BOARD CERTIFICATION EXAM STUDY GUIDES Lower Extremity Trauma
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On March 29, the House of Representatives voted 414-5 in favor of the Securing a Strong Retirement Act of 2022. If passed by the Senate, and then signed into law by President Joe Biden, the act could represent a massive economic policy shift regarding retirement savings and investment.
The retirement savings legislation, also known as SECURE Act 2.0, expands on the original SECURE Act and includes provisions to boost the required minimum distribution (RMD) age from 72 to 75 over time, broaden automatic enrollment in retirement plans, and enhance 403(b) plans.
The term integrative medicine was born from combining the practice of so-called “conventional” medicine and “complementary medicine.” Conventional medicine is what most doctors practice. This is also called “traditional Western medicine.”
Adding “outside-the-box” treatments such as chiropractic care, acupuncture, and other lifestyle recommendations like improving diet, supplements, herbs, exercise, stress management, and functional specialty labs results in the actual integration of the two disciplines. And we need both.
By Jules Lipoff, MD: Senior fellow at the Leonard Davis Institute of Health Economics and an assistant professor of clinical dermatology at Perelman School of Medicine, both of the University of Pennsylvania. Erica Mark, medical student at the University of Virginia, contributed to this article.The opinions expressed in this article do not necessarily represent those of the University of Pennsylvania Health System or the Perelman School of Medicine.
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If you follow the news or your social media feed, you know that crowdsourcing medical expenses is increasingly popular for financing health care costs. In fact, you might have contributed to one; 22 percent of American adults report donating to GoFundMe medical campaigns.
As of 2021, approximately $650 million, or about one-third of all funds raised by GoFundMe, went to medical campaigns. That staggering amount of money highlights how dysfunctional our health care system is, forcing people to resort to crowdsourcing to afford their medical care — but it’s not surprising. In the United States, 62 percent of bankruptcies are related to medical costs. This should be a wake-up call to address and reform the system further.
You’ve got a sense of your ideal retirement age. And you’ve probably made certain plans based on that timeline. But what if you’re forced to retire sooner than you expect? Aging baby-boomers, corporate medicine, the medical practice great resignation and/or the pandemic, etc?
Early retirement is nothing new, but it’s clear how much the COVID-19 pandemic has affected an aging workforce. Whether due to downsizing, objections to vaccine mandates, concerns about exposure risks, other health issues, or the desire for more leisure time, the retired general population grew by 3.5 million over the past two years—compared to an annual average of 1 million between 2008 and 2019—according to the Pew Research Center.1 At the same time, a survey conducted by the National Institute on Retirement Security revealed that more than half of Americans are concerned that the COVID-19 pandemic has impacted their ability to achieve a secure retirement.2
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There’s no need to panic, but those numbers make one thing clear, says Rob Williams, managing director of financial planning, retirement income, and wealth management for the Schwab Center for Financial Research. Flexible and personalized financial planning that addresses how you’d cope if you had to retire early can help you make the best use of all your resources.
So – Here are six steps to follow. We’ll use as an example a person who’s seeing if they could retire five years early, but the steps remain the same regardless of your individual time frame.
Step 1: Think strategically about pension and Social Security benefits
For most retirees, Social Security and (to a lesser degree) pensions are the two primary sources of regular income in retirement. You usually can collect these payments early—at age 62 for Social Security and sometimes as early as age 55 with a pension. However, taking benefits early will mean that you get smaller monthly benefits for the rest of your life. That can matter to your bottom line, even if you expect Social Security to be merely the icing on your retirement cake.
On the Social Security website, you can find a projection of what your benefits would be if you were pushed to claim them several years early. But if you’re part of a two-income couple, you may want to make an appointment at a Social Security office or with a financial professional to weigh the potential options.
For example, when you die, your spouse is eligible to receive your monthly benefit if it’s higher than his or her own. But if you claim your benefits early, thus receiving a reduced amount, you’re likewise limiting your spouse’s potential survivor benefit.
If you have a pension, your employer’s pension administrator can help estimate your monthly pension payments at various ages. Once you have these estimates, you’ll have a good idea of how much monthly income you can count on at any given point in time.
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Step 2: Pressure-test your 401(k)
In addition to weighing different strategies to maximize your Social Security and/or pension, evaluate how much income you could potentially derive from your personal retirement savings—and there’s a silver lining here if you’re forced to retire early.
Rule of 55
Let’s say you leave your job at any time during or after the calendar year you turn 55 (or age 50 if you’re a public safety employee with a government defined-benefit plan). Under a little-known separation-of-service provision, often referred to as the “rule of 55,” you may be able take distributions (though some plans may allow only one lump-sum withdrawal) from your 401(k), 403(b), or other qualified retirement plan free of the usual 10% early-withdrawal penalties. However, be aware that you’ll still owe ordinary income taxes on the amount distributed.
This exception applies only to the plan (including any consolidated accounts) that you were contributing to when you separated from service. It does not extend to IRAs.
4% rule
There’s also a simple rule of thumb suggesting that if you spend 4% or less of your savings in your first year of retirement and then adjust for inflation each year following, your savings are likely to last for at least 30 years—given that you make no other changes to your withdrawals, such as a lump sum withdrawal for a one-time expense or a slight reduction in withdrawals during a down market.
To see how much monthly income you could count on if you retired as expected in five years, multiply your current savings by 4% and divide by 12. For example, $1 million x .04 = $40,000. Divide that by 12 to get $3,333 per month in year one of retirement. (Again, you could increase that amount with inflation each year thereafter.) Then do the same calculation based on your current savings to see how much you’d have to live on if you retired today. Keep in mind that your money will have to last five years longer in this instance.
Knowing the monthly amount your current savings can generate will give you a clearer sense of whether you’ll have a shortfall—and how large or small it might be. Use our retirement savings calculator to test different saving amounts and time frames.
Step 3: Don’t forget about health insurance, doctor!
Nobody wants to spend down a big chunk of their retirement savings on unanticipated healthcare costs in the years between early retirement and Medicare eligibility at age 65. If you lose your employer-sponsored health insurance, you’ll want to find some coverage until you can apply for Medicare.
Your options may include continuing employer-sponsored coverage through COBRA, insurance enrollment through the Health Insurance Marketplace at HealthCare.gov, or joining your spouse’s health insurance plan. You may also find discounted coverage through organizations you belong to—for example, the AARP.
Step 4: Create a post-retirement budget
To make sure your retirement savings will cover your expenses, add up the monthly income you could get from pensions, Social Security, and your savings. Then, compare the total to your anticipated monthly expenses (including income taxes) if you were to retire five years early and are eligible, and choose to file, for Social Security and pension benefits earlier.
Take into account various life events and expenditures you may encounter. You may not pay off your mortgage by the date you’d planned. Your spouse might still be working (which can add income but also prolong certain expenses). Or your children might not be out of college yet.
You’re probably fine if you anticipate that your monthly expenses will be lower than your income. But if you think your expenses would be higher than your early-retirement income, some suggest that you take one or more of these measures:
Retire later; practice longer.
Save more now to fill some of the potential gap.
Trim your budget so there’s less of a gap down the road.
Consider options for medical consulting or part-time work—and begin to explore some of those opportunities now.
