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Book Dr. David Edward Marcinko CMP®, MBA, MBBS for your Next Medical, Pharma or Financial Services Seminar or Personal and Corporate Coaching Sessions 

Dr. Dave Marcinko enjoys personal coaching and public speaking and gives as many talks each year as possible, at a variety of medical society and financial services conferences around the country and world.

These have included lectures and visiting professorships at major academic centers, keynote lectures for hospitals, economic seminars and health systems, keynote lectures at city and statewide financial coalitions, and annual keynote lectures for a variety of internal yearly meetings.

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Investment Lessons Learned from the Poker Table

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“I don’t know”

vitaly

               By Vitaliy Katsenelson CFA                   

These three words don’t inspire a lot of confidence in the messenger and probably will not get me invited onto CNBC, but that is exactly what I think about the topic I am about to discuss. I received a few e-mails from people who had a problem with a phrase in one of my blog posts this fall.

In that article I examined various risks that other investors and I are concerned about. The phrase was “the prospect of higher, maybe even much higher, interest rates.” These readers were convinced that higher interest rates and inflation are not a risk because we are not going to have them for a long, long time, that we are heading into deflation. These readers basically told me that I should worry about the things that will come next, not things that may or may not happen years and years down the road. I am pretty sure that if that phrase had addressed the risk of deflation and lower interest rates ahead, I’d have gotten as many e-mails arguing that I was wrong — that we’ll soon have inflation and skyrocketing interest rates, and deflation is not going to happen. I don’t know whether we are going to have inflation or deflation in the near future.

More important, I’d be very careful about trusting my money to anyone holding very strong convictions on this topic and positioning my portfolio on the basis of them. Any poker player knows that the worst thing that can happen is to have the second-best hand. If you have a weak hand, you are going to play defensively or fold (unless you are bluffing) and likely won’t lose much.

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But, if you’re pretty confident in your hand, you may bet aggressively (god forbid you go all-in) — after all, you could easily have the winning cards. Four of a kind is a great poker hand unless your opponent has a straight flush. Generally, the more confident you are in an investment, the larger portion of your portfolio will be placed in that position.

Therefore superconvinced inflationists will load up on gold, and superconvinced deflationists will be swimming in long-term bonds. If their predictions are right, they’ll make a boatload of money. If they’re wrong, however, they will have the second-best-hand problem — and lose a lot of money. The complexity of the global economy has been increased by monetary and fiscal government interventions everywhere. There is no historical example to which you can point and say, “That is what happened in the past, and this time looks just like that.” When was the last time every major global economy was this overlevered and overstimulated? I think never. (Okay almost never, but you have to go back to World War II.) What is going to happen when the Fed unwinds its $4 trillion balance sheet? I don’t know.

Also the transmission mechanism of problems in our new global economy is so much more dynamic now than it was even a decade ago. Just think about the importance of China to the global economy today versus 2004. That year U.S. imports from China stood at $196 billion. Just in the first eight months of 2014, they were $293 billion. China was single-handedly responsible for the appreciation of hard commodities (oil, iron ore, steel) over the past decade as it gobbled up the bulk of incremental demand.

Now, I don’t want to sink to the level of the one-armed economist — but conversation about inflation and deflation is just that, an “on one hand . . . but on the other hand” discussion. Just like in poker, second-best hands may be tolerable if, when you went all-in, you did not leverage your house, empty your kid’s college fund or pawn your mother-in-law’s cat. Even if you lost your money, you will live to play another hand — maybe just not today.

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th

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In the “I don’t know” world, second-best hands when you bet on inflation or deflation are acceptable on an individual position level (you can survive them) but are extremely dangerous, maybe fatal, on an overall portfolio level.

Investing in the current environment requires a lot of humility and an acceptance of the fact that we know very little of what the future holds. I’d want the person who manages my money to have some discomfort with his or her economic crystal ball and to construct my portfolio for the “I don’t know” world.

Assessment

As a writer, you know you are in trouble when you have to quote both Albert Einstein and Mahatma Gandhi in the same paragraph, but when I ask readers to do something as difficult as I am in this column, I need all the help I can get. “It is unwise to be too sure of one’s own wisdom,” Gandhi said. “It is healthy to be reminded that the strongest might weaken and the wisest might err.” Einstein took the idea a step further: “A true genius admits that he/she knows nothing.” Smarter and humbler people than me were willing to say, “I don’t know,” and it is okay for us mortals to say it too.

Repeat after me . . . 

Conclusion

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Dr. David Edward Marcinko, editor-in-chief, is a next-generation apostle of Nobel Laureate Kenneth Joseph Arrow, PhD, as a health-care economist, insurance advisor, financial advisor, risk manager, and board-certified surgeon from Temple University in Philadelphia. In the past, he edited eight practice-management books, three medical textbooks and manuals in four languages, five financial planning yearbooks, dozens of interactive CD-ROMs, and three comprehensive health-care administration dictionaries. Internationally recognized for his clinical work, he is a distinguished visiting professor of surgery and a recipient of an honorary Bachelor of Medicine–Bachelor of Surgery (MBBS) degree from Marien Hospital in Aachen, Germany. He provides litigation support and expert witness testimony in state and federal court, with medical publications archived in the Library of Congress and the Library of Medicine at the National Institutes of Health.

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The third quarter for 2015 was a REAL humdinger!

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The Markets – Update
Art

By Arthur Chalekian GEPC

[Financial Consultant]

Well, the third quarter for 2015 was a REAL humdinger!
                                            ***
It began with the first International Monetary Fund (IMF) default by a developed country (Greece) and finished with Hurricane Joaquin possibly headed toward the east coast. In between, China’s stock market tumbled, the Federal Reserve tried to interpret conflicting signals, and trade growth slowed globally. After such a stressful quarter, we may see an uptick in the quantity of alcoholic beverages consumed per person around the world. That number had declined (along with economic growth in China) between 2012 and 2014, according to The Economist.
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No Grexit – for now
Despite defaulting on its IMF loan, rejecting a multi-billion-euro bailout plan, and closing its banks for more than two weeks, Greece was not forced out of the Eurozone. Instead, Europe cooked up a deal that left the IMF unhappy and analysts shaking their heads. The Economist reported the new deal for Greece was an exercise in wishful thinking. The problem is the deal relies on “the same old recipe of austerity and implausible assumptions. The IMF is supposed to be financing part of the bailout. Even it thinks the deal makes no sense.” It’s a recipe we’re familiar with in the United States: When in doubt, defer the problem to the future.
***
A downturn in China
Despite reports from the Chinese government that it hit its economic growth target (7 percent) on the nose during the first two quarters of the year, The Economist was skeptical about the veracity of those claims. During the first quarter.
***
“Growth in industrial production was the weakest since the depths of the financial crisis; the property market, a pillar of the economy, crumbled. China reported real growth (i.e., after accounting for inflation) of 7 percent year-on-year in the first quarter, but nominal growth of just 5.8 percent.”
***
That statistical sleight of hand implies China experienced deflation early in the year. It did not.
On a related note, from mid-June through the end of the third quarter, the Shenzhen Stock Exchange Composite Index fell from 3,140 to about 1,716, according to BloombergBusiness. That’s about a 45 percent decline in value.
***
Red light, green light at the Federal Reserve
Green light: employment numbers. Red light: consumer prices, inflation expectations, wages, and global growth. Late in the quarter, the Federal Reserve decided not to begin tightening monetary policy.
According to Reuters, voting members of the Federal Open Market Committee (FOMC) decided uncertainty in global markets had the potential to negatively affect domestic economic strength. They may have been right. The Wall Street Journal reported, although unemployment remained at 5.1 percent, just 142,000 jobs were added in September. That was significantly below economists’ expectations that 200,000 jobs would be created. The Journal suggested the labor market has downshifted after 18 months of solid jobs creation.
***
Global trade in the doldrums
The global economy isn’t as robust as many expected it to be. According to the Business Standard, the World Trade Organization (WTO) lowered its forecast for global trade growth during 2015 from 3.3 percent to 2.8 percent. Falling demand for imports in developing nations and low commodity prices are translating into less global trade. Expectations are trade growth will be 3.9 percent in 2016, which could help support global economic growth.
***
Coming Change
America’s share of the global economy is potent. Our country accounts for 16 percent (after being adjusted for currency differences) of the world’s gross domestic product (GDP) and 12 percent of merchandise trade.
Again, according to The Economist, we dominate “the brainiest and most complex parts of the global economy.” Our presence is strong in social media, cloud computing, venture capital, and finance. In addition, the dollar is the world’s dominant currency. While the view from the top is pleasing, we may not be there forever. The Economist explained:
***
“In the first change in the world economic order since 1920-45, when America overtook Britain, [America’s] dominance is now being eroded. As a share of world GDP, America and China (including Hong Kong) are neck and neck at 16 percent and 17 percent respectively, measured at purchasing-power parity. At market exchange rates, a fair gap remains with America at 23 percent and China at 14 percent … But any reordering of the world economy’s architecture will not be as fast or decisive as it was last time…the Middle Kingdom is a middle-income country with immature financial markets and without the rule of law. The absence of democracy, too, may be a serious drawback.”
***
It may be hard to believe, in light of recent economic and market events in China, but change is on its way. Regardless, the influence of the United States should continue to be powerful well into the future.

