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The Role of Asset Classes

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By Charles Schwab

Various Asset Classes and Diversification

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infographic_web-1-updated_3

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More:

Conclusion

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Are We Over-Optimizing Portfolio Asset Classes?

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Too Many Other Asset Classes?

[By Dr. David Edward Marcinko MBA CMP™]Dr. David E. Marcinko MBA

Some financial analysts believe that the focus on asset classes may have gone too far as physicians and other investors have sought to “over optimize” their portfolios.

In fact, colleague David Loeper, CEO of Wealthcare Capital Management, explained this concept as follows:

“Where things have really got off track has been the insistence on breaking asset classes into sub-classes by style, market capitalization, etc. The unpredictability of all the inputs into our optimizers, even over long periods of time, has been ignored. We have attempted to take efficient portfolios of stocks, bonds and cash and make them even more efficient by breaking the unpredictable asset classes into even less predictable sub-classes. This has all been done into the pursuit of “efficiency” as the proposal was validated by the Brinson & Beebower study, which purports to find that over 90% of the investment return variance is explained by asset allocation. The risk that you produce inefficient portfolios INCREASES if you increase the number of “asset classes” for which you must forecast not only the risk and returns but also each asset class’ correlation to the others.”

Assessment

If true, and I think it is a valid point, the results of the optimizer and your resulting portfolio’s efficiency is based on the accuracy of the inputs and NOT THE NUMBER OF THE INPUTS.

Stock_Market

Or, is this like the TNTC situation in cell cultures and microbiology [Too Numerous To Count].Certified Medical Planner  Conclusion

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It’s not how much you own [assets] – It’s how much you control

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Are non-asset owners financially ahead?

By Rick Kahler MS CFP® ChFC CCIM http://www.KahlerFinancial.com

Rick Kahler CFPOwning a home is part of the American Dream. Financial experts tell us owning a car is better than leasing. And who would think of not owning the clothes you wear? The concept of “that’s mine” runs so deep it’s probably hardwired into our brains. To prove it, just try to take a toy away from a two-year-old.

On the other hand, the control of an asset is often more valuable than ownership. If you could lease a new $25,000 car for one dollar a month for 10 years, do you really care if you don’t own it? Absolutely not!

Or take a middle-aged tenant with a lifetime lease on a property subject to rent controls who pays rent at a tenth of current market rates. Who has the more value from that asset, the tenant or the owner? Clearly, the tenant has a valuable leasehold interest that in some cases could be worth more than the ownership interest.

If we can have regular access to something, whether it’s using a beach house through a home swap, sharing power tools, or renting a trailer to haul a piano, we don’t need to own it. Often, we’re financially ahead not to own it.

Income Receipt

Can this same concept apply to the income you receive? It may. For some people, having access to benefits and services they don’t “own” through their earnings may be the better deal. This is the conclusion Gary Alexander, Secretary of Public Welfare for Pennsylvania, reached in a paper called “Welfare’s Failure and the Solution.”

He published a chart showing the government benefits that accrue to single mothers. Alexander states, “The single mom is better off earning gross income of $29,000 with $57,327 in net income and benefits than to earn gross income of $69,000 with net income and benefits of $57,045.”

According to Alexander, benefits that accrue in Pennsylvania to a single mom with two preschool children, who earns $29,000, include health insurance for her children ($5,000), various childcare benefits ($15,000), housing ($6,000), and food ($2,300). A single mom earning $69,000 doesn’t qualify for any of these benefits and actually takes home $182 less than the mom earning $29,000.

A chart in Alexander’s paper with even more serious implications illustrates that 110 million privately employed workers in the US now support 88 million welfare recipients and government workers. This trend is not economically sustainable. While the government can print all the money needed to fund the 88 million, inflation becomes a huge concern. If inflation and taxes continue to climb, at some point, the producers/taxpayers may say “enough.” They will either choose to become recipients instead of producers, or they might relocate themselves and their skills to a country that rewards productivity and incentive.

###

landlords

A painful reality in America

The financial blog ZeroHedge.com published an article on this topic on November 27, 2012. The piece calls it a “painful reality in America” that “for increasingly more it is now more lucrative—in the form of actual disposable income—to sit, do nothing, and collect various welfare entitlements, than to work.”

This is a difficult subject to raise. I am sure my inbox will fill with unhappy emails from folks who will miss my point and others who will give me illustrations of those less fortunate who legitimately depend on welfare.

Assessment

However, the painful long-term costs and consequences of welfare is one of the essential topics we need to talk about if we are to solve our nation’s fiscal problems. If our representatives come to depend more for reelection on those who receive tax funds than those who provide tax funds, we will only dig ourselves further into debt.

Conclusion

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Top Ten Wealth Management Posts for Doctors

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Conclusion

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Is There an “Efficient Frontier” for Medicare Payment Reform?