To the last point, finding a physician job later in life can be challenging, but certain employment agencies specialize in this area. If you can find work you like that covers a portion of your expenses, you’ll have the option of delaying Social Security and your company pension to get higher payments later—and you can avoid dipping into your retirement savings prematurely.
When you retire early, you have to walk a fine line with your portfolio’s asset allocation—investing aggressively enough that your money has the potential to grow over a long retirement, but also conservatively enough to minimize the chance of big losses, particularly at the outset.
“Risk management is especially important during the first few years of retirement or if you retire early,” Rob notes, because it can be difficult to bounce back from a loss when you’re drawing down income from your portfolio and reducing the overall number of shares you own.
To strike a balance between growth and security, start by making sure you have enough money stashed in relatively liquid, relatively stable investments—such as money market accounts, CDs, or high-quality short-term bonds—to cover at least a year or two of living expenses. Divide the rest of your portfolio among stocks, bonds, and other fixed-income investments. And don’t hesitate to seek professional help to arrive at the right mix.
Many people are unaccustomed to thinking about their expenses because they simply spend what they make when working, Rob says. But one of the most valuable decisions you can make about your life in retirement is to reevaluate where your money is going now.
This serves two aims. First, it’s a reality check on the spending plan you’ve envisioned for retirement, which may be idealized (e.g., “I’ll do all the home maintenance and repairs!”). Second, it enables you to adjust your spending habits ahead of schedule—whichever schedule you end up following. This gives you more control and potentially more income.
Step 6: Reevaluate your current spending
For example, if you’re not averse to downsizing, moving to a less expensive home could reduce your monthly mortgage, property tax, and insurance payments while freeing up equity that could also be invested to provide additional monthly income.
“When you are saving for retirement, time is on your side”. You lose that advantage when you’re forced to retire early, but having a backup plan that anticipates the possibility of an early retirement can make the unknowns you face a lot less daunting.
I was interviewed on PBS Newshour about the insanity that is happening in the NFT (non-fungible token) market. You can watch it here. If you read my “I Kid You Not Crazy” article, then you know everything I have to say about NFTs and cryptocurrency. I can sum up my thoughts on NFTs in one sentence: NFTs, just like cryptocurrencies, are a technology of the future, but a speculative bubble induced by excess global liquidity in the present.
DEFINITION: In corporate finance, a tender offer is a type of public takeover bid. The tender offer is a public, open offer or invitation (usually announced in a newspaper advertisement) by a prospective acquirer to all stockholders of a publicly traded corporation (the target corporation) to tender their stock for sale at a specified price during a specified time, subject to the tendering of a minimum and maximum number of shares.
In a tender offer, the bidder contacts shareholders directly; the directors of the company may or may not have endorsed the tender offer proposal.
Medicare Advantage Organizations (MAOs) delayed or denied payments and services to patients, even when these requests met Medicare coverage rules, according to a report released by federal investigators on Thursday.
According to One Survey, only 4% of People Understand the Basic Insurance Terms of Deductible, Co-Insurance, Copay and Out-of-Pocket Maximum.
In Another Survey by United Healthcare Itself, Only 9% Understood the Terms Premium, Deductible, Co-Insurance and Out-of-Pocket Max.
This Lack of Understanding is Not the Fault of the Employee Benefits Professionals or the Employees… Rather, the Health Insurance Plan Designs Are Just Too Complicated.
DEFINITION: A blank check company is a development stage company that has no specific business plan or purpose or has indicated its business plan is to engage in a merger or acquisition with an unidentified company or companies, other entity, or person.
According to Wikipedia, the Web3 (also known as Web 3.0 and sometimes stylized as web3) is an idea for a new iteration of the World Wide Web based on blockchain technology, which incorporates concepts such as decentralization and token-based economics. Some technologists and journalists have contrasted it with Web 2.0, wherein they say data and content are centralized in a small group of companies sometimes referred to as “Big Tech“. The term “Web3” was coined in 2014 by Ethereum co-founder Gavin Wood, and the idea gained interest in 2021 from cryptocurrency enthusiasts, large technology companies, and venture capital firms.
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Now, some experts argue that web3 will provide increased data security, scalability, and privacy for users and combat the influence of large technology companies.
Others have raised concerns about a decentralized web, citing the potential for low moderation and the proliferation of harmful content,the centralization of wealth to a small group of investors and individuals, or a loss of privacy due to more expansive data collection. Others, such as Elon Musk and Jack Dorsey, have argued that web3 only currently serves as a buzzword.
Asking a “Financial Advisor” if they’re a fiduciary isn’t always enough to hire them. People can “ice skate” around that terminology and give fuzzy or unclear answers to that question. Instead, you may consider asking them to sign a fiduciary oath.
“If someone is fee-only, not “fee-based”, they shouldn’t have a problem signing a document stating how they get compensated.” “If someone is, for example, a broker dealer, insurance agent or investment advisor who works on commissions, they probably wouldn’t be allowed to sign it.” Just say NOT to contract arbitration clauses, too! As well as “Dual Registration”. Remember Bernie Lawrence Madoff.
THE FIDUCIARY OATH
This one-page document outlines five fiduciary principles a financial adviser must follow to put the client’s interests ahead of their own. They include acting with prudence, not misleading the client, avoiding conflicts of interest, and disclosing and managing unavoidable conflicts.
The oath, meant to be printed out and signed by an adviser, has been around for several years. But recent events, such as the 5th Circuit Court of Appeals striking down the DOL rule, have increased the urgency to get it into circulation.
“With the 5th Circuit ruling, it is just so important to have this oath out there because it states fiduciary principles,” said Ms. P. Houlihan, president of Houlihan Financial Resource Group. “The oath is the answer, given that the DOL rule is gone.”
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.
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Unethical and illegal trading by specialists or market makers. A specialist may buy a stock for themselves from Dr. John Q. Public even though a better price is available from another seller. The specialist can view bid and ask prices and then manually mis-match them, or see ahead to a less favorable price. It happens in this editor’s experience, by observing how long it takes for a stop order to execute after the stop price was reached. This practice is a form of shimming. ***
Trading Imbalance
A situation where a large block of stock is put up for sale, but not enough buyers are available for purchase, and a market maker is unable to buy the imbalance. Lightly traded and tightly held stocks are considered temporarily illiquid during such imbalances. On occasion, a trading halt is put into place until enough buyers are available to purchase the deficit. On rare occasion, a handful of buyers can buy the stock at a huge discount if the stock was not halted during the imbalance. On the New York Stock Exchange, large stocks usually have a “delayed open” for such imbalances, as a trading specialist will fill the order by lining up buyers for the block, and then open trading for the stock for the day. ***
Triple Witching Hour
The final hour of trading on a Friday when stock index futures, stock index options, and stock options all expire. This happens on the third Friday in March, June, September, and December. See Quadruple Witching Hour. ***
DEFINITION: Public health is “the science and art of preventing disease, prolonging life and promoting health through the organized efforts and informed choices of society, organizations, public and private, communities and individuals”.
Google Starts Stop Loss Company Called Coefficient
Coefficient Will be a Part of the Verily Healthcare Subsidiary Within Google. Coefficient Will Also Be in Partnership and Partly Owned by the Giant, International ReinsuranceCompany Swiss Re.