Conclusion

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On Hospital Endowment Fund Management

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A Case Model Example

[By Dr. David Edward Marcinko MBA]

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Just as the field of medicine continuously changes, so too does the field of endowment management.

Endowment managers continue to increase their knowledge of the science and expand their skill in the art.

However, successful endowment managers will continue to focus on the areas that they can control in order to minimize the risk of the areas they cannot.

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So, here is a case model to show you how it is done.

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Endowment Fund

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Conclusion

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About the INSTITUTE OF MEDICAL BUSINESS ADVISORS, Inc.

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The Institute of Medical Business Advisors, Inc provides a team of experienced, senior level consultants led by iMBA Chief Executive Officer Dr. David Edward Marcinko MBA CMPMBBS [Hon] and President Hope Rachel Hetico RN MHA CMP™ to provide going contact with our clients throughout all phases of each project, with most of the communications between iMBA and the key client participants flowing through this Senior Team.

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Understanding the “Least” Important Issues for Physician-Investors

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

Rick Kahler MS CFPIn this ME-P, I will focus on the three least important things investors want to know. The rankings came from a survey of investors, funded by Dimensional Fund Advisors, conducted in March 2014 by Advisor Impact.

All three deserved to be much higher on the list. In my experience, they are what most physicians and all investors really need to know.

The factors

These three factors are:

  • What are the chances the investment will lose money? Only 10% of investors thought it was important to ask about factors that contributed to historic performance. Just one-third thought it important to even ask about historical performance in general.
  • What type of volatility can they expect? Only 17% of investors considered this important.
  • How and why did the advisor select the investment for their portfolio? Only 21% of survey respondents thought this was important, and just 8% asked about the investment managers chosen.

Drilling Down and Going Granular

Some of these factors may seem difficult to understand, but they do matter. Give your financial advisor a chance to explain them; it can help you become a more informed investor.

ME-P Physicians

  1. Chances of losing money

This factor could be better addressed by asking about the specific factors that influenced historic performance of the security over various long-term economic climates. True, looking at the past performance of an investment is never a guarantee of future performance.

Yet, if the historical periods evaluated contain a variety of economic conditions (high inflation, various economic cycles, various political influences, etc.) and long-term holding periods (at least 10 years or more), looking backward may give you a reasonable idea of what future performance might look like.

  1. Volatility

Most investors will cognitively agree they fully understand that most investments that carry any chance of real (after inflation) significant long-term return will fluctuate. I say “cognitively” because, once that fluctuation happens on the downside, all cognitive understanding sometimes goes out the window and the emotional brain takes control.

One way of internalizing the potential fluctuation of an investment is to ask about its volatility. Specifically, it’s standard deviation. This measure of the amount of variation from the average is something an advisor can easily find out for almost every bond, stock, and mutual fund. Take the standard deviation times three, then subtract that number from the average return. This is the amount of value over one year your investment could drop (or rise) in 99% of all years. Stated conversely, there is only a 1% chance your investment would drop further in any one year.

  1. Portfolio Fit

I recently sent back a shirt that hung on me like a tent. While it would have been perfect for a larger guy, it was not a fit for me. Investments are similar. While some are perfect matches for one portfolio, they can be lethal in another. An over-allocation to emerging market stocks may make perfect sense for a newborn, but it could be a retirement disaster for a 90-year-old.

Pensive Financial Advisor for Physicians

Assessment

It’s important to ask why an investment belongs in your portfolio. You want investments (asset classes) that complement one another by tending to fluctuate independently of each other.

In an ideal balance of investments, when some decrease in value the other half increase an equal or greater amount, and all of them earn a real return over time.

Conclusion

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A 2014 Stock Market Mid-Year Review

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What Do We Know?

[A SPECIAL R&D REPORT FOR THE ME-P]

By Lon Jefferies MBA CFP®

Lon JefferiesIf you pay close enough attention to the news media you’ll eventually learn that much emphasis is placed on pundits’ forecasts, but very little consideration is given to how accurate the projections turn out.

When 2014 started, there were some pretty widely-accepted expectations regarding the investment environment. Let’s take a minute to review those anticipations and analyze how precise they turned out to be.

Interest Rates

One of the most universally accepted beliefs going into 2014 was that interest rates were on the cusp of rising, and that consequently, bond returns would drop. (Of course, this has been the expectation for around five years now, but that is a discussion for a later time.) Investors were questioning whether they should reduce or eliminate the bond portion of their portfolios until the rate increase occurred.

So, have we experienced the rise in interest rates we were expecting? On 1/2/14, the yield on the 10-year Treasury note was 3%. As of 6/30/14, the yield on the same note was 2.516%.

That’s right — interest rates have actually decreased over the last six months. Did those who stuck with their investment strategies and maintained their bond positions experience a decline in their portfolio’s value?

Here is how a variation of different bonds have performed year-to-date (as of 6/30/14):

  • US Government Bonds (IEF): 4.89%
  • US TIPS (TIP): 5.25%
  • Corporate Bonds (LQD): 5.37%
  • International Bonds (IGOV): 5.66%
  • Emerging Market Bonds (LEMB): 6.42%

Equities

How about the equities side of the portfolio?

In January, predictions for stocks were all over the map — some predicted a full out correction (a loss of more than -20%), some predicted that we would keep chugging along at 2013′s pace, and most predicted something somewhere in between. There were, however, many factors that were a common cause of concern.

So, was the reduction of the Fed’s Quantitative Easing a legitimate fear? In fact, this possibility has come to fruition. In December, the Fed was buying $85 billion per month of financial assets from commercial banks and other private institutions. The Fed has reduced this monthly amount during every meeting it has held this year, and that amount is now down to $35 billion per month. However, the key question is what impact has this had on the stock market.

