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WHAT IS A CLOSED-END MUTUAL FUND

ON OPEN AND CLOSED MUTUAL FUNDS

By staff reporters

A closed-end fund (CEF) or closed-ended fund is a collective investment model based on issuing a fixed number of shares which are not redeemable from the fund.

Unlike open-end funds, new shares in a closed-end fund are not created by managers to meet demand from investors. Instead, the shares can be purchased and sold only in the market, which is the original design of the mutual fund, which predates open-end mutual funds but offers the same actively-managed pooled investments.

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BUSINESS, FINANCE, INVESTING AND INSURANCE TEXTS FOR DOCTORS
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Are Financial Asset Classes like a Box of Valentine Chocolates in 2020?

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On Valentine’s Day Diversification

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

Rick Kahler CFPWith displays of Valentine candy in every store, February is the perfect time to talk about chocolate. A creative financial planner might even steal Forrest Gump’s analogy and say, “Diversification is like a box of chocolates.”

Except that it isn’t.

True, a box of chocolates might have a lot of variety. Cream centers. Caramels. Nougats. Nuts. Dark chocolate. Milk chocolate. Truffles. Yet it’s all still chocolate.

Retirement Savings

Buying that box would be like investing your retirement savings in a variety of US stocks. Even if you had a dozen different companies, they would all be the same basic category of investment, or asset class.

For example, suppose you gave your true love a slightly more diversified Valentine gift made up of chocolates, Girl Scout cookies, baklava, and apple pie. That would compare to investing in different types of stocks like US, international, or emerging markets. But, everything would still be dessert.

Wiser Physician-Investors

You would be a wiser doctor-investor if you took your true love out for dinner and had a meat course, a salad, vegetables, bread, dessert, and wine. Now you’d start to see real diversification.

In addition to US, international, and emerging market stocks (all dessert), you might have some other asset classes like US and international bonds (meat), real estate (bread), cash (salad), commodities (veggies), and absolute return strategies (wine).

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box

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Long Term Growth Generator

This kind of asset class diversification is the best investment strategy for long-term growth. My preference is eight or nine different classes. For many clients, I recommend a mix of US and international stocks and bonds, real estate investment trusts, a commodities index fund, market neutral funds like merger arbitrage and managed futures, junk bonds, and Treasury Inflation Protected Securities (TIPS).

Market Fluctuations

Fluctuations in the market will tend to affect the various securities within a given asset class in the same way. Most US stocks, for example, would generally move up or down at the same times. So, owning shares of several different stocks wouldn’t protect you against changes in the market. When a portfolio is well-diversified, the volatility is reduced even during times when the markets are moving strongly up or down.

When I talk about investing in a variety of asset classes, I don’t mean owning stocks, real estate, gold, or other assets directly. For individual investors, mutual funds are a much better choice. Occasionally, someone will ask me, “But why should I have everything in mutual funds? That isn’t diversified, is it?”

Mutual Funds

Mutual funds are not an asset class. A mutual fund isn’t like a type of food; it’s like the plate you put the food on. A single plate might hold one food item or servings from several different food groups. More specifically, mutual funds are pools of money invested by managers. One fund might invest in real estate investment trusts (REITS). Another might have international stocks chosen for their high returns. Still others invest in a diversified mix of asset classes. The mutual fund is just the container that holds the investments.

heart[Courtesy GE Healthcare]

Annuities

Annuities and IRAs aren’t asset classes, either, but are also examples of different types of containers that hold investments. If you use your IRA to purchase an annuity, all you’re doing is stacking one plate on top of another. It doesn’t give you another asset class, it just costs you more for the second plate.

Assessment

Having a box of chocolates for dinner might seem more appealing in the short term than eating a balanced meal. Investing in the “get-rich-now” flavor of the month might seem tempting, too. Yet in the long run, asset class diversification is the best way to make sure you have a healthy investment diet.

***

February 14th, 2020

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Morningstar Expense Ratio Study Shows Fund Costs Falling

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Asset-Weighted Expense Ratios and Market Share

By Morningstar

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Conclusion

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The Danger of Groupthink with Endowment Fund Portfolio Managers

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A Historical Look-Back to the Future?

wayne-firebaugh

By Wayne Firebaugh CPA CFP® CMP™

www.CertifiedMedicalPlanner.org

It is not unusual for endowment fund managers to compare their endowment allocations to those of peer institutions and that as a result, endowment allocations are often similar to the “average” as reported by one or more survey/consulting firms.

One endowment fund manager expanded this thought by presciently noting that expecting materially different performance with substantially the same allocation is unreasonable [personal communication]. It is anecdotally interesting to wonder whether the seminal study “proving” the importance of asset allocation could have even had a substantially different conclusion. It seems likely that the pensions surveyed in the study had very similar allocations given the human tendency to measure one’s self against peers and to use peers for guidance.

Peer Comparison

Although peer comparisons can be useful in evaluating your institution’s own processes, groupthink can be highly contagious and dangerous.

For example, in the first quarter of 2000, net flows into equity mutual funds were $140.4 billion as compared to net inflows of $187.7 billion for all of 1999. February’s equity fund inflows were a staggering $55.6 billion, the record for single month investments. For all of 1999, total net mutual fund investments were $169.8 billion[1] meaning that investors “rebalanced” out of asset classes such as bonds just in time for the market’s March 24, 2000 peak (as measured by the S&P 500).

Of course, investors are not immune to poor decision making in upward trending markets. In 2001, investors withdrew a then-record amount of $30 billion[2] in September, presumably in response to the September 11th terrorist attacks. These investors managed to skillfully “rebalance” their ways out of markets that declined approximately 11.5% during the first several trading sessions after the market reopened, only to reach September 10th levels again after only 19 trading days. In 2002, investors revealed their relentless pursuit of self-destruction when they withdrew a net $27.7 billion from equity funds[3] just before the S&P 500’s 29.9% 2003 growth.

The Travails

Although it is easy to dismiss the travails of mutual fund investors as representing only the performance of amateurs, it is important to remember that institutions are not automatically immune by virtue of being managed by investment professionals.

For example, in the 1960s and early 1970s, common wisdom stipulated that portfolios include the Nifty Fifty stocks that were viewed to be complete companies.  These stocks were considered “one-decision” stocks for which the only decision was how much to buy. Even institutions got caught up in purchasing such current corporate stalwarts as Joe Schlitz Brewing, Simplicity Patterns, and Louisiana Home & Exploration.

Collective market groupthink pushed these stocks to such prices that Price Earnings ratios routinely exceeded 50. Subsequent disappointing performance of this strategy only revealed that common wisdom is often neither common nor wisdom.

Senate house conference committee meets wall street reform

[Wall Street Reform?]