According to Wikipedia, selling away in the U.S. securities brokerage industry is the inappropriate practice of an investment professional who sells, or solicits the sale of, securities not held or offered by the brokerage firm with which he is associated.
An example of the term expressed in a sentence is, “The broker was selling investments away from the firm.” Brokers marketing securities must have obtained the appropriate securities licenses for various types of investments. Brokers in the U.S. may be “associated” with one or more Brokerage firms and must obtain licenses by passing standardized Financial Industry Regulatory Authority exams such as the Series 6 or Series 7 exam.
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In the past I’ve held these as well as a Series 63 and 65 license [SEC].
Pink sheets are an over-the-counter (OTC) market that connects broker-dealers electronically. There is no trading floor and the quotations are also all done electronically. Since there is no central trading floor or stock exchange like the New York Stock Exchange (NYSE), the pink sheet-listed companies do not have the same criteria to fulfill as the companies listed on national stock exchanges. Many stocks listed on the pink sheets are low-priced penny stocks that trade for under $5 a share.
Pink sheets got their name because the original pink sheets listing the stocks were actually printed and distributed on pink pieces of paper. Trading over-the-counter (OTC) refers to the process of how securities listed on the pink sheets are traded through a broker-dealer network.
A stop-loss health insurance policy covers claims above a health insurance plan’s retained claims. The claims fund of a self-funded employer will pay claims up to the predetermined deductible for each of the company’s covered employees. The role of the stop-loss is to cover all claims above these deductible levels.
According to RoundStone Insurance, aggregate stop-loss insurance is designed to protect an employer who self-funds their employee health plan from higher-than-anticipated payouts for claims. Stop-loss insurance is similar to high-deductibleinsurance, and the employer remains responsible for claims below the deductible amount.
An individual stop-loss insurance carrier determines the average expected monthly claims per employee / per month PEPM based on the employer’s history. Then, this figure is multiplied by a percentage ranging from 110%-150%. That determined amount is then multiplied by the enrollment on a monthly basis to establish the aggregate deductible.
An inverse exchange-traded fund is an exchange-traded fund, traded on a public stock market, which is designed to perform as the inverse of whatever index or benchmark it is designed to track. These funds work by using short selling, trading derivatives such as futures contracts, and other leveraged investment techniques.
A general understanding of these types is suggested for any medical professional prior to launching a self-directed [ME, Inc], or even a guided investment strategy or wealth building portfolio effort with a financial advisor [FA], stock broker or wealth manager, etc.
This banking information is usually not included in any text on financial planning, or related, until now.
A retail bank is a typical small mass-market financial institution in which individual customers use local branches; usually of larger commercial banks. Services offered include savings and checking accounts, mortgages, personal loans, debit/credit cards and certificates of deposit (CDs).
Definition of Commercial Bank
A financial institution that provides services, such as accepting deposits, giving business loans and auto loans, mortgage lending, and basic investment products like savings accounts and certificates of deposit. The traditional commercial bank is a brick and mortar institution with tellers, safe deposit boxes, vaults and ATMs.
However, some commercial banks do not have any physical branches and require consumers to complete all transactions by phone or Internet. In exchange, they generally pay higher interest rates on investments and deposits, and charge lower fees.
Definition of Investment Bank
Investment banking activities are different than those of retail and commercial banking and include underwriting securities, acting as an intermediary between an issuer of securities and the investing public, facilitating mergers and other corporate reorganizations, and also acting as a broker for institutional clients.
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Assessment
This brief review provides a retrospective on implications for modernity.
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.
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The final hour of trading on a Friday when stock index futures, stock index options, and stock options all expire. This happens on the third Friday in March, June, September, and December. See Quadruple Witching Hour.
Triple witching sounds like something from a horror movie, but it’s actually a financial term. Options and derivatives traders know this phenomenon well because it’s the day when three different types of contracts expire. It happens only once a quarter and can cause wild swings in volatility, as large institutional traders roll over futures contracts to free up cash. Doing so creates a ton of increased volume—sometimes 50% higher than average, especially in the last trading hour of the day—but individual investors needn’t feel spooked. In fact, some might even view this volatility as a profit-making opportunity.
Which 3 Types of Derivative Contracts Expire on Triple Witching Day?
Stock Options: These are contracts taken out on the direction of a stock price at a future date. Unlike stocks, they’re not an investment in a company; rather, they’re the right to buy or sell shares of a company at a later time frame. Calls let you buy stock shares at a set price, known as the strike price, on or before the expiration date. Puts give you the right to sell shares.
Index Options: These are futures contracts on a stock index, such as the S&P 500. These options are settled in cash.
Index Futures: These are futures contracts on equity indexes. These contracts are also settled in cash.
A futures contract is also referred to as an “anticipated hedge” because it’s used to lock in prices on future buy or sell transactions. These hedges are a way to protect a portfolio from market setbacks without selling long-term holdings.
It’s worth noting that a few times a year, single stock futures also expire on witching day, adding a fourth asset to the trading cauldron, and that’s why some investors refer to this date as “quadruple witching,” although the terms are interchangeable.
When Is Triple Witching? Triple Witching Calendar 2022
In modern trading, triple witching happens on the third Friday of March, June, September, and December (the last month of each quarter).
Upcoming Triple Witching Dates
Friday, March 18, 2022
Friday, June 17, 2022
Friday, September 16, 2022
Friday, December 16, 2022
What Is the Witching Hour?
In the U.S. stock market, the last hour of the trading day, before the closing bell, sees the most trading activity, so the witching hour is from 3–4 pm EST. In folklore, the “witching hour” actually happens in the dead of night, from 3–4 am. It was known as a time when spirits reached the height of their powers. During the Middle Ages, the Catholic Church even banned people from venturing outside during this time, so as not to get caught in the chaos.
Today, such ideas aren’t taken any more seriously than mere superstition, but triple witching can cause chaos among investors, if they are not aware of what is happening.
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What Happens During Triple Witching?
As you might imagine, a lot of trading activity happens in the market when stock options, index options, and index futures contracts all expire. We’re talking a lot of money here: during Triple Witching in September 2021, for example, around $3.4 trillion of equity options expired.
So, what exactly is going on? Should they keep their hedges on? Should they speculate? Should they roll, or close out, their contracts, and if so, by how much? This is what generates the increased trading activity, and the large trades, especially from offsetting trades, can cause temporary price distortions.
At the same instant that the derivatives contracts expire, the anticipatory hedges that traders have placed become unnecessary, and so traders also seek to close these hedges, and the offsetting trades result in increased volume. These large volume increases can in turn cause price swing (i.e., volatility) in the underlying assets.
How Does Triple Witching Affect the Stock Market?
Triple witching itself doesn’t move the stock market; it just creates increased volume. In the same way, the expiration of the options and futures contracts don’t necessarily result in volatility—that’s caused by the actions that traders take based on the temporary price fluctuations of their underlying assets which can be moved due to the increased volume.
When this happens, arbitrageurs try to take advantage, often making trades that are completed in mere seconds. An arbitrageur is a trader who looks for price inefficiencies in a security and then seeks to make a profit by buying and selling it simultaneously. This practice involves much risk.