Here is how a wide basket of equities have performed year-to-date (as of 6/30/14):

The most widely accept fear among equity investors was the phasing out of the Fed’s Quantitative Easing (QE) program. Investors worried that the Fed would begin lowering the amount of loans the government would buy from commercial banks each month, which would lower the availability of capital in the economy.

Historically, less money in the system leads to less investing in new businesses, less innovation, and fewer jobs created.

  • Large Cap Stocks (IVV): 7.08%
  • Mid Cap Stocks (IJH): 7.57%
  • Small Cap Stocks (IJR): 3.30%
  • Foreign Stocks (IEFA): 4.34%
  • Emerging Markets (IEMG): 4.70%
  • Real Estate (IYR): 16.09%
  • Commodities (DJP): 7.32%
  • Gold (GLD): 10.27%

Volatility

The last widely-held viewpoint at the beginning of the year was that 2014 was likely to be a year more volatile than anything we had experience in 2012 or 2013. There was a lot of clatter about valuations and PE ratios being too high, concern about the war in Ukraine, a consensus that China was about to experience a drastic decline in both imports and exports, and a general feeling that the market was due for a significant (if not healthy) pullback.

Additionally, how much have we heard about unfavorable weather patterns over the last six months?

Managing a Stock Portfolio

Lessons Learned

Of course, all of this is not to say that interest rates will never rise, that bond values will never decline, and that the market won’t return to the roller coaster it is.

In fact, all those things are certain to happen. Unfortunately, anyone who contends to know the uncertain part of this equation — when — likely doesn’t actually know anymore than you or me. For this reason, having and sticking to a diversified investment strategy that coincides with a detailed financial plan is the most likely path to financial success.

The most significant lesson inherent in these numbers is that market expectations are essentially useless. Near the beginning of the year, the vast majority of experts anticipated interest rates to rise, bond values to drop, and volatility to increase. Unfortunately, pundits making projections are rarely held to their inaccurate forecasts and are allowed to continue making a living showing they have no greater knowledge than the average investor.

Assessment

So, has 2014 been a wild ride?

The S&P 500 dropped by -5.51% from 1/22/14 – 2/03/14, and by -3.89% from 4/2/14 – 4/11/14. These are the only declines of more than 2% that the S&P 500 has experienced all year!

Additionally, as of 6/30/14, the S&P 500 has now gone 54 consecutive trading days without an up or down move of greater than 1%, the longest stretch since 1995! By historical standards, 2014 is considered to be a very smooth ride.

More:

Stock Market at New Highs!

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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Let’s Meet Dr. Peter Benedek CFA

At Your Service as Our Newest ME-P “Thought-Leader”

By Ann Miller RN MHA

[Executive-Director]

www.retirementaction.com

Peter Benedek retired in 2002, after almost thirty years working as an engineer, manager and then executive in telecommunications Research and Development. While having a PhD in Electrical Engineering, he was always also interested in the financial world.

Enabling Others to Control their Destinies

However, due to work and family pressures, he had the opportunity to delve deeply in a formal finance related study only after retirement. The collapse of telecom industry, coincidental with retirement, reinforced his interest in financial related matters – not just as an intellectual pursuit – but also as a means to better understand how to manage his own personal financial affairs, and assist others to better manage their affairs in order to achieve some level of control over their destinies.

What Peter Brings to the ME-P Ecosystem

Dr. Benedek is no novice however. In the summer of 2006 he successfully completed the three levels of study toward the Chartered Financial Analyst designation offered by the CFA Institute®. He is thus a CFA charter-holder.

Assessment 

In addition to authoring his pro bono website, he started providing research and consulting services to investment management firms in 2009.

Conclusion

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A Review of Current Personal Finance and Investment Literature

Current Synopsis [Around the Literary World of Economics]

By Dr. Peter Benedek CFA

http://retirementaction.com/

Investors will grapple with more turbulence surrounding Europe’s deepening debt problems this week and the prospect of another round of dismal data on the faltering U.S. economy. So, let us listen while Doctor Benedek speaks.

Dr. David E. Marcinko; FACFAS, MBA, CMP[Publisher-in-Chief]

In the Globe and Mail’s “In an emergency, is your info safe?” Dianne Nice suggests a teachable moment associated with the recent US andOntario tornadoes, north-eastern earthquake and hurricane threat. Specifically, she suggests that we consider taking steps to safeguard our important papers, should our home be destroyed. The ICBA recommends keeping important documents in a bank safe: marriage certificate, tax returns, property deeds, birth certificates insurance policies, credit card number, and list of household valuables for insurance claims, paper or electronic copies of important computer records. Additionally consider keeping copies in the home in sealed plastic bags (Probably not a bad idea.)

Scott Willenbrock in the Financial Analysts Journal’s “Diversification return, portfolio rebalancing, and the commodity return puzzle” argues that “the underlying source of the diversification return is the rebalancing, which forces the investor to sell assets that have appreciated in relative value and buy assets that have declined in relative value, as measured by their weights in the portfolio. Although a buy-and-hold portfolio generally has a lower variance than the weighted average variance of its assets, it does not earn a diversification return. Diversification is often described as the only “free lunch’’ in finance because it allows for the reduction of risk for a given expected return. Diversification return might be described as the only “free dessert” in finance because it is an incremental return earned while maintaining a constant risk profile. The contrarian activity of rebalancing, however, must be performed to earn the diversification return; diversification is a necessary but not sufficient condition. Although an un-rebalanced portfolio generally has reduced risk, it does not earn a diversification return and suffers from a varying risk profile. The control of risk, together with the diversification return, is a powerful argument for rebalanced portfolios.”

In the CFA Institute’s Financial Analysts Journal’s “The winners’ game” Charles Ellis looks at the investment profession’s challenges and opportunities. He writes that the investment profession has made three errors:  two of commission and one of omission. He writes that “In addition to the two errors of commission—accepting the increasingly improbable prospect of beat-the-market performance as the best measure of our profession and focusing more and more attention on business achievements rather than on professional success— we have somehow lost sight of our best professional opportunity to serve our clients well and shifted our focus away from effective investment counseling. Some of the help clients need is in understanding that selecting managers who will actually beat the market over the long term is no longer a realistic assumption or a “given” … most investors need help in developing a balanced, objective understanding of themselves and their situation: their investment knowledge and skills; their tolerance for risk in assets, incomes, and liquidity; their financial and psychological needs; their financial resources; their financial aspirations and obligations in the short and long run … Our profession’s clients and practitioners would all benefit if we devoted less energy to attempting to “win” the loser’s game of beating the market and more skill, knowledge, and time to helping clients recognize market realities, understand themselves as investors, and clarify their realistic objectives and then stay the course that is best for each of them.” (Charles Ellis is the author of the must read book entitled“Winning the Loser’s Game- Timeless Strategies for Successful Investing”.)

Glenn Ruffenach in the WSJ SmartMoney’s “5 best online retirement guides” provides a list from  “One of the most comprehensive and valuable sites online is also among the least known: the Employee Benefits Security Administration.”

In WSJ SmartMoney’s “Why Wall Street’s forecast can’t be trusted” Alex Tarquinio writes that “Over the years, some market forecasters have been about as accurate as, well, weather forecasters… But some financial planners ignore the Wall Street prognostications altogether. George Papadopoulos, the owner of the eponymous financial planning firm in Novi, Mich., says most stock strategists tend to be too bullish, save a few who are “perma-bears.” Ignore the headline number, he says, and “focus on what you can control,” like finding a good balance of stocks and bonds for your portfolio.” (Now there is some sensible advice; ignore talking-heads, ‘strategists’, ‘prognosticators’ and soothsayers. Remember there are very few things that you can actually control: your spend-rate, saving-rate, investment fees and costs, asset allocation and rebalancing.)