More Current Examples

More recently, the New York Times reported on June 21, 2007, that Bear Stearns had managed to forestall the demise of the Bear Stearns High Grade Structured Credit Strategies and the related Enhanced Leveraged Fund.

The two funds held mortgage-backed debt securities of almost $2 billion many of which were in the sub-prime market.  To compound the problem, the funds borrowed much of the money used to purchase these securities.

The firms who had provided the loans to make these purchases represent some of the smartest names on Wall Street, including  JP Morgan, Goldman Sachs, Bank of America, Merrill Lynch, and Deutsche Bank.[4]

Assessment

Despite its efforts Bear Stearns had to inform investors less than a week later on June 27th that these two funds had collapsed.

Conclusion

Is this same Groupthink mentality happening on Wall Street, today? 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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[1]   2001 Fact Book, Investment Company Institute.

[2]   Id.

[3]   2003 Fact Book, Investment Company Institute.

[4]    Bajaj, Vikas and Creswell, Julie. “Bear Stearns Staves off Collapse of 2 Hedge Funds.”
New York Times, June 21, 2007.

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Is Passive Investing Right for You?

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On the “Buy low and Sell high” Strategy 

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

Rick Kahler CFP“Buy low and sell high.” That was my simple approach when I was a smart young investment advisor. I poured over a company’s balance sheet, earnings statements, and forecasted returns. Then I bought those companies that were bargains and waited for my gains to roll in. More times than not, they did—eventually.

The problem came with the “not” and “eventually.” A majority of my picks did go up in value, but the minority that were “nots” still lost enough to have a negative impact on my bottom line. Even more frustrating, some of my “nots” turned into gains “eventually” after I sold them.

My investment returns were similar to findings from Dalbar, Inc., a financial services research firm. Dalbar’s studies have shown that average active investors barely beat inflation over the long term. They significantly underperform investors who put their money in an index fund of stocks and leave it alone.

So much for my early investment brilliance! Over the past 40 years, I’ve learned that with every passing year I know less than I thought I did the year before. I’ve proven to myself I have no idea where any market is going tomorrow, next month, next year, or in the next 10 years.

This awareness has led me to become increasingly passive in my investments. In passive investing, rather than trying to time the buying and selling of winners and losers, you instead buy a representative sample of the entire market. This is possible in any market: bonds, stocks, real estate investment trusts, or commodities. You simply buy mutual funds and exchange-traded funds (ETF’s) called index funds.

Benefits

The two biggest benefits of passive investing are cost and diversification.

Costs

Index funds have incredibly low costs, with annual fees as low as 0.1%. Contrast that with the average equity fund that costs 1.5%, fifteen times more. According to research, 97% of active mutual fund managers don’t beat the index over 20 years. Even the 3% who do must beat the index by more than the 1.5% fee they charge, in order for their investors to come out ahead.

Diversification

The smaller number of stocks owned – the more my fortunes are tied to those few companies. It’s the old adage, “don’t put all your eggs in one basket.” By owning index funds, I own hundreds or thousands of securities. While I will never hit a home run, I also will never strike out. My returns will be “average.” Investing may be one of the few professions where being average puts you in the 97th percentile of all investment managers.

The NaySayers

Not all of my peers agree with this philosophy. Many very smart investment advisors jumped off the passive investing bandwagon after 2008 and returned to tactical asset allocation, which is another name for timing the markets.

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Harold’ Strategy

A noted investment advisor, Harold Evensky MBA CFP® of Evensky & Katz, addressed this issue at a conference last year. After the 2008 crisis, his firm hired researchers to evaluate whether they could find any tactical strategies that would have avoided the crisis. They found some that, in hindsight, would have worked. Yet he didn’t feel those strategies could be comfortably applied looking forward. Instead, the firm decided to add a 20% allocation to non-correlated alternative investments, something I’ve done since the late 90’s. In other words, they increased their clients’ diversification.

Assessment

The bottom line is that passive investing actually gives you more control. It allows you to focus on reducing costs and taxes, the aspects of investing you can control. It frees you from trying to beat the market and worrying over what you can’t control.

Conclusion

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Are Physicians Investing in International Bonds?

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A Global Approach to Investing

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

Rick Kahler CFPUS investors and fans of the St. Louis Rams have something in common. Both have seen their home teams fall from prominence to mediocrity in the past ten years. In 2000 the Rams won the Super Bowl, but in 2011 they ended the season tied for the worst record in the league. The US ranked as the world’s third freest economy in 2000, but by 2010 had fallen to number 18.

So, how do physicians and other investors allocate their funds in a country that’s in economic decline? Much like an ardent fan of the Rams who is also an astute gambler! You cheer for your team to win, but you place your bets on the stronger opponents.

Global Investing

It’s critical today to take a global approach to investing. Since the US now makes up less than half of the world’s wealth, it makes sense to invest the majority of your portfolio in the stocks and bonds of other countries. This is simply another form of diversification. Not only does it make sense to have US government bonds and the bonds from a wide range of companies in your portfolio, it also makes sense to diversify and hold a wide range of bonds of international companies and foreign governments.

While it isn’t uncommon for physician investors to have some exposure to international stocks, I find it is unusual for them to have investments in international bonds.

Investing in Bonds

When you invest in bonds, you are lending to a borrower who promises to pay interest and to repay the loan on a certain date. Bonds represent an IOU from a US or foreign corporation or government.

As with any bond, an important factor to consider is the credit quality of the issuer. This can become more complex with foreign bonds, as many countries don’t have the same standards of accounting required in the US.

More:

Foreign Bonds

A unique feature of foreign bonds is the effect that currency exchange rates have on your investment. Fluctuations in the local currency can enhance or depress your returns.

For example, if you want to purchase bonds denominated in the Australian dollar (AUD) you will first need to exchange your US dollars (USD) for AUD and then purchase the bonds. If the USD drops in value against the AUD, then the value of your Australian bonds goes up because your AUD now buy more USD. The reverse happens if the USD appreciates against the AUD.

Global investing

Direct Purchase of Mutual Funds

There are two ways to purchase international bonds. You can buy bonds directly from a securities broker or purchase shares of a mutual fund that invests in foreign bonds. Any fund with “international” in its name invests only in bonds of countries outside the US. If the fund has “global” in its name, it includes both foreign and US bonds in its mix.

The two categories of international bonds include those issued by developed nations like the United Kingdom, Japan, or Germany, and those issued by emerging market nations like India, Brazil, or Morocco. Emerging market bond funds invest in bonds from developing nations, risking greater losses for the chance of higher returns.

In my portfolios, I generally split my bond allocations 50/50 between the US and foreign bonds. Currently, our fund manager favors the bonds of Australia, New Zealand, and Canada.