Is Triple Witching Bullish or Bearish?
Historically speaking, triple witching is not always an “up” day, and it’s not always a “down” day for the markets. It does not signify a trend. Typically, it neither moves the market significantly higher nor lower; it simply adds a temporary increase in volume and liquidity.
However, it’s important to note that market volumes also tend to be higher on index re-balancing day as well as during and after broader macroeconomic news events, and so, when taken in tandem with triple witching, these events can cause big moves in the market.
Examples of Triple Witching Volatility in Light of News Events
On June 18, 2021, a record number—$818 billion—of stock options expired, which led to nearly $3 trillion in “open interest,” or open contracts. On this day, the Federal Reserve also announced that it might raise interest rates in 2023 due to inflationary pressures. These news events resulted in increased volatility, and the S&P 500 lost 1.3% while the Dow Jones Industrial Average dropped 1.6%.
On September 17th, 2021, one week ahead of the Federal Reserve’s meeting, market volatility was growing based on mounting concerns about the COVID-19 Delta variant impacting the economy as well as the Federal Reserve’s announcement that it would begin to unwind its monetary stimulus. These news events, taken along with the S&P 500’s quarterly index rebalancing, which also happened that day, caused the S&P 500 to lose 1%.
Is There Such a Thing as “Quadruple” Witching?
Single Stock Futures are the fourth type of derivative contract which can expire on triple witching day. This can cause the phenomenon to be called “quadruple witching,” although one term can replace the other. Single stock futures are futures contracts placed on individual stocks, with one contract controlling 100 shares being typical. They are a hedging tool that was previously banned from trading in the United States. The Commodity Futures Modernization Act lifted the ban in 2000, and single stock futures were traded on the One Chicago Exchange from November, 2002 until September, 2020, although currently they are only available on overseas financial markets.
How Did Triple Witching Affect 1987’s “Black Monday?”
On October 19th, 1987, the Dow Jones Industrial Average lost 22.6% in a single trading session. The day became known as “Black Monday,” but triple witching events, which took place the Friday before, on October 16, 1987, had caused the selloff of options and futures contracts to rapidly accelerate, resulting in stocks tanking in pre-day trading. The massive sell orders were left unchecked by any kinds of systematic stop gaps, and so financial markets roiled globally throughout the day. This stock market crash was the greatest one-day decline to occur since the Great Depression in 1929.
Taking lessons from the event, regulators moved the options expiration from the morning to the afternoon and put “circuit breakers” into place that would let the exchanges temporarily halt trading in the event of another massive sell off.
How Can Investors Prepare for Triple Witching Days?
The triple witching takeaway is that investors should be aware of what happens on these days and understand that there is a lot more volume in the markets. There could be some drastic price swings, but investors shouldn’t be carried away by any short-term emotions (which, really, is great advice any day in the markets).
6. In the long run, stocks revert to their fair value
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EDITOR’S NOTE: Although it has been some time since speaking live with busy colleague Vitaliy Katsenelson CFA, I review his internet material frequently and appreciate this ME-P series contribution. I encourage all ME-P readers to do the same and consider his value investing insights carefully.
By Vitaliy Katsenelson, CFA
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6. In the long run, stocks revert to their fair value
Reversion to fair value is not a pie-in-the-sky concept. If a stock is significantly undervalued for a long time, then this undervaluation gets cured, eventually. That can happen through share buybacks – the company can basically buy all of its shares and take itself private.
Or it can happen by the company’s paying out its earnings in dividends, thus creating yields that the market will not be able to ignore. Or the company’s competitors will realize that it is cheaper for them to buy the company than to replicate its assets on their own. Either way, undervaluation gets cured.
This faith that undervaluation will not last forever is paramount to value investing. But this is not your regular faith, which requires belief without proof. This is evidence-supported faith with hundreds of years of data to back it. Just look at the US stock market: it has gone through cycles when it was incredibly cheap and others when it was incredibly expensive. At some points in its journey from one extreme to the other, it touched its fair value, even if it was transitory.
Historically, value investing (owning undervalued companies) has done significantly better than other strategies. Paradoxically, the reason it has done well in the long run is because it did not work consistently in the short run. If something works consistently (keyword), everybody piles into it and it stops working.
These aforementioned cycles of temporary brilliance and dumbness are not just common to us mere mortals. Even Warren Buffett’s Berkshire Hathaway goes through them. As just one example, in 1999, when the stock market went up 21%, Berkshire Hathaway stock declined 19%. In 1999, the financial press was writing obituaries for Buffett’s investment prowess.
Suddenly, in 1999, Buffett’s IQ was lagging the market by 40%. At the time, investors were infatuated with internet stocks that were not making money but that were supposed to have a bright future. Investors were selling unsexy “old economy” stocks that Buffett owned in order to buy the “new economy” ones.
If at the end of 1999, you were to sell Berkshire Hathaway and buy the S&P 500 instead, you would have done the easy thing, but it would have been a large (though very common) mistake. Over the next three years Berkshire Hathaway gained over 30% while the S&P declined over 40%. During the year 1999, Buffett’s IQ did not change much; in fact, the (book) value of businesses Berkshire Hathaway owned went up by 0.5% that year. But in 1999, the market’s attention was somewhere else and it chose to price Berkshire Hathaway 19% lower.
As a value investor, if you do a reasonable job estimating what the business is worth, then at some point the stock market will price it accordingly. You need to have faith. I am acutely aware how wishful this statement sounds. But this faith, the belief in mean reversion, has to be deeply ingrained in our psyche. It will allow us to remain rational when people around us are not.
EDITOR’S NOTE: Although it has been some time since speaking live with busy colleague Vitaliy Katsenelson CFA, I review his internet material frequently and appreciate this ME-P series contribution. I encourage all ME-P readers to do the same and consider his value investing insights carefully.
By Vitaliy Katsenelson, CFA
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5. Risk is a permanent loss of capital (not volatility)
Conventional wisdom views volatility as risk. Not value investors. We befriend volatility, embrace it, and try to take advantage of it. For someone who has not researched a company, it is not readily apparent whether a decline in shares is temporary or permanent. After all, if you don’t know what the company is worth, the quoted price becomes the quotient of intrinsic value. If you do know what the company is worth, then the change in intrinsic value is all that is going to matter. The price quoted on the exchange will be your friend, allowing you to take advantage of the difference between intrinsic value and quoted stock price. If the quoted stock price is significantly cheaper than your estimated intrinsic value, you buy it (or buy more of it if you already own it). If the opposite is true, you sell it.
What is a company worth?
Determining the intrinsic value requires a combination of art and science, in that order – it is not quoted on the exchanges. We go about this the same way a businessman would figure how much he’d want to pay for a gas station or a McDonald’s franchise. Analysis of each company will be different, but at the core we estimate the cash flows the business will produce for shareholders in the long run (at least ten years) and what the business will be worth then (based on our estimate of its earnings power at the time). The combination of the two provides us an approximation of what the business is worth now. To further embed “the right” type of risk analysis into our investment operating system, we build financial models. Models help us to understand businesses better and provide insights as to which metrics matter and which don’t. They allow us to stress test the business: We don’t just look at the upside but spend a lot of times looking at the downside – we try to “kill” the business. We look at known risks and try to imagine unknown ones; we try to quantify their impact on cash flows. This “killing” helps to us understand how much of a discount (margin of safety) we should demand to what the business is worth. By applying this discount to fair value, we arrive at a buy price. For every stock we buy we probably look at a few dozen (at least).