In the Globe and Mail’s “Hunting high and low for safe yields” John Heinzl enumerates some of the available options for ‘safe yields’ and concludes that none come even close to paying off your 4% mortgage which at 40% tax rate gives you 6.67% guaranteed.

In Bloomberg’s “Homeowners on East Coast may have to pay for earthquake damage” Leondis and Ody report that “Earthquake protection is generally excluded from standard homeowners’ insurance policies, and consumers have to purchase coverage either as a separate policy…“For most of us, having earthquake insurance doesn’t make sense,” said Sheryl Garrett, founder of Shawnee Mission, Kansas-based Garrett Planning Network Inc., a network of fee-only financial planners. That’s because residents of areas where earthquakes rarely occur generally don’t need the coverage, and policies in parts of the country with frequent earthquakes are more expensive to compensate for the increased risk, she said.”

In the Globe and Mail’s “Vanguard to launch six ETFs in Canada” Shirley Won reports that Vanguard is launching “six exchange-traded funds (ETFs) inCanada. The stock ETFs include Vanguard MSCI Canada and the Vanguard MSCI Emerging Markets, as well as the Vanguard MSCI U.S. Broad Market and Vanguard MSCI EAFE, which will both be hedged to Canadian dollars. The bond category includes Vanguard Canadian Aggregate Bond and Vanguard Canadian Short-Term Bond ETFs.”

Real Estate

On the Canadian front, in the Globe and Mail’s “Most housing ‘reasonably affordable’: RBC” Steve Ladurantaye reports that Vancouver house prices are in “uncharted territory” and “it would take 92 per cent of the median household’s pretax income to own a bungalow in the city at current prices – the highest reading yet in its quarterly national survey on affordability. However according to RBC most (other) Canadian cities offered reasonably affordable” housing options in the second quarter compared to the first. Nationally, a condo required 29.2 per cent of pretax household income (a 0.8 per cent increase), a bungalow 43.3 per cent (1.7 per cent) and a detached home 49.3 per cent (1.8 per cent)… The bank’s affordability index looks at the proportion of pre-tax household income needed to service the costs of owning different categories of homes at current market values. Its standard measure is a 1,200-square-foot bungalow, and the carrying costs include mortgage payments (principal and interest), property taxes and utilities.”

However in the WSJ’s “Toronto wary of condo correction” (note this is in WSJ, not the Globe and Mail or the National Post) Monica Gutschi reports that “A condominium-building boom is lifting Canada’s largest city into the same stratosphere as London, Sydney, Vancouver and Miami, but deepening the worries about a potential tumble…Toronto is a long way from Miami, but the condominium boom north of the border has begun to evoke ominous comparisons, even among real-estate agents. TheToronto area is home to 1,198 condo projects with 210,000 units, according to research firm Urbanation. About 40,000 additional condominium units are under construction, including 16,000 set to hit the market next year. “There’s more supply coming than the market really needs, unless we have a stronger economy than we have today,” says independent housing economist Will Dunning…As many as 60% of recent condominium buyers in Toronto are investors who bought their units from developers before construction began—and then sold their condos…But buyers whose condominiums are investments are getting squeezed. Stagnant rents make it harder to cover mortgage payments.”

On the US front, in Bloomberg’s “Home prices decline 5.9% in second quarter” Kathleen Howley reports that “Home prices in the U.S. fell 5.9 percent in the second quarter from a year earlier, the biggest decline since 2009, as foreclosures added to the inventory of properties for sale…Purchases decreased 3.5 percent to a 4.67 million annual rate, the weakest since November.” Furthermore Nick Timiraos in WSJ’s  “Home-loan delinquencies rise again” reports that “The Mortgage Bankers Association said 12.87% of mortgage loans on one-to-four-unit homes were 30 days or longer past due or in the foreclosure process at the end of the second quarter, representing more than 6.3 million households. The second-quarter figure was down from 14.4% one year earlier but up from 12.84% at the end of March…While mortgage delinquencies remain highest in states hard hit by the housing bubble—such as Nevada, California and Florida—the inventory of loans in foreclosure is highest in states that require banks to obtain court approval when they foreclose on homeowners. Nationally, about 4.4% of all loans were in foreclosure at the end of June. Of the nine states that exceeded the national average, all but one—Nevada—have a judicial foreclosure process. Foreclosure rates were highest inFlorida (14.4%),Nevada (8.2%),New Jersey (8%),Illinois (7%),Maine andNew York (5.5%).”

In Florida context, in Palm Beach Post’s “Palm Beach County home sales slump in July from previous month” Kimberly Miller reports that “A Florida Realtors report released Thursday found 972 single-family Palm Beach County homes traded hands in July, a 21 percent increase from the same time in 2010, but an 18 percent drop from the previous month. The median sales price in Palm Beach County fell 17 percent from last year to $187,900 – a price not seen consistently since 2002. Statewide, sales of existing homes fell 12 percent in July from the previous month, but were up 12 percent compared to July 2010. The median sales price of $136,500 remained mostly stable…The inventory of homes for sale in Palm Beach County was down to an eight month supply in June, a 46.5 percent decrease from 2010 and down 62 percent from 2009, according to the Realtors Association of the Palm Beaches. That may change soon. Forbes, as well as Realtor Dean Hooker, owner of Pompano Beach-based Southeast REO, said banks are preparing to release more foreclosures for re-sale. Also in the PBP is Jeff Ostrowski’s article “Foreclosure-related sales’ prices fall, and the discount widens” in which ne reports that “The average price of a foreclosure sold inPalm BeachCounty in the second quarter was $116,642, down from $142,997 a year ago. And the discount for foreclosure sales compared to non-foreclosure sales widened to 38 percent this year from 23 percent a year ago. There were 3,253 distressed sales – including foreclosure sales, pre-foreclosure sales and sales after a lender has taken ownership – inPalm BeachCounty in April, May and June, according to RealtyTrac. Those sales made up 37 percent of all transactions in the county. In St. Lucie County, 701 foreclosure deals in the quarter accounted for 44 percent of all sales. Statewide, there were 34,558 foreclosure sales in the second quarter, accounting for 35 percent of all sales in the state.”

In the Globe and Mail’s “Foreign buyers see value in U.S. real estate” Simon Avery writes that with Florida prices off typically 50% since the peak, low mortgage rates, the strong Canadian dollar: ” As an alternative investment, U.S. real estate may never look so attractive to Canadians again…At the moment, the best deals in the Miami area are in South Beach, an area where the properties on average are older. There are currently 172 properties listed under $150,000 and 50 per cent of them are within walking distance to the beach. Generally, these are small, art deco-style, low rises. Their monthly maintenance fees run $320 or less and the sizes range from 240 square feet to 440 square feet.” (That doesn’t sound that cheap for an average of 340 SF units comes to about $441/SF…bargain??? You be the judge.)

Things to Ponder

In the Globe and Mail’s “Amid slowdown, Fed has few tools left” Kevin Carmichael discusses the limited remaining options available for the Fed to provide stimulus to rekindleUS growth and employment. The real problem, however, might be related to that “these aren’t normal times. When businesses and consumers would rather save than spend, as currently is the case in theUnited States, the power of monetary policy is muted. Corporations are sitting on some $2-trillion (U.S.) in profits and the household savings rate has climbed to more than 5 per cent from zero before the financial crisis, even though the cost of borrowing already is at record-low levels… What theU.S. economy needs is a massive jolt to demand that would encourage companies to hire and invest. The best way to do that, many economists argue, is through fiscal policy.”