Assessment

The Rams did better in 2012 than in 2011, so fans can hope they regain their top status in 2013. We can also hope the US can stop its economic slide and regain its global prominence in the next decade. But, until there is evidence of a turnaround, international bonds are one way physicians can avoid betting too heavily on the home team.

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Are Target Date Mutual Funds a Good Choice?

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An Easy Answer to Retirement Planning -or- MisStep?

By David Wallace [Search and social media marketer from Anthem, Arizona]

Investing in a target date mutual fund seems like the easy answer to retirement planning.

But, how can a single fund be appropriate for thousands of investors, doctors and medical professionals?

Assessment

Check out the above infographic published by Jemstep to see the limitations of target date funds.

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Why Doctors Must Consider Fees When Building A Retirement Nest Egg

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Understanding Mutual Fund Share Classes and Costs

[By Rick Kahler MS CFP® ChFC CCIM]

www.KahlerFinancial.com

Doctors – Do you want to add $500,000 or more to your retirement nest egg? Pay attention to the fees that mutual funds charge you for investing your money. Few physicians or small investors understand that the same mutual fund can charge a wide range of fees, depending on the share class you select.

For many medical professionals and most Americans, the best way to build wealth is to live on less than you make and invest 15% to 35% of your paycheck into mutual funds. It’s essential to find funds that are diversified among five or more asset classes.

The Choice After Mutual Fund Selection

Once you’ve found a mutual fund with a mix of appropriate asset classes, there’s one more choice to make. What class of shares should you buy? The most popular classes are A, B, and I shares; however, many funds offer even more classes like C, F, and R shares.

The difference between the classes has nothing to do with the underlying management or structure of the mutual fund. All share classes own the same stocks or bonds. The difference lies in the fees you pay the mutual fund for their services and for commissions to brokers who sell the funds.

Types of Share Classes

Many A shares and almost all B, C, F, and R shares impose sales commissions, often called “loads,” which are based on the amount you invest. For example, A shares usually charge you a one-time commission ranging from 4.0% to 5.75% of your initial investment. With B shares there is no up-front commission, but they will charge you a stiff penalty to sell the funds in the early years and will impose an additional annual commission often ranging from .25% to 1.00% a year. Some discount brokers will waive the upfront commission on A shares for their customers.

Typically the best shares to purchase are the I class, which don’t have any commissions associated with them and offer the lowest management fees of any other share class. The downside is that I shares often require a minimum investment ranging from $10,000 to $1,000,000. Financial advisors often have relationships with discount brokers that allow them to purchase the shares for clients in smaller amounts.

Fee Comparisons

It pays to compare fees.

For example, a comparison of fees available at the website of the Financial Industry Regulatory Authority (finra.org/fundanalyzer) shows that a $10,000 investment in the Invesco S&P 500 Index fund’s A shares will cost you $129 a year, while the same investment in the C shares will run $163. If instead you invest in the Fidelity Spartan 500 Index fund you will pay just $11.50 annually, which is over 1% less than the Invesco A shares.

The Savings

It’s surprising what a 1% savings means to your retirement nest egg. According to a study by the Vanguard Group reported by Jack Hough in SmartMoney.com, if a 25-year old saves 9% of his pay in a mutual fund, paying .25% a year in expenses versus 1.25% amounts to having an additional $500,000 by age 65.

Assessment

With all that said, most investors don’t have either the knowledge or the time to construct a diversified portfolio of mutual funds that will carry them through to retirement. Paying a fee or commission for advice can ultimately save you a lot of money. There are advisors who will help smaller investors select investments for an hourly or flat fee. Others charge fees based on the size of your portfolio, which normally range from .3% to 1.5%.

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The “Collective Trust” – A New Financial Product?

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Much Like a Mutal Fund – But Less Transparent

By Staff Reporters

Recently, we received this query from a physician-investor. So, we went right to the innovator of this financial product for the answer.

A collective trust is similar to a mutual fund that only sells to institutional investors like 401-k and 403-b plans. Because a collective trust doesn’t take on retail investors, it’s exempt from some regulatory requirements, so beware!

But, not having to deal with retail investors also makes the costs lower.

Link: http://thefinancebuff.com/collective-trust-vs-mutual-fund-whats-the-difference.html

Assessment

The BlackRock EAFE Equity Index Collective Trust invests in stocks in developed countries, tracking the MSCI EAFE index.

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Investing Behaviors That Leave Money on the Table

Are Physicians Guilty, Too?

By Rick Kahler, CFP®, MS, ChFC, CCIM

If you had half a million dollars for your retirement fund, and invested it in mutual funds, chances are you would leave $25,000 a year of potential income on the table. Over 20 years, that underperformance could cost you over $1,000,000 when you include reinvestment.

The Dalbar Study

This conclusion is based on a recent study by Dalbar, Inc. It found that mutual fund investors (individuals and investment advisors) consistently earn below-average rates of return. This group’s average annual rate of return for 20 years underperformed the average by over 5%.

The Results

The study concluded most of this underperformance has little to do with sound investment strategy and everything to do with psychological factors. It outlined several behaviors that contribute to poor investment decisions such as badly-timed buying and selling.

Lack of Diversification – Many investors try to reduce risk through diversification, but very few do it properly. They try to diversify by having several advisors, many brokerage companies, or different mutual funds. Using these strategies creates a false sense of security that one’s portfolio is diversified. Real diversification is having investments in many different asset classes, i.e., stocks, bonds, real estate, cash, commodities, absolute return, and international equivalents.

Anchoring – This is relating something to a familiar experience that isn’t necessarily true. For example, a financial salesperson may compare investing in an equity mutual fund to growing a tomato plant. You put in a little seed and watch your plant grow and grow, until one day you have a bushel basket of luscious tomatoes. It’s an appealing image, but it sets an unrealistic expectation of an equity mutual fund. Neither stocks nor tomato plants grow that steadily. Some don’t grow at all. Others grow overnight and then die just as suddenly. Some get wiped out by hail. And some thrive.

Media Reporting – Reacting to the financial news without a more in-depth examination can ruin the most sound investment strategy. Very few financial reporters have degrees in economics or finance. Most financial reporting is faddish, trendy, sensational, and shallow. Research suggests investors who shun or limit their intake of financial news do better than those who don’t.

Herding – This is the concept that the herd knows best. Few people want to be going east when the whole herd is heading west. This is especially true when the herd is panicking: selling out of fear that their investments are going to nothing or buying out of fear of being left behind. The most successful investors avoid stampedes.

Loss Aversion – This is placing more emphasis on avoiding loss than on the possibility of gain. It results in investors wanting their cake and eating it too by searching for an investment with a high return and low or no risk. Such investments don’t exist. When they discover this, many investors don’t invest at all. Others go into an investment expecting it won’t go down, then sell out at precisely the wrong time when it does.