For instance, if we are looking at a company that is selling products or services to consumers, we’ll be focusing on customer-acquisition costs. We try to drill down to the essential operating metrics of each company. If it’s a convenience store retailer, we’ll look into gallons of gas sold and profit per gallon. If it’s an oil driller, we’ll look at utilization rates, rigs in service, average revenue per rig per day. If it’s a pharmaceuticals company, we’ll have revenue lines for each major drug it sells and model the company for the eventuality that patents will run out. (Revenues usually decline 80-90% when a patent expires).
These models help us to understand the economics of the business. We usually build two type of models. We start with what we call the “tablecloth” model. This is a very detailed, in-depth model that zeros in on different aspects of the business. But the risk we run with a tablecloth model is that we get lost in the trees and forget about the forest.
This brings us to our “napkin” model. It’s a much simpler and smaller model that focuses only on the essentials of the business. It is easier to build the tablecloth model than the “napkin.” If we can build a napkin model, that means we understand the drivers of the business – we understand what matters. Models are important because they help us remain rational. It is only the matter of time before a stock we own will “blow up” (or, in layman’s terms, decline).
In this type of analysis, what happens this month, this quarter, or even this year is only important in the context of the long run – unless the company’s good or bad earnings report in any quarter changes our assumptions on the company’s long-term cash flows. If you methodically focus on what the company is worth and if your Total IQ is maximized, then price fluctuations are just noise. Volatility becomes your friend because you can rationally take advantage of it. It’s an under-appreciated gift from Mr. Market.
Side Note:As an advisor, I feel it is one of my great responsibilities to be an honest and clear communicator. There is an asymmetry of information between us and our clients. We have invested weeks and months of research into the analysis of each stock; therefore, we have a good idea what each company is worth. Our clients have not done this research, and they should not have to – that is what they hired us to do.This is why we pour our heart and soul into our quarterly letters – we want to close this informational gap and so we try as hard as we can to explain what we think the companies in our portfolio are worth. Our letters are often 15-20 pages long.
EDITOR’S NOTE: Although it has been some time since speaking live with busy colleague Vitaliy Katsenelson CFA, I review his internet material frequently and appreciate this ME-P series contribution. I encourage all ME-P readers to do the same and consider his value investing insights carefully.
By Vitaliy Katsenelson, CFA
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4. Margin of safety – leave room in your buy price for being wrong
Margin of safety is a function of two dimensions: a company’s quality and its growth.
I am generalizing here, but exogenous events have a greater impact on a lower-quality business than a higher-quality one. Thus a high-quality company needs a lower margin of safety than a lower-quality one.
A company that is growing earnings and paying dividends has time on its side and thus may not need as much margin of safety as a lower-growing one.
We quantify both a company’s quality and growth, and thus margin of safety is deeply embedded in our investment operating system.
The larger discount to the stock’s fair value (the $1) the less clairvoyance you need to have about the future of the business. For instance, in 2013, when Apple stock was trading at $400 (pre-split) we didn’t have to have a very clear crystal ball about Apple’s future; Apple just had to be able to barely fog the mirror.
In later years, at $900, we need to have a lot more precision in our analysis of Apple’s future.
“Physicians who don’t understand modern risk management, insurance, business, and asset protection principles are sitting ducks waiting to be taken advantage of by unscrupulous insurance agents and financial advisors; and even their own prospective employers or partners. This comprehensive volume from Dr. David Marcinko and his co-authors will go a long way toward educating physicians on these critical subjects that were never taught in medical school or residency training.” —Dr. James M. Dahle, MD, FACEP, Editor of The White Coat Investor, Salt Lake City, Utah, USA
“With time at a premium, and so much vital information packed into one well organized resource, this comprehensive textbook should be on the desk of everyone serving in the healthcare ecosystem. The time you spend reading this frank and compelling book will be richly rewarded.” —Dr. J. Wesley Boyd, MD, PhD, MA, Harvard Medical School, Boston, Massachusetts, USA
QUESTION: We are in near bear market correction territory – especially for tech stocks – so what are the 2 major types of valuation approaches for common stock?
ANSWER: There are basically two different approaches for common stock valuation; top-down and bottom-up. Under either of the two fundamental approaches, a physician investor will have to work with individual company data. In reality, each of these approaches is used by investors and security analysts when doing fundamental analysis.
With the bottom-up approach, investors focus directly on a company’s prospects. Analysis of such information as the company’s products, its competitive position, and its financial status leads to an estimate of the company’s earnings potential, and, ultimately, its value in the market. Considerable time and effort are required to produce the type of detailed financial analysis needed to understand a firm’s standing. The emphasis in this approach is on finding companies with good long-term growth prospects, and making accurate earnings estimates.
The top-down approach is the opposite of the bottom-up approach. Investors begin with the economy and the overall market, considering such important factors as interest rates and inflation. They next consider likely industry prospects, or sectors of the economy that are likely to do particularly well (or particularly poorly). Finally, having decided that factors are favorable for investing, and having determined which parts of the overall economy are likely to perform well, individual companies are analyzed.
QPADEFINITION: The qualifying payment amount is generally the median of contracted rates for a specific service in the same geographic region within the same insurance market as of January 31, 2019. The rate will be adjusted per the Consumer Price Index for All Urban Consumers (CPI-U).
When trying to decide whether to buy a used car or a new one, it’s typically financially wiser to buy used. But if you want to buy new, you should plan to drive the car for 10 years or more.
Better yet – do not buy a new vehicle.
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The 20/4/10 rule for buying a vehicle
If you have to borrow when buying a car, to avoid spending more than you can afford you should put down at least 20%, keep the loan limited to no more than four years (to avoid interest), and spend no more than 10% of your gross income on transportation costs (which includes the car payment, parking, gas, and insurance).
Devaluation is the deliberate downward adjustment of the value of a country’s money related to another currency, group of currencies or currency standard. It is often confused with depreciation and is the opposite of revaluation which refers to the readjustment of a currency exchange rate.
The government of a country may decide to devalue its currency and like depreciation it is not the result of non-governmental activities.
One reason a country made devalue its currency is to combat a trade imbalance. Devaluation reduces the cost of a country’s export rendering them more competitive in the Global market which is which in turn increases the cost of imports.
If imports are more expensive domestic consumers are less likely to purchase them further strengthening domestic businesses because exports increase and imports decrease there is typically a better balance of payments because the trade deficit shrinks. In short a country that devalue its currency can produce is difficult because there is a greater demand for cheaper exports.
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In accountancy, depreciation refers to two aspects of the same concept: first, the actual decrease of fair value of an asset, such as the decrease in value of factory equipment each year as it is used and wear, and second, the allocation in accounting statements of the original cost of the assets to periods in which the assets are used (depreciation with the matching principle).
Depreciation is thus the decrease in the value of assets and the method used to reallocate, or “write down” the cost of a tangible asset (such as equipment) over its useful life span. Businesses depreciate long-term assets for both accounting and tax purposes. The decrease in value of the asset affects the balance sheet of a business or entity, and the method of depreciating the asset, accounting-wise, affects the net income, and thus the income statement that they report.