Jack Hough in WSJ SmartMoney’s “Treasurys versus stocks: spot the safe one” provides some support to Jeremy Siegel’s arguments that “bonds are in a bubble and stocks are good deal”. Arnott says that the 10-year Treasurys yield about zero, given nominal yields of 2.1% and past year’s inflation of 3.6%; whereas the S&P 500 dividend yield is 2.3%. “Bond yields are usually larger because stock dividends tend to grow over time and bond coupons don’t, so bond buyers typically want to be compensated for this…The choice is between stocks’ higher and rising yield and bonds’ lower and flat one…The third reason is that stocks have a better chance of keeping up with inflation…Dividends have rarely looked safer…Today’s payments are 29% of S&P 500 profits. That’s the lowest level since 1900, and perhaps in history…(but) Economists have slashed growth forecasts for most rich economies, and many put the chances of renewed U.S. recession at a coin flip.” So it depends on your horizon/risk tolerance, but “savers with a decade to wait” will find the arguments for stocks persuasive. But not everyone agrees that the metrics are valid. For example, in the Financial Times Lex column’s “Equities: metrics of the trade” discusses pundits indicating that based on P/E ratios and dividend yields compared to bond yields, it is time to buy stocks. Lex suggests that “the big flaw with this approach is that current or near-future earnings are very unlikely to represent an equilibrium return from stocks… It is a fact that company returns normalise, so a much longer earnings period against which to compare stock prices is needed. Inflation also needs be taken into account, as do accounting changes over time. Robert Shiller’s cyclically adjusted p/e ratio is a step in the right direction. Such an approach holds the S&P 500 to be anywhere up to 40 per cent overvalued… Likewise, history shows there to be no predictive power comparing equity and bond yields. Why should there be? Dividends are risky and rise with inflation; coupons are risk free and do not. It is like buying apples because pears are cheap. There are good reasons why stocks might rally – flaky valuation metrics are not among them.”

In the Guardian’s “Rating agencies suffer ‘conflict of interest’, says former Moody’s boss” Rupert Neate reports that “ratings agencies suffer from a conflict of interest because they are paid by the banks and companies they are supposed to rate objectively.”This salient conflict of interest permeates all levels of employment, from entry-level analyst to the chairman and chief executive officer of Moody’s corporation,” Harrington said in a filing to theUS financial regulator the Securities and Exchange Commission (SEC), which is considering new rules to reform the agencies. Harrington claims that Moody’s uses a long-standing culture of “intimidation and harassment” to persuade its analysts to ensure ratings match those wanted by the company’s clients.” (Recommended by the CFA Institute Financial Newsbrief)

In Bloomberg’s “Baby Boomers selling shares may depress stocks for decades, Fed paper says” Vivien Lou Chen writes that “Aging baby boomers may hold down U.S. stock values for the next two decades as they sell their investments to finance retirement, according to researchers from the Federal Reserve Bank of San Francisco … Jeremy Siegel, 65, a finance professor at the University of Pennsylvania’s Wharton School in Philadelphia, has also researched the link between demographics and U.S. stocks. He said that growth in developing countries should generate enough demand to absorb a baby-boomer selloff and “keep stock prices high.””

In the Financial Times’ “Inflation a danger for safe havens” Steve Johnson argues that the US/UK/German 10-year government bonds yielding in the 2-2.2% range is due to their perceived “safe haven” status from the wild swings of the markets. “But these miserly yields must also reflect investors’ confidence that inflation will be muted over the next decade. How logical is this assumption?…this insouciance about the prospects for inflation misses the international dimension, that stemming from rising import prices … (but) For the seven US recessions between 1957 and 1991, commodity prices on average fell 1.6 per cent during the period between the start of the recession and two years after its end. The equivalent figure for the two recessions so far this century is a rise of 27.3 per cent… Rather than enjoying a tailwind from falling commodity prices and low inflation rates, it may become the norm for recession-ravaged developed nations to face a commodity headwind and stubbornly high inflation.”

Assessment

And finally, in the NYT’s “In Korea, the game of trading has rules” Floyd Norris writes that “Finance ought to provide an economy with an efficient means of allocating capital. It should provide a means of price discovery of assets, whether real or financial. It should provide a safe and reliable payments system. Financial innovations are worthwhile if, and only if, they help in those areas.  All too often, players see financial innovations as providing ways to manipulate the system and make money off less savvy traders.” In South Korea things are changing. Four traders were indicted for intentionally manipulating stock prices for profit, specifically for causing a market drop. “Countries around the world felt called upon to bail out banks during the financial crisis. That made sense because a functioning financial system is necessary. But these kind of games are not necessary, whether or not they are criminal. These charges provide an endorsement of the Volcker Rule, named for Paul A. Volcker, the former Federal Reserve chairman, and included in the Dodd-Frank law in theUnited States, which sought to restrict proprietary trading by banks whose deposits are insured. If such games are to be played, let them be played by others.“ The article concludes with the need for prison terms for these traders to insure a deterrent effect  (Thanks to DB for recommending.)

Conclusion

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Understanding and Using Portfolio Performance Benchmarks

Concerning Periodic Measurements and Meters

By Dr. David Edward Marcinko MBA, CMP™

[Publisher-in-Chief]

The stock market has been booming lately; flirting with DJIA 12,000. Up almost 100% since March 2009, after being down almost 50%. And so, perhaps this is a good time to [re]-evaluate the performance of your investment portfolio[s]. But how?

Performance measurement has an important role in monitoring progress towards any physician’s portfolio’s goals.  The portfolio’s objective may be to preserve the purchasing power of the assets by achieving returns above inflation or to have total returns adequate to satisfy an annual spending need without eroding original capital, etc.  Whatever the absolute goal, performance numbers need to be evaluated based on an understanding of the market environment over the period being measured.

Time Weighted Return

One way to put a portfolio’s a time-weighted return in the context of the overall market environment is to compare the performance to relevant alternative investment vehicles.  This can be done through comparisons to either market indices, which are board baskets of investable securities, or peer groups, which are collections of returns from managers or funds investing in a similar universe of securities with similar objectives as the portfolio.  By evaluating the performance of alternatives that were available over the period, the physician investor and his/her advisor are able to gain insight to the general investment environment over the time period.

The Indices

Market indices are frequently used to gain perspective on the market environment and to evaluate how well the portfolio performed relative to that environment.  Market indices are typically segmented into different asset classes. 

Common stock market indices include the following:

  • Dow Jones Industrial Average- a price-weighted index of 30 large U.S. corporations.
  • Standard & Poor’s (S&P) 500 Index – a capitalization-weighted index of 500 large U.S. corporations.
  • Value Line Index – an equally-weighted index of 1700 large U.S. corporations.
  • Russell 2000 – a capitalization-weighted index of smaller capitalization U.S. companies.
  • Wilshire 5000 – a cap weighted index of the 5000 largest U.S. corporations.
  • Morgan Stanley Europe Australia, Far East (EAFE) Index – a capitalization-weighted index of the stocks traded in developed economies. 

Common bond market indices include the following:

  • Lehman Brothers Government Credit Index – an index of investment grade domestic bonds excluding mortgages [N/A].
  • Lehman Brothers Aggregate Index – the LBGCI plus investment grade mortgages [N/A].
  • Solomon Brothers Bond Index – similar in construction to the LBAI.
  • Merrill Lynch High Yield Index – an index of below investment grade bonds.
  • JP Morgan Global Government Bond – an index of domestic and foreign government-issued fixed income securities. 