Delusion – This is an attitude that “bad things only happen to others, but not me.” A deluded investor is one who holds onto an investment even when it’s apparent that it’s never coming back.

Narrow Framing – This is making a quick decision without gathering or being aware of all the facts and considering the implications. Usually, the investor doesn’t uncover “the rest of the story” until it’s too late and the financial damage is done.

Assessment

And so, are you guilty of any of the above investing behaviors? No one – not even doctors and medical professionals – wants to leave a sizeable amount of potential retirement income on the table. 

The best tool for getting more of that income into your pocket isn’t necessarily studying investment philosophy. It may be more important to learn more about your own behavior.

The Author

Rick Kahler, Certified Financial Planner®, MS, ChFC, CCIM, is the founder and president of Kahler Financial Group in Rapid City, South Dakota. In 2009 his firm was named by Wealth Manager as the largest financial planning firm in a seven-state area. A pioneer in the evolution of integrating financial psychology with traditional financial planning profession, Rick is a co-founder of the five-day intensive Healing Money Issues Workshop offered by Onsite Workshops of Nashville, Tennessee. He is one of only a handful of planners nationwide who partner with professional coaches and financial therapists to deliver financial coaching and therapy to his clients. Learn more at KahlerFinancial.com

Conclusion      

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SPDRs vs. Index Mutual Funds

Understanding Vehicular Pros and Cons

By Dr. David Edward Marcinko MBA CMP™

www.CertifiedMedicalPlanner.org

[Publisher-in-Chief]

It is possible to buy or sell during a trading day with SPDRs, just as one would with a common stock, and, accordingly, the trading price may be set anytime during the day. This could prove valuable in a sudden market downturn. Also, they may be traded using the same types of orders used for stocks (market, limit, at the close, and at the opening) and sold short, even on a downtick.

However, dividend reinvestment is provided by only a few brokers. Since SPDRs represent passive equity portfolios, they tend to be fully invested in the stock market, which removes a significant drag on performance; their expense ratios are significantly below that of stock mutual funds in general, and below many index mutual funds; and they have virtually no turnover and accordingly, minimal capital gains.

Index Mutual Funds

Index funds, on the other hand, may only be purchased or redeemed at the net asset value (NAV) at the end of the trading day. Short sales are not possible; however, dividend reinvestment is available.

The Disadvantages

On the down side, SPDRs are sold like common stocks and, therefore, incur brokerage commissions, but this can be minimized by using discount brokers. SPDRs have been so successful that both the American and New York Stock Exchanges launched internationally indexed products modeled after SPDRs in the spring of 1996. They are termed World Equity Benchmark Shares (WEBS) and Country Baskets.

Note: “Index Stocks: An Introduction to SPDRs—S&P 500 Depository Receipts,” Robert T. Kleiman, in his article, AAII Journal, January 1997, pp. 23–26, American Association of Individual Investors [312] 280-0170).

Conclusion

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Musings on Sector Mutual Funds

A Historical Review

By Dr. David Edward Marcinko MBA, CMP™

www.CertifiedMedicalPlanner.org

[Publisher-in-Chief]

Although less than 5-10% of the total number of mutual funds are considered true sector funds, year after year, 40-50% or more of the top-performing funds have been sector funds. However, for some physician investors sold on a buy-and-hold strategy, sector funds may not be their cup of tea. But, sector funds do offer an opportunity to outperform the market indices, possibly even substantially, according to Marshall Schield in “Developing a Sector Funds Strategy” (Personal Financial Planning, November/December 1996, pp. 39–42, Warren, Gorham & Lamont, [800] 950-1205).

A Volatile Strategy

Typically sector funds are more volatile than the majority of growth funds. This volatility springs from: (1) the fact that the majority of stocks in a particular sector fund move together, thereby magnifying the fund’s movement; (2) the focus of the sector fund manager only on stocks in that sector, enabling him or her to target high potential stocks; and (3) the rotation of “in” and “out” sectors at particular times.

So – What’s a Doctor Investor to Do?

An investor in sector funds needs a strategy that will target sectors on the upswing and signal when to move out of declining funds. When selecting sector funds, Schield recommends building a list of funds that are manageable, full of choices in all types of markets, diversified (three to four funds for an aggressive portfolio or 10–12 for a less aggressive approach) and liquid.

The Balancing Act

Also, develop a healthy balance—not a “hit-or-miss” approach. Schield suggested using the “relative strength” approach for sector selection by computing the percent change in the price of funds over a certain number of days and then ranking them for short-term, intermediate, and long-term periods. With respect to determining the proper timing for buying or selling, the author suggests the use of an individual fund timing system, such as comparing the current NAV of the sector against a moving average for 50 or 75 days or combining both short- and long-term moving averages.

Simplicity Rules

In creating buy-and-sell signals:

  • Keep it simple and manageable.
  • Do not look for perfection.
  • Practice patience.
  • Cut losses and let profits run.
  • Stick with your relative strength.
  • Buy/sell signals consistently.

Assessment

Most of all; be prepared to spend and invest the time necessary to be successful. But, have you or your sector funds been successful in the last decade, or so? If so, which sectors? Please opine?’

Conclusion

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Why You’re Better off with Variable Annuities than Mutual Funds?

Investing Under the Umbrella

By Dr. David Edward Marcinko MBA, CMP™

[Editor-in-Chief]

http://www.CertifiedMedicalPlanner.org

While participation in savings programs such as 401(k), 403(b), IRAs, and SEPs were at record numbers before the “flash-crash” of 2008-09, each of these plans is subject to a contribution cap.

Consequently, investors are always looking for tax-efficient methods to save more for retirement; especially medical professionals as the economy improves as it has been doing of late. Many have turned, or continue to use, mutual funds. In fact approximately 47% of mutual fund assets are composed of nonqualified funds. And, investors tend to buy mutual funds on the basis of before-tax performance rankings.

Enter the VAs

But these folks might far better off with variable annuities [VAs] according to C. Michael Carty and Robert E. Skinner in the article “Variable Annuities vs. Mutual Funds” (Financial Planning, November 1996, pp. 75–84, Securities Data Publishing, Inc). In fact, they present a strong case for investing in variable annuities (said to operate under an umbrella that protects them from current taxation and inflation) as compared to mutual funds, which may continue today.

The Dickson-Shoven Study

Carty and Skinner refer to a 1993 study by Dickson and Shoven conducted at Stanford University in which mutual funds were ranked on an after-tax basis. The change in relative rankings was dramatic. Dickson and Shoven concluded that:

  • Investors should always use after-tax rankings to evaluate and select mutual funds.
  • Given two investments with similar pretax returns, an investor should select the one involving fewer taxes.
  • A variety of approaches to sheltering or deferring taxes should be considered.