BE AWARE ALL ADVISORS … NEXT GEN FINANCIAL ADVICE IS HERE?
Are you a financial planner, insurance agent or investment advisor seeking to assist your physician clients with medical practice enhancement solutions, along with healthcare targeted financial planning services, but don’t know where to turn for help?
OR, maybe you’ve already had a bad experience with a young physician or astute healthcare professional client that was actually more informed than you in these areas?
OR, a doctor/nurse client who demanded a true fiduciary advisor [not fee-based advice, with no dual licenses and no arbitration clauses] documented in writing].
After an understandable slowdown in 2020, due to the onset of the COVID-19 pandemic, merger & acquisition (M&A) activity in the healthcare industry accelerated in 2021, and the industry is expected to continue the high number of deals and high deal volume in 2022.
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This Health Capital Topics article will review the U.S. healthcare industry’s M&A activity in 2021, and discuss what these trends may mean for 2022. (Read more…)
DEFINITION: The alternative minimum tax (AMT) is a tax imposed by the United States federal government in addition to the regular income tax for certain individuals, estates, and trusts. As of tax year 2018, the AMT raises about $5.2 billion, or 0.4% of all federal income tax revenue, affecting 0.1% of taxpayers, mostly in the upper income ranges.
According to Tejvan Pettinger, a public good has two characteristics:
Non-rivalry: This means that when a good is consumed, it doesn’t reduce the amount available for others. – E.g. benefiting from a street light doesn’t reduce the light available for others but eating an apple would.
Non-excludability: This occurs when it is not possible to provide a good without it being possible for others to enjoy. For example, if you erect a dam to stop flooding – you protect everyone in the area (whether they contributed to flooding defenses or not.
A public good is often (though not always) under-provided in a free market because its characteristics of non-rivalry and non-excludability mean there is an incentive not to pay. In a free market, firms may not provide the good as they have difficulty charging people for their use.
NOTE: This piece is a little more technical, and contains a bit more stock-market jargon, than most essays you get from me. While how we build portfolios is important to us and our clients, we realize that the puts and takes might bore many readers.
DEFINITION: Trickle-down economics is a colloquial term for supply-side economic policies. In recent history, the term has been used by critics of supply-side economic policies, such as “Reaganomics”. Whereas general supply-side theory favors lowering taxes overall, trickle-down theory more specifically advocates for a lower tax burden on the upper end of the economic spectrum. Empirical evidence shows that the proposition is regressive and has never managed to achieve all of its stated goals as described by the Reagan administration.
SAY’S LAW: In classical economics, Say’s law, or the law of markets, is the claim that the production of a product creates demand for another product by providing something of value which can be exchanged for that other product. Thus, production is the source of demand
DEFINITION: In classical economics, Say’s law, or the law of markets, is the claim that the production of a product creates demand for another product by providing something of value which can be exchanged for that other product. Thus, production is the source of demand.
SYNOPSIS: The home office deductionallows qualified taxpayers to deduct certain home expenses when they file taxes. And, now that some doctors and many of us are working remotely, you may be wondering whether working from home will yield any tax breaks. If your small medical or healthcare consulting or other business qualifies you for a home office tax deduction, should you be concerned about triggering an audit? How does a business qualify in the first place; etc?
Well, to claim the home office deduction on their 2021 tax return, taxpayers generally must exclusively and regularly use part of their home or a separate structure on their property as their primary place of business.
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If I work from home, do I qualify for a home office tax deduction?
If you’re an employee working remotely rather than an employer or business owner, you unfortunately don’t qualify for the home office tax deduction (however, please note that it is still available to some as a state tax deduction). Prior to the Tax Cuts and Job Acts (TCJA) tax reform passed in 2017, employees could deduct unreimbursed employee business expenses, which included the home office deduction. However, for tax years 2018 through 2025, the itemized deduction for employee business expenses has been eliminated.
If I’m self-employed, should I take the home office tax deduction?
You may have heard that taking the home office deduction sends a red flag to the IRS and ups your chances of being audited. Although there may have been some merit to this advice in the past, changes in the tax rules in the late 1990s made it easier for people who work out of their homes to qualify for these write-offs. So if you qualify, by all means, take it.
Do I qualify for the home office tax deduction?
Generally speaking, to qualify for the home office deduction, you must meet one of these criteria:
Exclusive and regular use: You must use a portion of your house, apartment, condominium, mobile home, boat or similar structure for your business on a regular basis. This also includes structures on your property, such as an unattached studio, barn, greenhouse or garage. It doesn’t include any part of a taxpayer’s property used exclusively as a hotel, motel, inn, or similar business.
Principal place of business: Your home office must be either the principal location of your business or a place where you regularly meet with customers or clients. Some exceptions to this rule include day care and storage facilities.
What is “exclusive use”?
The biggest roadblock to qualifying for these deductions is that you must use a portion of your home exclusively and regularly for your business.
The law is clear and the IRS is serious about the exclusive-use requirement. Say you set aside a room in your home for a full-time business and you work in it ten hours a day, seven days a week. If you let your children use the office to do their homework, you violate the exclusive-use requirement and forfeit the chance for home office deductions.
The exclusive-use rule doesn’t mean:
You’re forbidden to make a personal phone call from the office.
You have to rush outside whenever a family member needs a moment of your time.
Although individual IRS auditors may be more or less strict on this point, some advisers say you meet the spirit of the exclusive-use test as long as personal activities invade the home office no more than they would be permitted to in an office building. The office can also be a section of a room if the division is clear — thanks to a partition, for example — and you can show that personal activities are excluded from the business section.
What is “regular use”?
There’s no specific definition of what constitutes regular use. Clearly, if you use an otherwise empty room only occasionally and its use is incidental to your business, you’d fail this test. If you work in the home office a few hours or so each day, however, you might pass. This test is applied to the facts and circumstances of each case the IRS challenges.
What does “principal place of business” mean?
In addition to passing the exclusive- and regular-use tests, your home office must be either the principal location of that business or a place for regular customer or client meetings.
If your home office is in a separate, unattached structure — a detached garage converted into an office, for example — you don’t have to meet the principal-place-of-business or the deal-with-clients test. As long as you pass the exclusive- and regular-use tests, you can qualify for home business write-offs.
What if your business has just one home office, but you do most of your work elsewhere?
Remember that the requirement is that your home office is your principal place of business, not your principal workplace. As long as you use the home office to conduct your administrative or management chores and you don’t make substantial use of any other fixed location to conduct those tasks, you can pass this test.
If you’re an employee of another company but also have your own part-time business based in your home, you can pass this test even if you spend much more time at the office where you work as an employee.
This rule makes it much easier to claim home office deductions for individuals who conduct most of their income-earning activities somewhere else (such as outside salespeople or tradespeople).
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What qualifies as a business?
As with the regular-use test, whether your endeavors qualify as a business depends on the facts and circumstances. The more substantial the activities, in terms of time and effort invested and income generated, the more likely you are to pass the test.