The selection of an appropriate market index depends on the goals of the portfolio and the universe of securities from which the portfolio was selected.  Just as a portfolio with a short-time horizon and a primary goal of capital preservation should not be expected to perform in line with the S&P 500, a portfolio with a long-term horizon and a primary goal of capital growth should not be evaluated versus Treasury Bills.

While the Dow Jones Industrial Average and S&P 500 are often quoted in the newspapers, there are clearly broader market indices available to describe the overall performance of the U.S. stock market.  Likewise, indices like the S&P 500 and Wilshire 5000 are capitalization-weighted, so their returns are generally dominated by the largest 50 of their 500 – 5000 stocks.  While this capitalization-bias does not typically affect long-term performance comparisons, there may be periods of time in which large cap stocks out- or under-perform mid-to-small cap stocks, thus creating a bias when cap-weighted indices are used versus what is usually non-cap weighted strategies of managers or mutual funds. 

Finally, the fixed income indices tend to have a bias towards intermediate-term securities versus longer-term bonds.  Thus, an investor with a long-term time horizon, and therefore potentially a higher allocation to long bonds, should keep this bias in mind when evaluating performance.

Assessment

RIP: Lehman Brothers

Peer group comparisons tend to avoid the capitalization-bias of many market indices, although identifying an appropriate peer group is as difficult as identifying an appropriate market index.  Further, peer group universes will tend to have an additional problem of survivorship bias, which is the loss of (generally weaker) performance track records from the database.  This is the greatest concern with databases used for marketing purposes by managers, since investment products in these generally self-disclosure databases will be added when a track record looks good and dropped when the product’s returns falter.  Whether mutual funds or managers, the potential for survivorship bias and inappropriate manager universes make it important to evaluate the details of how a database is constructed before using it for relative performance comparisons.

Conclusion

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How Investment Professionals Evaluate Time Periods for Portfolio Comparison

On Capturing a Full Range of Market Environments

By Dr. David Edward Marcinko MBA, CMP™

[Publisher-in-Chief]

What is the appropriate time period for portfolio growth comparison? 

Performance measurements over trailing calendar periods, such as the last one, three, five or 10 years, are often used in the mutual fund and investment industry.  While three-to-five-to-ten years may seem like a long enough time for an investment strategy to show its value added, these time periods will often be dominated by either a bull or bear market environment, and/or a large cap or small cap dominated environment, etc. 

Market Cycles

One way to lessen the possibility of the market environment biasing a performance comparison is to focus on a time period that captures full range of market environments; a market cycle. 

The market cycle is defined as a market peak, with high investor confidence and speculation, through a market trough, in which investor bullishness and speculation subsides, to the next market peak. 

A bull market is a market environment of generally rising prices and investor optimism.  While there have been several definitions of a bear market based upon market returns (e.g., a decline of –15 percent or more, two consecutive negative quarters, etc.), the idea implied by its name is a period of high pessimism and sustained losses. 

Thus, one returns-based rule-of-thumb that can be used to identify a bear market is a negative return in the market that takes at least four quarters to overcome. 

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Assessment

The stock market has been booming lately. Up almost 100% since March 2009, after being down almost 50%. And so, perhaps this is a good time to re-evaluate the performance of your investment portfolio[s].

And so, by examining performance over a full market cycle, there is a greater likelihood that short-term market dislocations like the “flash crash” of 2009 will not bias the performance comparison.

Conclusion

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Thinking Beyond Portfolio Asset Allocation

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Don’t Forget Your Spending Policy – Doctors

By Dr. David Edward Marcinko MBA CMP™

www.CertifiedMedicalPlanner.com

[Publisher-in-Chief]

If you are economically literate – or read the ME-P regularly – you may be tired of hearing the familiar saw, “the single most important determinant of investment results over time is asset allocation.”

But, as most of us realize, this glosses over critical obstacles to building personal wealth—taxes, inflation, and spending policy. A doctor’s spending policy itself is as critical as asset allocation in preserving wealth, as well as for all investors who understand the trade-offs: there are both allocation and spending strategies that stand to preserve wealth and insulate against excessive equity risk at the same time.

Income versus Security

In proving his point a decade ago, the author—Roger Hertog in “Income Versus Security”— traced the growth of a $1 million portfolio during the period of 1960–1994. He showed that while an all-stock portfolio would have experienced a compound growth rate of 10.1%, an all-bond portfolio of 7.4%, and an all T-bill portfolio of 6.1%, these growth rates dropped to 8%, 5%, and 3.7%, respectively, after taxes and conservative transaction costs. When further reduced by inflation, they dropped to 3.1%, 0.2%, and -1%, respectively. Stocks still nearly tripled in real value after taxes.

Next, Hertog factored in spending. He showed that the greater the equity exposure, the more likely investors will preserve or increase their levels of real spending and wealth. Also, he demonstrated how a spending policy of a fixed percentage of the portfolio; or of spending all the income is ill-suited to estate building. He arrived at an optimum allocation of 60% stocks and 40% bonds with a policy of spending all stock dividends but only spending interest to the extent it exceeds inflation. This latter spending policy adjusts for the fact that in – unlike today but perhaps again in the near future – an inflationary environment a portion of bond interest is a return of principal. This type of asset allocation and spending policy resulted in the greatest amount of growth over the years and gained on inflation. Hertog contends that the 60/40 allocation provides an appealing combination of growth and protection.

IOW: It gives investors a milder ride.

Assessment

Over the 35-year period studied, a 60/40 mix returned almost as much as the all-stock portfolio both before taxes and after taxes and achieved some 75% of its real after-tax growth. Also, the portfolio’s worst year was only half as bad as the all-stock portfolio. Hertog believed that balancing with bonds softened the downside. But – what about the “flash-crash” of 2008-09?

Note: “Income Versus Security: Do You Have To Choose?” Roger Hertog, Trust & Estates, March 1997, pp. 44–62, Intertec Publishing Corporation.

Conclusion

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Why Classic Retirement Planning Often Fails Doctor Colleagues?

Monitor the Money – Not the Returns

Dr. David Edward Marcinko MBA CMP™

http://www.CertifiedMedicalPlanner.org

[Publisher-in-Chief]

While taking my certified financial planner courses to earn the CFP® designation, almost two decades ago at Oglethorpe University in Atlanta, I learned that in classic retirement planning engagements the financial planner or advisor determines the client’s retirement income needs, the assets already earmarked for the retirement portfolio, the desired retirement date, how distributions will need to be made, the assumed inflation rate, and life expectancy, etc.

Then, if a shortage develops, the advisor changes the asset allocation, increases the savings rate, proposes postponing retirement, or suggests reducing retirement income expectations, etc.

However, later in business school I learned that even when the inflation rate and investment returns prove to be accurate; this approach often fails doctors and all investors.

Geometry not Arithmetic

Why? Most planners focus on the wrong thing when monitoring portfolios. Possibly, there is confusion between compounding investment returns and compounding wealth. Planners tend to compound the arithmetical average return in projecting ending wealth over multi-period horizons. But, the accumulation of wealth is determined by the geometric compounding of actual returns.

Law of Large [Small]  Numbers

Still later on in B-school, I learned of the LoLN [normal distributions, parametric equations and cohorts], as well as Poisson distributions [non-normal or asymmetric distributions, and non-parametric equations and cohorts] or Law of Small Numbers.