An Essay on Financial Health Risk Self-Selection

By Dr. David Edward Marcinko MBA CMP™

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[Publisher-in-Chief]

Health economist Austin Frakt PhD, of the Incidental Economist, alerted us to this recent publication “Achieving Cost Control, Care Coordination, and Quality Improvement through Incremental Payment System Reform”, by and from: (Averill, et al., JACM, 2010). The paper describes various Medicare payment reform methods.

The Abstract

The healthcare reform goal of increasing eligibility and coverage cannot be realized without simultaneously achieving control over healthcare costs. The reform of existing payment systems can provide the financial incentive for providers to deliver care in a more coordinated and efficient manner with minimal changes to existing payer and provider infrastructure. Pay for performance, best practice pricing, price discounting, alignment of incentives, the medical home, payment by episodes, and provider performance reports are a set of payment reforms that can result in lower costs, better coordination of care, improved quality of care, and increased consumer involvement. These reforms can produce immediate Medicare annual savings of $10 billion and create the framework for future savings by establishing financial incentives for long-term provider behavior changes that can lead to lower costs.

Patient Risk Sharing

Of course, the third dimension of risk [beyond traditional doctor/hospital provider and Medicare insurer] would be the risk borne by the patient insured (degree of cost-sharing or “consumer responsibility”). This relationship is represented diagrammatically right here:

Brief Review of MPT

Modern portfolio theory (MPT) attempts to maximize investment portfolio expected returns for a given level of risk by carefully choosing the proportions of various asset classes. As a mathematical formulation, the concept of diversification aims to select a collection of assets that collectively lowers risk [measured by standard deviation] more than any individual asset class. This pleasing point is known as the “efficient frontier.” And, it can be seen intuitively because different types of assets often change in value in opposite ways.

Is There an Insurance Efficient Frontier?

Health insurance [medical payment reform] econometric considerations may now be extended in this analogy to suggest that medical providers and CMS payers are the surrogates for two dimensions in the MPT. The third might be the risks borne by the patient insured (degree of cost-sharing or “consumer responsibility”), as above.

Assessment

Then, patients could self-select where they wish to fall on the health insurance “efficient frontier”, balancing all three dimensions as in MPT, along with lifestyle and moral hazard considerations, etc.

Conclusion

And so, your thoughts and comments on this ME-P are appreciated. Is there an “efficient frontier” for Medicare payment reform?

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Developing a Sound Investment Portfolio

Asset Class Investing for Today, and Beyond

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In 1997, The Prudent Investor’s Guide to Beating the Market was released by John Bowen Jr., and published by Irwin Professional Publishing.  Since then, it has become somewhat of a classic. And so, the time may be right to review the basic concepts it exposes during the current climate of marketplace turmoil, volatility and the impending recessionary financial ecosystem.  

Basic Concepts

In the book, Bowen describes the concepts necessary to develop a sound portfolio of asset class investing. These include:

• Utilize diversification effectively to reduce risk—While diversification is generally good; realize that bad diversification also exists. If your investments move together (or in tandem), this is ineffective diversification.

• Dissimilar price-movement diversification enhances returns—The most important component of investing is understanding correlation coefficients (dissimilar price movements). By combining assets with low correlations, the physician investor can lower the overall portfolio risk while enhancing risk-adjusted rates of return. If two portfolios have the same average return, the one with the lower volatility will have the greater compound rate of return over time.

• Utilize institutional asset class mutual funds—This belief stems from markets being efficient. Therefore, the best way to add value to mutual funds is to diversify into asset class mutual funds so you can achieve dissimilar price movements that will allow you to diversify effectively.

• Diversify globally—If you have all your money in a single country, you will not achieve diversification because those investments, on average, tend to move together.

• Design portfolios that are efficient—Your portfolio should be designed to provide you with the highest rate of return for the level of risk with which you are comfortable.

Stay the Course

Bowen believes the secret to asset class investing is having the discipline to stay-on-track. He further states that the investor must stay the course and avoid market timing, because it simply does not work. He tells his readers that only through a patient, long-term perspective will they realize their financial goals. He states that more than 90% of the market gain recorded each year has been concentrated in a single 30-day period.

Risk Management

To determine how much risk any physician-investor is willing to take, Bowen suggests looking at the 1973–1974 domestic stock market performance. These two years experienced the worst financial recession since World War II. In selecting the risk tolerance that’s appropriate, physicians and other investors should consider their optimal portfolio at its average risk level. Bowen believes that just because Wall Street doesn’t acknowledge the existence of those years, doesn’t mean you shouldn’t.

Assessment

He also states that you should only be in the equity market if your time horizon exceeds five years. This way, you’ll be able to weather the business cycles with peace of mind.

For any portfolio less than five years, Bowen states that it should be predominantly made up of fixed income securities. He also states that most portfolios should consist of a money market account, a one-year corporate bond, a five-year government fund, a US large company fund, a U.S. small company fund, an international large company fund, and an international small company asset class mutual fund.

Conclusion

The original book is written in a clear and concise format. It gives a history of the market and shows the reader what works, what doesn’t, and explains why. The book should again be a prerequisite reading for physician-investors and financial advisors; especially today.

Any thoughts, opinions and comments are appreciated.

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