Making money from your efforts is a prerequisite, but for purposes of this tax break, profit alone isn’t necessarily enough. If you use your den solely to take care of your personal investment portfolio, for example, you can’t claim home office deductions because your activities as an investor don’t qualify as a business.
Taxpayers who use a home office exclusively to manage rental properties may qualify for home office tax status but as property managers rather than investors.
What if I operate a child care or storage facility?
The exclusive-use test doesn’t apply if you use part of your house to:
Provide day care services for children, older adults or individuals with disabilities. If you care for children in your home between 7 a.m. and 6 p.m. each day, for example, you can use that part of the house for personal activities the rest of the time and still claim business deductions. To qualify for the tax break, your home care business must meet any applicable state and local licensing requirements.
Store product samples or inventory you sell in your business. Assume your home-based business is the retail sale of home-cleaning products and that you regularly use half of your basement to store inventory. Occasionally using that part of the basement to store personal items wouldn’t cancel your home office deduction. To qualify for this exception, your home must be the principal location of your business.
How do I calculate the home office tax deduction?
Your home office business deductions are based on either the percentage of your home used for the business or a simplified square footage calculation.
The most exact way to calculate the business percentage of your house is to measure the square footage devoted to your home office as a percentage of the total area of your home. If the office measures 150 square feet, for example, and the total area of the house is 1,200 square feet, your business percentage would be 12.5%.
An easier calculation is acceptable if the rooms in your home are all about the same size. In that case, you can figure out the business percentage by dividing the number of rooms used in your business by the total number of rooms in the house.
Special rules apply if you qualify for home office deductions under the day care exception to the exclusive-use test.
Your business-use percentage must be reduced because the space is available for personal use part of the time.
To do that, you compare the number of hours the child care business is operated, including preparation and cleanup time, to the total number of hours in the year (8,760).
Assume you use 40% of your house for a nursing daycare business that operates 12 hours a day, five days a week for 50 weeks of the year.
12 hours x 5 days x 50 weeks = 3,000 hours per year.
3,000 hours ÷ 8,760 total hours in the year = 0.34 (34%) of available hours.
34% of available hours x 40% of the house used for business = 13.6% business write-off percentage.
Simplified square footage method
Beginning with 2013 tax returns, the IRS began offering a simplified option for claiming the deduction. This new method uses a prescribed rate multiplied by the allowable square footage used in the home.
For 2021, the prescribed rate is $5 per square foot with a maximum of 300 square feet.
If the office measures 150 square feet, for example, then the deduction would be $750 (150 x $5).
The space must still be dedicated to business activities.
With either method, the qualification for the home office deduction is determined each year. Your eligibility may change from one year to the next. Finally, please note that only certain expenses such as rent, mortgage interest and property taxes qualify for the deduction, and the deduction is limited to $10,000.
A bear market relief rally describes a period inside of a bear market in which prices of stocks temporarily increase during, sometimes quite sharply, before returning to new lows. This rise in prices is typically a short-lived increase, sometimes lasting anywhere from days to months, amidst an overall long-term downward trend in the market.
Personal health sensors and apps equip patients with personalised data so that they can become more proactive in managing their health. But what is still mostly the norm is that these sensitive data are governed by the companies providing these services; and they often profit out of it, oblivious to patients.
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But even though NFTs are still in their infancy, the technology might evolve in the future to become more compelling for patients to favor the agency it provides over their data.
The International Franchise Association (IFA) estimates that that about $1 trillion in sales, or 40% of all retail sales, were made through franchised establishment last year. On the positive side, franchises offer a branded practice concept with management training and access to proprietary methods, marketing and advertising campaigns and a host of support.
Moreover, there are franchises available for virtually every healthcare product or service, including: diet, weight loss and fitness; vein care and laser surgery; vitamins, nutriceuticals and pharmaceuticals; plastic and cosmetic surgery; dermatology, tanning and skin care; home healthcare and extended, etc. Some well know established healthcare and medical franchises are: Doctors Express, Being There Senior Care, Home Care Assistance, Personal Training Institute, Inches-A-Weigh, Remedy Intelligent Staffing, Visiting Angels, Unlimited MedSearch, prnYourHealth and Any Lab Test Now, etc.
On the downside, franchises incur high start-up costs, rules and obligations, payment of franchise percentages and many contractual obligations. Questions to consider when contemplating this business entity include:
Franchise stability, track record, licensing and costs.
Training, support and proximity of other franchises.
Independence, ownership laws, contracts and dispute resolutions,
Screening methods, market size and potential market share.
Replacement cost and transferability?
For more information on Uniform Franchise Offerings Circulars (UFOCs) contact www.FranChoice.com or:
DEFINITION: Fractional shares are partial shares of a company’s stock. Instead of owning one or more full shares of the stock, you own a portion, or fraction, of one. In the past, investors generally would end up with fractional shares only after a stock split, since brokers allowed the purchase of full shares only.
A fractional share is a portion of an equity stock that is less than one full share.
Fractional shares often result from stock splits, which don’t always result in an even number of shares.
Mergers or acquisitions create fractional shares, as companies combine new common stock using a predetermined ratio.
Fractional shares can make it easy to buy very small stakes in many different companies. But, if your brokerage charges commissions, you might wind up paying a lot of fees due to the temptation to invest in many different companies.
DEFINITION: A poison pill is a defense tactic utilized by a target company to prevent or discourage hostile takeover attempts. Poison pills allow existing shareholders the right to purchase additional shares at a discount, effectively diluting the ownership interest of a new, hostile party.
DEFINITION: A hostile takeover refers to the acquisition of one company by another corporation against the wishes of the former. The company being acquired in a hostile takeover is called the target company while the one executing the takeover is called the acquirer. In a hostile takeover, the acquirer goes directly to the company’s shareholders or fights to replace management to get the acquisition approved. Approval of a hostile takeover is generally completed through either a tender offer or a proxy fight.
An interval fund is a type of closed-end fund with shares that do not trade on the secondary market. Instead, the fund periodically offers to buy back a percentage of outstanding shares at net asset value (NAV). The rules for interval funds, along with the types of assets held, make this investment largely illiquid compared with other funds.
For a while in the value investing community the number of positions you held was akin to bragging on your manhood– the fewer positions you owned the more macho an investor you were. I remember meeting two investors at a value conference. At the time they had both had “walk on water” streaks of returns. One had a seven-stock portfolio, the other held three stocks. Sadly, the financial crisis humbled both – the three-stock guy suffered irreparable losses and went out of business (losing most of his clients’ money). The other, after living through a few incredibly difficult years and an investor exodus, is running a more diversified portfolio today.
Under-diversification: Is dangerous, because a few mistakes or a visit from Bad Luck may prove to be fatal to the portfolio.
On the other extreme, you have a mutual fund industry where it is common to see portfolios with hundreds of stocks (I am generalizing). There are many reasons for that. Mutual funds have an army of analysts who need to be kept busy; their voices need to be heard; and thus their stock picks need to find their way into the portfolio (there are a lot of internal politics in this portfolio). These portfolios are run against benchmarks; thus their construction starts to resemble Noah’s Ark, bringing on board a few animals (stocks) from each industry. Also, the size of the fund may limit its ability to buy large positions in small companies.