And, in one of the first comparison of returns between variable annuities and mutual funds, Rodney Rhoda of Fidelity Investments demonstrated that the difference in expense charges between variable annuities and mutual funds are less than one would expect because of lower variable annuity trading costs and a more stable asset base, which is usually more fully invested.

Assessment

I am not a fan of VAs as several essays in this ME-P suggest. Fees, expenses, loads and commissions are just too darned high.  And, most are sold, not bought.

However, the authors demonstrated that under either lump-sum or gradual withdrawal assumptions, variable annuities consistently beat mutual funds, particularly for medium to high tax-bracket investors who achieve only median investment performance. Low tax-bracket investors who achieve average or lower investment performance benefit least from variable annuities. Also, variable annuities have been shown to be more likely to withstand the ravages of inflation.

And so, the conundrum continues.

Conclusion

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Whither Physician Self-Portfolio Management?

Do it Yourself Considerations

By Clifton N. McIntire, Jr.; CIMA, CFP®

By Lisa Ellen McIntire; CIMA, CFP®fp-book

In order to self create and monitor an investment portfolio for personal, office, or medical foundation use, the physician investor should ask him/herself 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?

How Am I Doing?

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 during last year’s debacle, or so far this year in 2009. 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 were doing fine” -or- “We did terrible last year.”

But, ask how much risk is in the portfolio and help is needed. Nobel laureate Harry Markowitz, PhD 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.

Your Own Portfolio

How, and even whether or not to create and manage your own portfolio, is what this brief post is about.

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.

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 wrap accounts, service fees, AUMs, commissions and compare mutual funds with private money management.

Monitor

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 or 403(b) plans, pension plans, retirement accounts, as well as how to change doctor trustees or managers when necessary.

Assessment

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 illustrated. An actual physicians’ financial plan with investing portfolio was reviewed previously, along with the steps taken to improve returns and reduce risk.

Link: https://healthcarefinancials.wordpress.com/2009/09/03/evaluating-a-sample-physician-financial-plan-iii/

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Tax Efficient Investing

Friends and ME-P Readers,

By Sean G. Todd; Esq, M.Tax, CPA, CFP®

Summer is here for sure in Atlanta—90 degrees plus day after day. I’ve been enjoying the fresh sweet corn, a BLT and a large glass of sweet tea at dinner—now that is a fine meal. Why do I share this with you — because at mid-year, I think from time to time we have to step back from all that we are involved in, concerned with, and what we think is important to actually appreciate all that we have and not overlook the small things. Which brings me to the topic of this Medical Executive-Post and not overlooking the small things—like taxes. As a physician-investor, you have to keep an eye on the impact taxes have on your investment portfolio because it is what you keep after taxes that counts.

Of the Markets

During my last post—I indicated that I was not sure if the recent reprieve in the markets was sustainable. And, we did experience a mild reversal recently. But, did you know that doing nothing is actually doing something? I’m pretty certain that the past investment strategies are not going to work going forward and I share these with ME-P readers as to why I believe this is true; and how best to position your portfolio going forward. Other professionals agree—the rules have changed — have you changed anything? Let’s move on to the real reason you continue to read our posts: To be able to make the right long-term decision during these difficult times. In this post we need to focus on the importance of tax-efficient investing.  We are confident that you and your friends and colleagues whom you choose to share this ME-P will benefit from the information discussed, as well.

Why Tax Efficient Investing is Important

Physicians and all investors have experienced some turbulent times over the last 12 months and it appears more rough waters lie ahead. As a physician-investor, you are unable to control the markets but there are certainly things you can control and should. One of these is taxes. Given the level of government spending, additional tax revenues will be needed which equates to higher taxes. You cannot plan your taxes on April 15th but you have to implement a tax strategy plan during the year so you can capture the benefit on April 15th. With increased taxes on the horizon, tax-efficient investment is going to be more important than ever. Brokers or the 1-800 do-it-yourself brokerage firms are not licensed to give you tax advice, but CPAs and EAs, are. The old saying goes, “It’s not what you make, but what you keep after taxes that counts”. This statement will become even more important going forward.

Returns Lost to Taxes

Have you thought of the impact on your portfolio that taxes have on your investment returns? Good financial advisors should as these are still some of the most important decisions you face as an investor.

Take for example a physician-investor in the top tax bracket earned an average return of 15% on actively managed mutual funds in a taxable account from 1981 to 2001. After taxes, average return dwindled to roughly 12% – which means our investor lost an average of 2.4% in return to taxes (the numbers reflect a compound rate of return). Investment return lost to taxes don’t just affect mutual fund investors — you have to look at your entire holdings in your taxable accounts and how you manage your investments, because, investors in individual stocks and bonds are vulnerable too. Like I indicated, you do have a lot of control over your taxes and should actively control them given the significant impact on your total investment return. Something for consideration: Diversification and asset allocation are great tools for helping to reduce portfolio volatility, but we’re still going to be subject to the short-term whims of the market, no matter how diligent we might be in setting up our portfolios and selecting our individual investments. One of the areas that we have the greatest degree of control is the area of tax-efficient implementations. Doesn’t it make sense that where we can exercise the most control, we do so?

Tax-Efficient Investing is More Important than Ever

Work with me here. If we assume that over the next 20 years annual compound returns for the broad stock market average between 8% and 10%, and bonds average about half that, then average portfolio returns would be less than what we enjoyed over the last 20 years. What this actually means is that any return lost to taxes will be a much bigger deal. In other words, losing 2.4% per year to taxes may not have seemed like much if you were making 15-20% annual returns. But if you only expect to make 9% on your investments, keeping as much of that return as possible, can be vital to achieving your long-term goals. The real impact– 2.4% tax impact will cause you to lose 26% of your 9% gain. Thinking you got a 9% gain but your real after-tax gain is only 6.6%. This is a big annual difference and a significant compound difference.

The second reason tax efficiency is more important than ever is because of the changes to the tax rules in 2003. A notable provision: the 15% tax rate on qualified dividend income. Often a missed opportunity! Previously it might have made sense to hold dividend-paying stocks in a tax-deferred account such as an IRA instead of a taxable account. Either way, dividends were taxed at your ordinary income tax rate between 28% and 39.6% prior to 2001. The thought was the IRA offered tax-deferred potential growth.

Currently, qualified dividends in a taxable account are taxed at a maximum rate of 15%. Those save dividends would be taxed at the ordinary rate—currently as high as 35% when withdrawn from your tax-deferred account. As a result, the value of putting dividend-paying stocks in taxable accounts has grown significantly.

What Investments Go Where?

