it.” 

Arranging by Industry Sector

Take the list of your of stocks, and arrange them according to sector to see which sectors are overweighed or under weighted. Using the S&P 500 as our benchmark, you see that there are 500 stocks in the average, sorted into 89 industries and 11 economic sectors. Let’s just settle for 10 of the 11 economic sectors since the “transportation” sector is very small and we do not have enough money to buy into all 89 industries, let alone each of the 500 companies. This is not a handicap since you would not want to own all the stocks or industries, even if you could. 

Now, let’s make some decisions on how to weight our portfolio among the sectors. Do not forget cash (money market fund) so that if it there is a market correction we can be proactive buyers. This is known as “target” weighting.

Portfolio Diversification 

It has been determined that somewhere between 22 and 30 positions are necessary to achieve proper diversification.  After you pass 30, you are just adding names. There is little benefit to diversification beyond 30 positions. We want to reduce risk. There are two types of risk related to investing in stocks: systematic and unsystematic.

Systematic risk is inherent in the market itself.  Market risk describes the phenomena that all securities tend to move up when the market moves up and down when the market goes down.  As an example, assume Ben Bernanke, the Chairman of the Federal Reserve, unexpectedly announces an increase in interest rates of .25 percent, the market would fall and that includes most stocks. There is very little that we can do about systematic risk. Diversification does not help. The Fidelity Magellan Mutual Fund, with 890 different issues, certainly one of the most diversified portfolios, fell 31 percent in the 60 days following the correction of October 1987. 

Unsystematic risk however, is more company specific and can be reduced.  This is risk associated exclusively with a particular company.  GM autoworkers go out on strike – again. Phillip Morris loses a big lawsuit unexpectedly.  Cisco’s routers are oversold. Intel expects PC sales to drop.  A promising new Google technology bombs, etc. Any event that is only to affect a single company presents unsystematic risk. We can diversify away unsystematic risk to the point where it will not have a major impact on our portfolio.  A good rule of thumb is “No more than 10 percent in any one industry (note that we said industry, there are 89 industries versus 11 sectors) and no more than 5 percent in anyone stock initially.  Theoretically you would have 20 stocks with 5 percent in each but when a single position appreciated to the point where it was 10 percent of your holdings, you would begin to sell off portions to reduce your exposure in that single issue.   

Portfolio Time Frame 

Successful physician investors have, without exception, a long-range philosophy. We asked one such physician “old-timer” to name the best investment he ever made. He replied, “Jefferson Pilot. It just kept going up, increasing the dividend and splitting the stock over and over again. During the forty years that I owned Jefferson Pilot, it was a real good performer. There was one ten-year period when it did absolutely nothing, flatter than a pancake, but other than that it did beautifully.”  Very few doctors are willing to hold on for ten years; very few of have done as well. They were also never “married” to the stock. To them it was an investment not a person, a belief, a creed, or anything of more value than the latest stock quotation. But they did their homework. They bought the stock as if they were buying the whole company. They liked the management, industry, products, and potential; never just because someone else thought it was a good idea. 

Selecting the Assets

Asset allocation is the most important decision you will make in effecting your total return in keeping with your risk tolerance.  It has been said that over 90 percent of the variability of returns come from asset allocation. This is a hard concept to grasp.  Most doctors believe that picking the right stocks (those that go up fast) is all that is necessary to be successful.  That certainly would make you successful but it just isn’t that simple. Over an extended period of time, if stocks go up and you own a diversified portfolio of stocks, your portfolio will most likely be worth more. If on the other hand, bonds go up (and stocks go down) your portfolio will most likely be worth less. A combination of asset classes is the better way to go.  That is why professional money managers spend so much time and money on the subject of asset allocation. 

Periodically, the “C” section in the Wall Street Journal illustrates various asset allocation models proposed by major brokerage firms. These firms are attempting to forecast the best asset mix going forward. The same information is easily found on the Internet. Most asset allocation models and studies illustrate historical data giving various combinations of asset classes that can best satisfy your investment risk and return objectives. Basic asset allocation assigns a percentage weighting to stocks, bonds, cash, and international stocks.  A more elaborate proposal would include various classes of these four main categories. 

Types of Stocks 

Stocks can be broken down into small, mid and large capitalization. Value and growth styles are also used to diversify the mix.  Bonds can be of varying quality and maturity as well as corporate, government, and municipal. The first thing to realize about asset allocation is that it can reduce risk. Most healthcare professionals would initially assume that a portfolio made up of 100 percent U.S. Government bonds would be as stable as it gets. Yet, the lowest standard deviation (risk) is actually 80 percent bonds and 20 percent stocks.

Adding “international” stocks to a portfolio made up of exclusively U.S. investments also reduces our standard deviation over a long period of time. There is a feeling among doctors that international stocks are risky. By themselves they are a more volatile asset class but they have historically had a very low correlation to domestic stocks and therefore, over time will reduce overall volatility. 

Correlation Co-Efficients

Correlation is used in reference to assets selected for use in the portfolio; and can be statistically represented in co-efficient statistics.  Low “correlation” means that when one asset class goes up 50 percent, the other asset class goes up by a lesser amount, let us say 10 percent.  Inverse “correlation” means two asset classes go in different directions (when one goes up, the other goes down).  You want to have a group of assets that have low, or in some cases, even inverse “correlation” to reduce the volatility of the account. Note that historically, the “most favored asset class” often changes from year to year.  Therefore, asset allocation is the most important investment decision you will make. 

Whither Self-Management? 

If you elect to mange your own portfolio, you are going to be competing with the best investment talent in the world.  Like physicians, many investment professionals have studied and practiced for years to attain the level of competence they enjoy. They have been educated in some of the finest schools in the world and initially practiced under the tutelage of the most successful in the profession. And, they are making the decision to buy only after listening to extensive presentations from analysts who not only read most of what is published on the company, but personally visited the management as well as the companies’ banker, insurance people, union, and competitors. 

Assessment 

Investing and managing your own portfolio, the pension plan of your office, or the endowment fund of your hospital is serious business. It should not be a hobby. You need the best advice you can obtain, because mistakes may not be discovered until it is too late. 

Conclusion 

Remember, when considering money management, be sure to understand the ultimate fiscal consequences and your own personal liability; and going forward – be sure to tell us how you do?

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