There are several problems with this approach. First, and this is the important one, it breeds indifference: If a 0.5% position doubles or gets halved, it will have little impact on the portfolio. The second problem is that it is difficult to maintain research on all these positions. Yes, a mutual fund will have an army of analysts following each industry, but the portfolio manager is the one making the final buy and sell decisions. Third, the 75th idea is probably not as good as the 30th, especially in an overvalued market where good ideas are scarce.
Then you have index funds. On the surface they are over-diversified, but they don’t suffer from the over-diversification headaches of managed funds. In fact, index funds are both over-diversified and under-diversified. Let’s take the S&P 500 – the most popular of the bunch. It owns the 500 largest companies in the US. You’d think it was a diversified portfolio, right? Well, kind of. The top eight companies account for more than 25% of the index. Also, the construction of the index favors stocks that are usually more expensive or that have recently appreciated (it is market-cap-weighted); thus you are “diversified” across a lot of overvalued stocks.
If you own hundreds of securities that are exposed to the same idiosyncratic risk, then are you really diversified?
Our portfolio construction process is built from a first-principles perspective. If a Martian visited Earth and decided to try his hand at value investing, knowing nothing about common (usually academic) conventions, how would he construct a portfolio?
We want to have a portfolio where we own nottoo many stocks, so that every decision we make matters – we have both skin and soul in the game in each decision. But we don’t want to own so few that a small number of stocks slipping on a banana will send us into financial ruin.
In our portfolio construction, we are trying to maximize both our IQ and our EQ (emotional quotient). Too few stocks will decapitate our EQ – we won’t be able to sleep well at night, as the relatively large impact of a low-probability risk could have a devastating impact on the portfolio. I wrote about the importance of good sleep before (link here). It’s something we take seriously at IMA.
Holding too many stocks will result in both a low EQ and low IQ. It is very difficult to follow and understand the drivers of the business of hundreds of stocks, therefore a low IQ about individual positions will eventually lead to lower portfolio EQ. When things turn bad, a constant in investing, you won’t intimately know your portfolio – you’ll be surrounded by a lot of (tiny-position) strangers.
Portfolio construction is a very intimate process. It is unique to one’s EQ and IQ. Our typical portfolios have 20–30 stocks. Our “focused” portfolios have 12–15 stocks (they are designed for clients where we represent only a small part of their total wealth). There is nothing magical about these numbers – they are just the Goldilocks levels for us, for our team and our clients. They allow room for bad luck, but at the same time every decision we make matters.
Now let’s discuss position sizing. We determine position sizing through a well-defined quantitative process. The goals of this process are to achieve the following: Shift the portfolio towards higher-quality companies with higher returns. Take emotion out of the portfolio construction process. And finally, insure healthy diversification.
Our research process is very qualitative: We read annual reports, talk to competitors and ex-employees, build financial models, and debate stocks among ourselves and our research network. In our valuation analysis we try to kill the business – come up with worst-case fair value (where a company slips on multiple bananas) and reasonable fair value. We also assign a quality rating to each company in the portfolio. Quality is absolute for us – we don’t allow low-quality companies in, no matter how attractive the valuation is (though that doesn’t mean we don’t occasionally misjudge a company’s quality).
The same company, at different stock prices, will merit a higher or lower position size. In other words, if company A is worth (fair value) $100, at $60 it will be a 3% position and at $40 it will be a 5% position. Company B, of a lower quality than A but also worth $100, will be a 2% position at $60 and a 4% position at $40 (I just made up these numbers for illustration purposes). In other words, if there are two companies that have similar expected returns, but one is of higher quality than the other, our system will automatically allocate a larger percentage of the portfolio to the higher-quality company. If you repeat this exercise on a large number of stocks, you cannot but help to shift your portfolio to higher-quality, higher-return stocks. It’s a system of meritocracy where we marry quality and return.
Let’s talk about diversification. We don’t go out of our way to diversify the portfolio. At least, not in a traditional sense. We are not going to allocate 7% to mining stocks because that is the allocation in the index or they are negatively correlated to soft drink companies. (We don’t own either and are not sure if the above statement is even true, but you get the point.) We try to assemble a portfolio of high-quality companies that are attractively priced, whose businesses march to different drummers and are not impacted by the same risks. Just as bank robbers rob banks because that is where the money is, value investors gravitate towards sectors where the value is. To keep our excitement (our emotions) in check, and to make sure we are not overexposed to a single industry, we set hard limits of industry exposure. These limits range from 10%–20%. We also set limits of country exposure, ranging from 7%–30% (ex-US).
CONCLUSION
In portfolio construction, our goal is not to limit the volatility of the portfolio but to reduce true risk – the permanent loss of capital. We are constantly thinking about the types of risks we are taking. Do we have too much exposure to a weaker or stronger dollar? To higher or lower interest rates? Do we have too much exposure to federal government spending? I know, risk is a four-letter word that has lost its meaning. But not to us. Low interest rates may have time-shifted risk into the future, but they haven’t cured it.
Decentralized Autonomous Organizations in Health Care?
By Staff Reporters
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DEFINITION: A decentralized autonomous organization (DAO), sometimes called a decentralized autonomous corporation (DAC), is an organization represented by rules encoded as a computer program that is transparent, controlled by the organization members and not influenced by a central government. A DAO’s financial transaction record and program rules are maintained on a blockchain.
What it is: Exactly what it sounds like. The North American crude oil benchmark, known as West Texas Intermediate (WTI), is one of three main oil benchmarks used around the globe. While WTI is sourced primarily from Texas, it’s considered one of the highest-quality oils and is often refined into gasoline.
How it works: WTI is the physical commodity behind oil futures contracts traded on the New York Mercantile Exchange. Oil futures = financial instruments that allow investors to buy “abstract oil.” When the futures contract expires, that investment is converted into IRL oil, cashed out, or rolled into a future futures contract.
Why it matters: Oil prices are affected by economic conditions, supply and demand, and geopolitical forces. The coronavirus pandemic caused a historic collapse in prices this spring, and while prices have stabilized, the outlook is shaky.
Tax planning can be quite a tedious process, but there are benefits for all seniors to make it less taxing. And senor medical professionals should take particular note:
Free Advice: IRS-certified volunteers will help older taxpayers with tax return preparation and electronic filing between January 1st and April 15th each year.
No Withdrawal Penalties: Anyone aged 59 years or over can withdraw money from an IRA, without incurring the common 10% tax.
Catch-Up Contributions: Healthcare Workers aged 50 or older can defer income tax on an extra $6,500 or a total of $26,000 if contributed to a 401(k) plan, resulting in a tax savings of $6,240 for an older worker in the 24% tax bracket.
Additional IRA Contribution: Workers age 50 and older can contribute an additional $1,000 to an IRA, or a total of $7,000 in 2020.
The 4% Rule is a practical rule of thumb that may be used by retirees to decide how much they should withdraw from their retirement funds each year; according to Investopedia.
The purpose of adopting the rule is to keep a steady income stream while maintaining an adequate overall account balance for future years. The withdrawals will consist primarily of interest and dividends on savings.
CHALLENGE: But, experts like Mike Kitces are divided on whether the 4% withdrawal rate is the best option. Many, including the creator of the rule, say that 5% is a better rule for all but the worst-case scenario.
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