I need to speak in general terms here, investment that tend to lose less of their return to income taxes are good selections to go into taxable accounts. With that said the opposite should be true: Investments that lose more of their return to taxes could go into tax-deferred accounts. Here’s where tax-smart investors might want to place their investments.

Taxable Accounts Tax-Deferred accounts – Traditional IRAs, 401(k)s and deferred annuities
Ideally place…
Individual Stocks you plan to hold more than one year Individual stocks you plan to hold one year or less
Tax-managed stock funds, index funds, low turnover stock funds Actively managed funds that generate significant short-term capital gains
Stocks or mutual funds that pay qualified dividends Taxable bond funds, zero-coupon bonds, inflation protected bonds or high yield bond funds
Municipal bonds, I bonds Reits

DISCLOSURE: This assumes you hold investments in both types of accounts. A different set of rules would apply if you held all your investments in a taxable account or a tax-deferred account.

In general, holding tax-efficient investment in taxable account and less tax-efficient investment in tax-advantaged account should add value over time. It appears that the above serves as a simple set of guidelines to go by but there are additional considerations before making the above allocation.

Additional Considerations

Reallocation of your Portfolio

To maintain your strategic asset allocation will cause additional tax drag on return, to the extent you rebalance in taxable accounts. You may want to focus on your rebalancing efforts on your tax-advantaged accounts, including your taxable accounts only when necessary. Keep in mind, adding new money to underweighted asset classes in also a tax-efficient way to help keep your portfolio allocation in balance.

Active Trading

Active trading by individuals or by mutual funds, when successful tends to be less tax efficient and better suited for tax-advantaged accounts. A caveat: Realized losses in your tax-advantaged accounts cannot be recognized to offset realized gains on your tax return.

Liquidity Preference

If an investor wanted liquidity, then they might be holding bonds in their taxable accounts, even if it makes more sense to form a tax perspective to hold them in tax advantaged accounts. In other situations, it may be impractical to implement all of your portfolio’s fixed income allocation using taxable bonds in tax-advantaged accounts. If so, compare the after-tax return on taxable bonds to the tax-exempt return on municipal bonds to see which makes the most sense on an after-tax basis.

Estate Planning Issues

One cannot overlook the estate planning issues in deciding which account will hold a given type of investment. Also, what is the philanthropic intent of the doctor or investor? Stocks held in taxable accounts receive a step-up in cost basis at death (something heirs greatly appreciate) which is not the same for tax-advantaged accounts. Additionally, highly appreciated stocks held in taxable accounts more than a year might be well-suited for charitable giving.

Roth IRA

This type of account might just be an exception to all of the above. The rules are different when investors involve a Roth IRA. Since qualified distributions are tax free, assets you believe will have the greatest potential for higher return are best placed inside a Roth IRA, when possible.

Conclusion

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Product Details  Product Details

Discount Brokerages versus On-Line Brokerages

Physicians Must Appreciate the Differences

By Daniel B. Moisand; CFP® and the ME-P StaffME-P Blogger

Here are a few questions for all physician-investors to consider in 2009:

1. True or False? 

The key to investment success is to pay as little for a trade as possible.

2. True or False? 

The higher the number of trades in an investment account, the better the investment results.

3. True or False? 

The majority of revenue of a discount or on-line brokerage comes from trades. 

A: The answers should be crystal clear! False, False and True. It is almost entirely that simple.

Cost Control

Much like a medical practice, keeping costs down is an important objective of personal finance but, it is certainly not the key to success.  There are many studies that show that active trading garners inferior results compared to a longer term buy and hold type of strategy. One of the most publicized recently was conducted by a UC-Davis team led by Dr. Terrance Odean. The study examined the actual tracing activity of thousands of self-directed accounts at a major discount brokerage over a six-year period. The results were clear. Regardless of trading level, most of the accounts underperformed the market and showed that the higher the number of trades, the worse the result.

Of Bulls and Bears

While the U.S. markets were on a dramatic upswing a decade ago, the general interest level in them increased as well.  More households owned financial assets than ever before. Demographics drive much of this surge. The older edge of the baby boom generation is finding that as the children leave home, they have more income than ever before and saving for retirement becomes a higher priority. The proliferation of defined contribution [401-k, 403-b] retirement plans has also forced more people to take responsibility for their long-term security. When, the US stock market was on a tear; one would have be wise to remember an old Wall Street saying – “Don’t confuse brains with a bull market.” Unfortunately today, far too many self-directed investors did not heed the warnings. The media is full of stories about investors whose portfolios were decimated by the recent bear market. While this loss of wealth is somewhat tragic, in almost all cases the losses were made possible by poor planning and/or poor execution that a mediocre advisor would have avoided.

The Business of Advice

One also cannot conclude that everyone is acting as his or her own investment advisor. The advice business continues to thrive. Sales of load mutual funds have continued to grow, as has commission revenue at full-service firms. No-load funds have continued to grow as well and gain market share from the load funds. However, it would be inaccurate to tie that growth to do-it-yourselfers. Much of the growth of no-load funds can be attributed to the advice of various types of advisors who are recommending the funds. In addition, several traditionally no-load fund families have begun to offer funds through brokers for a load.

The Discounters

For physicians and all clients, the primary attraction to a discounter is cost. Everyone loves a bargain. Once it is determined that it is a good idea to buy say 100 shares of IBM, the trade needs to get executed. When the trade settles one owns 100 shares of IBM, regardless of what was paid for the trade. There is no harm in saving a few bucks. However, the decision to buy the IBM shares and when to sell those shares will have a far greater impact on the investment results than the cost of the trade as long as the level of trading is kept at a prudent level. The fact is that most good advisors use discount firms for custodial and transaction services. The leading providers to advisors are Schwab, Fidelity, and Waterhouse.fp-book1

Ego Driven

In addition to cost savings, discounters appeal to one’s ego for business. Everyone wants to feel like a smart investor; especially doctors. Often, marketing materials will cite the IBM example and portray the cost difference as an example of how the investor is either stupid or being ripped off. There is also a strong appeal to one’s sense of control. An investor is made to feel like they are the masters of their own destiny.  All of this is a worthy goal. One should feel confident, in control, and smart about financial issues. Hiring a professional should not result in losing any of these feelings, rather solidify them. Getting one’s affairs in order is smart. The advisor works for the client so a client should maintain control by only delegating tasks to the extent one is comfortable. Knowing that the particular circumstances are being addressed effectively should yield enhanced confidence.

Sales Pressure Release

The final reason people turn to discount and on-line brokerages is to avoid sales pressure. Unlike the stereotypical stockbroker, no one calls to push a particular stock. Instead, sales pressure is created within the mind of the investor. By maintaining a steady flow of information about stocks and the markets to the account holders, brokerages keep these issues in the forefront of the investor’s minds. This increases the probability that the investor will act on the information and execute a trade. Add some impressive graphics and interfaces and the brokerage can keep an investor glued to the screen. The Internet has made this flow easier and cheaper for the brokerages, lowering costs and increasing the focus on trade volume to achieve profitability.