Planners and Advisors often believe in the former Law of Large Numbers, and eschew [or are unaware of] the later — that is, that over time, average annual returns will approach ever more closely the expected return. The longer the investment horizon, the further the portfolio can wander from its expected dollar value despite the fact that it is approaching its expected return. The future value of each portfolio is determined by the unique and unpredictable pattern of compounded returns and inflation it suffers.

IOW: The longer the period over which this pattern can exercise its effects, the greater the potential divergence from its required return. In fact, while the expected range for the annualized rate of return narrows over time, the expected range for the terminal value of the portfolio diverges over time.

Assessment

Today, forward thinking advisors use “portfolio sufficiency monitoring” to adjust nominal performance results for inflation by establishing benchmarks for performance objectives, setting triggers for reevaluation of the portfolio when it wanders too far from established benchmarks, and monitoring and adjusting portfolio risk to maximize the probability of meeting retirement portfolio objectives.

It answers the question: “Will I have sufficient assets to meet my retirement income needs?” while investment performance monitoring answers the question, “Is my retirement portfolio performing well relative to other portfolios?” My doctor clients retire; not others!

Note: Monitoring Retirement Portfolio Sufficiency,” by Patrick J.Collins, Kristor J. Lawson, and Jon C. Chambers, Journal of Financial Planning, February 1997, pp. 66–74, Institute of Certified Financial Planners.

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™

http://www.CertifiedMedicalPlanner.org

[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

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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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How Equity-Based Securities Affect a Physician’s Total Financial Plan

Equity Securities Provide a Portfolio Growth Engine

By Dr. David Edward Marcinko MBA, CMP™

www.HealthcareFinancials.com

[Editor-in-Chief]

Equity securities provide growth. Theoretically, the amount of growth potential in an equity security is infinite. A stock’s price appreciation possibilities have no limit. However, a stock’s price can also go to zero and an investor can lose the entire amount invested. Therefore, while stocks contribute long-term growth to a portfolio, they also add risk.

Stock Diversification is Key

Diversification is the best defense against risk, so only a portion of every portfolio should be in stocks. Other investments—fixed income securities; cash equivalents that can be used to take advantage of opportunities or for emergencies; real estate; and even commodities (precious metals, for instance, or securities of companies whose businesses are commodity-based)—should all be considered by the responsible physician-investor or financial advisor as components of a well-rounded, balanced portfolio.

And So is Portfolio Diversification

The stock portfolio itself should also be diversified. Diversify among all types of equity securities such as some large capitalization stocks, some small capitalization stocks, some utilities, some cyclical stocks, some value stocks, some growth stocks, and some defensive stocks. Because it is difficult to adequately diversify an equity portfolio with a small amount of money, consider mutual funds or ETFs for some doctors or financial advisory clients. At least this is the philosophy of our Certified Medical Planner™ [CMP] online educational program.  

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Assessment

Always remember that, because the equity component of the portfolio can be expected to provide more than its proportionate share of the risk of a portfolio, it must be constantly monitored. Also remember that every physician-investor as a different level of risk tolerance, and some may be able to handle ownership of only the most solid and stable equity investments.

Conclusion

And so, your thoughts and comments on this ME-P are appreciated. But, what is “di-worsification?” 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 ME-P Recommends: Financial Planning and Risk Management Handbooks

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Financial Planning and Risk Management Handbooks from iMBA, Inc

For Doctors and their Financial Advisors

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For more on these topics, see the handbooks below:

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Conclusion

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Common Physician Retirement Plan Payout Methods

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Targeting Portfolios and Medical Endowment Funds

[By Staff Reporters]

According to Wayne Firebaugh CPA, CFP® CMP™ recognizing the risk that market volatility represents to long-term portfolio portfolios or medical endowments utilize a variety of methods to calculate periodic payouts. These include the following:

  • Investment Yield: A portfolio/endowment using this method spends only its dividends and interest and re-invests any unrealized and realized gains. There would appear to be two primary disadvantages of this method. First, the payout amount will be extremely volatile as yields on equity and fixed income investments fluctuate. Second, the endowment manager could be encouraged to adopt a short-term focus on yield to the detriment of purchasing power preservation.
  • Percentage of the Prior Year’s Ending Market Value: An endowment/portfolio using this method would withdraw some fixed percentage of the prior year’s market value. As with the Investment Yield method, disbursements from the endowment can be somewhat volatile under this method.
  • Moving Average: This approach, which is most common among educational institutions, generally involves taking a percentage of a moving average of the endowment market value. The percentage commonly approximates 5% over a 3-year period.
  • Inflation Adjusted: This method simply adds some factor to the applicable rate of inflation for the institution/portfolio.
  • Banded Inflation or Corridor: This method is similar to the Inflation Adjusted method except that it establishes a corridor or band of minimum and maximum increases in an attempt to limit the volatility of disbursement amounts for the portfolio/endowment.

Mature Woman

Assessment

How does the above compare to the typical 4% withdrawal rate suggested by many FAs today … too much or too little?

Does a private MD “spend-down” or “conserve” principle like an endowment fund make sense?

Conclusion

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Understanding the Tactical Approach to Medical Endowment Fund Management

Guiding Long-Term Investment Decisions

By Staff Reporters

www.HealthcareFinancials.com

According to Wayne Firebaugh CPA, CFP® CMP™ many successful medical endowment funds will establish a “strategic” allocation policy that is intended to guide long-term (greater than one-year) investment decisions. This strategic allocation reflects the endowment’s thinking regarding the existence of perceived fundamental shifts in the market.

Asset Class Target Ranges

Most endowments will also establish a target range or band for each asset class. The day-to-day managers then have the flexibility to make tactical decisions for a given class so long as they stay within the target range.

Definition

The term “tactical” when used in the context of investment strategy refers to the manager’s ability to take advantage of short-term (under one year) market anomalies such as pricing discrepancies between different sectors or across different styles.

Historically, tactical decisions with respect to asset allocation were derided as “market timing.” However, market timing implies moving outside of the target ranges whereas tactical decision making simply addresses the opportunistic deployment of funds within the asset class target range.

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Assessment

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Conclusion

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When to Change Portfolio Managers

Some Considerations for Medical Professionalsfp-book

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

By Lisa Ellen McIntire; CIMA, CFP®

Sometimes even the best made physician financial plans just don’t work out. And, despite extensive time and energy spent on due diligence before hiring an investment or portfolio manager, it becomes evident that you must change managers.

Some Thoughts for Doctors

Here are a few thoughts when considering a portfolio manager change:

  • You should have initially hired the manager with a long-term relationship in mind. Realizing that styles go in and out of favor, we were not simply buying last quarter’s best numbers; in 2009.
  • Market statistics often mask “real” performance of money managers, both good and bad. The S&P 500’s 2007 performance can be attributed to a few very large companies.
  • Generally, a full market cycle would be required to assess money manager performance. Having said that, what could happen that would warrant changing managers? Here is a brief list:
  1. Style Drift: You have a growth manager and when growth stocks turn down, you begin to see the purchase of “value” stocks.
  2. Not Sticking to Previously Established Disciplines: If the process is to sell if the price declines 20 percent down from the original buy range and now they are holding because, “This time, it is different.”
  3. Personnel Changes: New analysts are hired with a different philosophy. Recent transactions seem 180 degrees off course.
  4. Principals Leave: Like professional sports figures, good money managers are in demand and sometimes change firms. The replacement may be a 29-year-old MBA with little experience.
  5. The Firm is Sold: This may be good new if it broadens ownership and helps retain good people.  Look for long-term incentive driven “staying” bonus plans.
  6. Loss of Major Accounts: Reduced revenues may force cut backs in personnel and services. Attention may shift from portfolio management to marketing.