Assessment

The pressurized information flow however, does little to protect investors during a bear market. Ironically, this focus on trading is one of the very conflicts investors are trying to avoid by fleeing a traditional full service broker.

Conclusion

And so, your thoughts and comments on this Medical Executive-Post are appreciated. What are your feelings on discount and internet brokers? Tell us what you think. Feel free to review our top-left column, and top-right sidebar materials, links, URLs and related websites, too. Then, be sure to subscribe to the ME-P. It is fast, free and secure.

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Understanding Managed Bond Funds

Considerations for the Physician-Investor

By Staff Reportersdhimc-book11

Proper diversification among types of bonds is an important investment objective. The maturity schedule and the number of issuers are often very important, along with the issuers’ creditworthiness.

Individual Constraints

The constraints on purchases of individual bond issues often put the physician-investor at a disadvantage. Minimum amounts of investments are imposed by the marketplace or the issuer. Many doctor-investors find it impractical to meet these requirements and also obtain proper diversification (the amount of portfolio funds committed to debt-based securities simply is not large enough to obtain diversification and at the same time meet the other limitations). Accordingly, many investors find mutual funds devoted to debt-based securities most effective in achieving diversification.

A Large Marketplace

The mutual fund marketplace has many types of bond funds, and diversification can be obtained quite easily. The investor with a relatively reduced amount to invest in debt-based securities should consider using mutual funds.

Assessment

For more terminology information, please refer to the Dictionary of Health Economics and Finance.

www.HealthDictionarySeries.com

Conclusion

And so, your thoughts and comments on this Medical Executive-Post are appreciated?

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About National Compliance Services, Inc.

Want, Need or Risk Reduction Mechanism?
Staff Reporters

cmp-logo6

As readers and subscribers to the Medical Executive Post, and our related print periodicals, dictionaries and books are aware, choosing the right financial consulting firm, or consultant, is always a challenging task www.HealthCareFinancials.com Today, this is true more than ever, given the financial meltdown and the all too obvious shenanigans of Wall Street www.HealthDictionarySeries.com Lay and physician investors alike are affected; along with related financial advisors of all stripes, degrees and designations [spurious or more credible] www.MedicalBusinessAdvisors.com

National Compliance Services

According to the National Compliance Services, Inc. [NCS] website, an experienced team of customer-oriented professionals is in place that strives to meet personal and corporate compliance needs so that clients can focus on areas of expertise www.NCSonline.com

A Protean Focus

NCS operates in the financial compliance and regulatory services industry. Its strength may be in providing efficient, and reasonably priced products and services for many different sub-arenas, such as: investment and financial advisors, hedge and mutual funds, stock-brokers and broker-dealers. Their customized services are designed to structure a compliance program that is appropriate for any individual, or firm’s unique regulatory needs. NCS works to ensure compliance with applicable federal and/or state rules and regulations.

Range of Products and Services

NCS has offered its personalized services to more than 6,000 clients, both domestically and internationally. Their consultants include former regulatory examiners, accountants, attorneys, and other individuals with extensive hands-on industry experience.

Verification Services

NCS also offers a standard or customized line of verification services to Mutual Funds, Hedge Funds, Custodians, Broker-Dealers, Investment Advisers, and Third-Party Vendors. Verification services can be customized to include any or all of the following:

  • Firm Registration/Notice Filing with the Proper Jurisdiction(s)
  • Adviser Representative Registration(s)
  • Adviser Representative Degree(s) or Professional Designation(s)
  • Firm Reported Disciplinary History
  • Adviser Representative Reported Disciplinary History
  • Proper Registration of Solicitors
  • Proper Registration of Wholesalers and Third-Party Vendors
  • Bank Background and Activity Reports, and
  • OFAC Checks, etc.

Assessment

Moreover, claims of verification for over 15,000 Registered Investment Advisers, and Investment Adviser Representatives, seem plausible. For example, NCS recently contacted www.CertifiMedicalPlanner.com to verify the good-standing of a member and charter-holder.

Contact Info:

For further information, please contact:

Alex Aghyarian
National Compliance Services, Inc
Verification Technician
Phone: 561.330.7645 ext 302 and Fax: 561.330.7044
aaghyarian@ncsonline.com

Conclusion

And so, your thoughts and comments on this Medical Executive-Post are appreciated. Verification in most any space is worthwhile of course; but is membership in a vague or nebulous organization helpful or harmful to the uninitiated?

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

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Mutual Fund Selection Checklist

The Cautious Physician

Staff Reporters

After today’s 777 point drop on the DJIA; 200 points on the NASDAQ; and 106 points on the S&P; a new bailout reconfiguration is being planned in Washington to avert another calamity going forward. Some say, the current strife was brought about – in large measure – by the financial system operating the way financial operators told us it was supposed to function.  The money is needed, we are told, to bail out the financiers who assured us – up until just a couple of weeks ago – that the system they operated was sound and would need no rescue. So, what really gives? Since no one knows for sure, MDs should do the following regularly:

  • Check your taxation issues. Review your tax returns every year. Review line 53 of the federal tax Form 1040. Total and divide by 12 to show your total tax paid, on average, each month. The result will show excessive taxes paid because of taxable interest, dividends, and capital gain. You will often do yourself a favor by discovering assets that have not been discussed.
  • Check with the mutual fund companies that you do business with to see if they have tax-managed portfolios.
  • Double-check your arithmetic, and don’t worry so much about taxes that you forfeit by mixing too many income-producing bonds in a portfolio looking for long-term growth.
  • Check the fund prospectus and statement to see how much buying and selling are going on inside the fund so you can at least be aware of this and be able to educate your clients.
  • Look at companies who “manage” money managers such as SEI and Lockwood Financial, etc.

Assessment

How true, false or parsed are the above perspectives?

Conclusion

Your comments are appreciated?

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Medical Risk Management: http://www.jbpub.com/catalog/9780763733421

Healthcare Organizations: www.HealthcareFinancials.com

Health Administration Terms: www.HealthDictionarySeries.com

Physician Advisors: www.CertifiedMedicalPlanner.com

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Advantages of IMAs

A Doctor’s Case against Mutual Funds

By Dr. David Edward Marcinko; MBA CMP

Publisher-in-Chief

The case against Mutual Funds [MFs], and in favor of Individually Managed Accountants [IMAs]:

  • No unrealized capital gains
  • The ability of the physician-investor to dictate or organize a portfolio around current stocks
  • The manager is not obliged to buy additional securities, no matter how much money pours in
  • The physician’s portfolio is not subject to a pooled mentality
  • A physician-investor can own a specified number of securities without over diversifying
  • Lower fees and Lower commissions as portfolio grows
  • Ongoing customization in step with world trends
  • Hands-on or hands-off philosophy, as the investor prefers
  • Custom diversification blend-in strategies for low-basis stocks
  • Individual doctor recognition as to tax consequences.

Assessment

How true, false or parsed are the above perspectives?

Conclusion

Your comments are appreciated?

Practice Management: http://www.springerpub.com/prod.aspx?prod_id=23759

Physician Financial Planning: http://www.jbpub.com/catalog/0763745790

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Healthcare Organizations: www.HealthcareFinancials.com

Health Administration Terms: www.HealthDictionarySeries.com

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Fiduciary Burden of Participant-Directed Investment Plans

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An Emerging Issue for Physician-Executives

[By Jeffery S. Coons; PhD, CFP]

Managing Principal-Manning & Napier Advisors, Inc

fp-book1

The goal of designing a participant-directed investment menu should be to provide enough diversification of roles to allow participants to make an appropriate trade-off between risk and return, without having so many roles as to create participant confusion. 

Medical Administrative Burden

Ultimately, the burden on plan administrators and physician executives is to adequately educate employees and is largely driven by the investment decisions we require them to make in the plan, with more choices necessitating a greater understanding of the fundamental differences between and appropriate role for each choice.  The logical questions that arise when selecting options on a menu are:

  • Are there clear differences among the options?
  • Are these differentiating characteristics inherent to the option or potentially fleeting?
  • Are the differences among options easily communicated to and understood by the typical plan participant?
  • Most importantly, if participants are given choice among these different options, can the decisions they make reasonably be expected to result in an appropriate long-term investment program?

Fiduciary Concerns and Liabilities

All this adds up to additional fiduciary concerns for the health care entity and plan sponsor. 

For example, can the typical participant understand growth and value as concepts when even the experts can not agree on their definitions? The use of style based menus for self-directed plans bring this issue to the forefront. What about investment strategy?  What choices are we expecting the participant to make when offering growth and value styles for one basic asset class role? 

Finally, beyond the responsibility to provide effective education, what other fiduciary issues are associated with style categorization for a participant-directed investment menu?

Effective Style Communications

Consider whether the differences among manager styles can be effectively communicated to the average participant.  Because the general style categories of “growth” and “value” are not well defined, we are expecting the participant to understand how the manager is making investments in a fundamental manner and the differences in risk/return characteristics of these alternative approaches.  This exercise is difficult for investment professionals and trustees, so it will be even more unlikely to be properly understood by an average participant.

Given Assumptions

Let’s assume for the moment that there is an effective means for understanding the different risk and return characteristics of two managers investing in what is ultimately the same basic asset class.  When allowing the choice of these two differing approaches, what decision can the participant make?  There are four possibilities:

  1. Select the single manager whose investment philosophy makes the most sense overall to the participant;
  2. Time the decision of when to move from one management philosophy to another;
  3. Split the allocation between the two managers; or,
  4. Give up from confusion and do not participate in the plan.

We have already discussed the difficulty of the first choice, so let’s consider the second possibility.  This decision is an extremely risky choice that typically leads to poor or even catastrophic performance. 

Why?  Timing decisions such as this are typically based upon recent past performance, which is cyclical in nature.  In essence, investors generally chase after yesterday’s returns and invest in funds after their period of strong relative performance.  The strong flows into S&P 500 Index funds and growth/momentum firms of today were preceded by flows into value/fundamentally-oriented investment firms a few years ago. 

In fact, a Journal of Investing academic article in the Summer of 1998 (“Mutual Fund Performance: A Question of Style”) found that mutual funds changing their investment style had the worst performance of any style individually.

Allocation Choices

The next choice is to split the allocation between growth and value.  While this approach may mean that the participant will not under-perform significantly when any one style is out-of-favor, it also means that the participant will generally never out-perform either.

Nevertheless, by combining two halves of the same basic universe within an asset class, it is likely that the basic performance of the asset class will result (i.e., index-like returns).  Since the participant is paying the higher expenses of active, value-added mutual funds, the end result is likely to be index-like returns less the significantly greater fees and consistent under-performance over the long-term.

Assessment

While there may be participants who can handle the investment process, the previous discussion illustrates why it remains an open question whether educational efforts and typical menu choices provided by plan fiduciaries will be adequate from a regulatory and legal standpoint.

However, while it is unreasonable for participants to select the single best manager, it is reasonable for trustees to choose managers by defining investment policy and objectives that focus on characteristics like broad asset classes. 

And; do you think that by creating an investment menu that removes soft, overlapping, and largely qualitative distinctions such as style; plan sponsors can take a significant step toward mitigating the potential for participant confusion that inevitably could lead to litigation?

Conclusion

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

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Product Details  Product Details

Professionally Managed Portfolios and Mutual Funds

Advantages and Disadvantages for Physician Investors

[By Staff Writers]

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The following briefly summarizes the advantages and disadvantages of professionally managed portfolios and mutual funds according to size and taxation factors.

Portfolio Size

A major factor that impacts the selection process is the size of the physician-investor’s portfolio. For example, is there a size at which it makes more sense to use managed portfolios?

Except for large portfolios [>$3 – 5 million dollars, USD], mutual fund portfolios can meet most physician investors’ needs. Investors who need substantial individual attention should also consider managed portfolios (perhaps in conjunction with funds or ETFs to add additional asset classes).

Income Tax Consideration

Professionally managed portfolios often offer the physician greater control over the timing of taxable transactions.

For example, at the end of the tax year, it may be appropriate to defer capital gains that would otherwise incur, or conversely, the doctor may wish to accelerate recognition of capital losses.

Mutual funds do not allow physicians or other individual investors to influence the timing of these types of transactions. On the other hand, private portfolio managers are often sensitive to a client’s specific income tax planning needs.

In addition, mutual funds are required to distribute 95% of capital gains recognized during the year. These gains are taxable to shareholders of record on the date of the capital gains distribution, even if the shareholder did not benefit from the gains.

For example, a doctor-shareholder who invests in a mutual fund near the end of the year may pay taxes on gains that were incurred earlier in the year when the fund manager was required to sell securities to raise cash for the purpose of redeeming shares of other investors.

***

***

Assessment

The problem is accentuated in long-term bull markets, where the recognized gains in one year result from an income tax basis to the fund that was established in past years, when the find manager bought securities at very low prices. Private portfolios have the advantage that clients normally are not penalized for events that occurred before they invested with a portfolio manager.

MORE: Vehicles

Conclusion

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 Product Details

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