Assessment

Finally, sometimes it is just not working. Misjudgments in asset allocation and poor stock selection over a reasonable period of time can be reason enough to change managers.

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Take the Hospital Endowment Fund Management Challenge!

Calling all Financial Advisors – Are You CMP™ Worthy?

By Staff ReportersBecome a CMP

After conducting a comprehensive fundraising program, the Hoowa Medical Center received initial gifts of $50 million to establish an endowment. Its status as the community’s only trauma center and neonatal intensive care unit causes it to provide substantial amounts of unreimbursed care every year. This phenomenon, together with the declining reimbursements and an estimated 6% increase in operating costs, leaves the Center with a budgeted cash shortfall of $4 million next fiscal year. Although the new endowment’s funds are available to cover such operating shortfalls, the donors also expect their gifts to provide perpetual support for a leading-edge medical institution.

The Treasurer

Bill, the Center’s treasurer, has been appointed to supervise the day-to-day operations of the endowment. One of his initial successes was convincing his investment committee to retain a consultant who specializes in managing endowment investments. The consultant has recommended a portfolio that is expected to generate long-term investment returns of approximately 10%. The allocation reflects the consultant’s belief that endowments should generally have long-term investment horizons. This belief results in an allocation that has a significant equity bias. Achieving the anticipated long-term rate of returns would allow the endowment to transfer sufficient funds to the operating accounts to cover the next year’s anticipated deficit. However, this portfolio allocation carries risk of principal loss as well as risk that the returns will be positive but somewhat less than anticipated. In fact, Bill’s analysis suggests that the allocation could easily generate a return ranging from a 5% loss to a 25% gain over the following year.

The Committee

Although the committee authorized Bill to hire the consultant, he knows that he will have some difficulty selling the allocation recommendation to his committee members. In particular, he has two polarizing committee members around whom other committee members tend to organize into factions. John, a wealthy benefactor whose substantial inheritances allow him to support pet causes such as the Center, believes that a more conservative allocation that allows the endowment to preserve principal is the wisest course. Although such a portfolio would likely generate a lower long-term return, John believes that this approach more closely represents the donors’ goal that the endowment provide a reliable and lasting source of support to the Center. For this committee faction, Bill hopes to use MVO to illustrate the ability of diversification to minimize overall portfolio risk while simultaneously increasing returns. He also plans to share the results of the MCS stress testing he performed suggesting that the alternative allocation desired by these “conservative” members of his committee would likely cause the endowment to run out of money within 20 to 25 years.

The Polarizer

Another polarizing figure on Bill’s committee is Marcie, an entrepreneur who took enormous risks but succeeded in taking her software company public in a transaction that netted her millions. She and other like-minded committee members enthusiastically subscribe to the “long-term” mantra and believe that the endowment can afford the 8% payout ratio necessary to fund next year’s projected deficit. Marcie believes that the excess of the anticipated long-term rate of return over the next year’s operating deficit still provides some cushion against temporary market declines. Bill is certain that Marcie will focus on the upside performance potential. Marcie will also argue that, in any event, additional alternative investments could be used as necessary to increase the portfolio’s long-term rate of return. Bill has prepared a comparative analysis of payout policies illustrating the potential impact of portfolio fluctuations on the sustainability of future payout levels. Bill is also concerned that Marcie and her supporters may not fully understand some of the trade-offs inherent in certain of the alternative investment vehicles to which they desire to increase the allocated funds.

Key Issues:

1. Given the factors described in the case study (anticipated long-term investment return, anticipated inflation rate, and operating deficit) how should Bill recommend compromise with respect to maximum sustainable payout rates?

2. How should Bill incorporate the following items into his risk management strategy?

a. educating the committee regarding types of risk affecting individual investments, classes, and the entire portfolio;

b. measuring risk and volatility;

c. provisions for periodic portfolio rebalancing;

d. using tactical asset allocation; and,

e. developing and implementing a contingency plan.

3) What additional steps should Bill take to form a group consensus regarding the appropriate level of endowment investment risk?

4) What additional elements should Bill add to his presentation to target the concerns of the “conservative” and “aggressive” committee members, respectively?

Assessment

And so, financial advisors, planners and wealth managers; are you up to answering this challenge? We dare you to respond! Visit: www.CertifiedMedicalPlanner.com

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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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Understanding Expenses and Investment Portfolio Performance

A Direct Relationship

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

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

Expenses can play an important role in portfolio performance. You don’t hear much about expense ratios in an up market, like early 2007. If your account was up +28 percent, whether the expense was 3 percent or 1 percent doesn’t seem to make much difference. But, let the market decline, like it did later on in October 2007 and we change our perspective. A 10 percent portfolio decline plus charges of 3 percent equals a 13 percent decline. Now we need a 15 percent increase net of fees just to get even.

The Four Cost Horsemen

Basically you have four cost areas:

  1. Custody—someone must hold the stocks and bonds, collect dividends and interest, prepare tax information for the government, issue monthly statements, and send checks.
  2. Commissions—orders must be executed, transfer securities into and out of your account, trades settled.
  3. Investment Decisions—the money manager must be paid.
  4. Monitoring Performance and Advice—usually an investment management analyst is engaged to provide this service; as well as write the investment policy statement and prepare the asset allocation study.

Portfolio Size

Naturally, size makes a difference. For a doctor’s stock account with a $200,000 total value, all of the above can be accomplished for annual fees between 2.00 and 3.00 percent. An account with $1,500,000 in total assets part bonds and part stocks would pay annual fees between 1.25 and 1.75 percent depending on the ratio of stocks and bonds. These are annual fees and are all-inclusive. Commissions, portfolio management fees, and statements check charges are all included. One quarter of the annual fee is charged every three months. Family related accounts are generally grouped for a quantity fee discount.

Assessment

Some financial consultants prefer to use mutual funds with smaller accounts. A charge of 1 percent per year for their service with a stated minimal fee is common practice. This does not include fees deducted from the account by the mutual fund (anywhere from .50 to 2.50 percent) or commissions paid by the fund managers for trade executions. 

Morningstar Report: Morningstar Expense Ratio Results

Conclusion

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Impact of Performance Fees on Mutual Funds and Physician Portfolios

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More Complex than Realized by Some Doctors

[By Dr. David Edward Marcinko; FACFAS, MBA, CMP™]

[By Professor Hope Rachel Hetico; RN, MHA, CMP™]dave-and-hope4

Physician-investors may find themselves paying advisory fees, brokerage commissions, and other sales charges and expenses. All of these layers of expense can reduce or eliminate the advantage of professional management, if not monitored carefully. Also, fees can have a major impact on investment results. As a percentage of the portfolio, they normally range from low of 15–30 basis points (or .15% to .30%, a basis point is one one-hundredth of one percent) to a high of 300–400 basis points or even higher.

Charges are Universal

All portfolio managers, mutual funds, and investment advisors charge fees in one form or another. Ultimately, they must justify their fees by creating value added, or they would not be in business. Value added includes tangibles, such as greater investment return, as well as intangibles, such as assurance that the investment plan is successfully implemented and monitored, investor convenience, and professional service.

Comparisons Required

Always compare investment performance of funds or managed accounts after fees are deducted; only then can adequate comparisons be made. Also, compare fees within asset classes. Management fees and expenses of investing in bonds or bond funds are much different than the fees of investing in, for example, small companies or emerging market stocks. Whereas 100–200 basis points of fees may be appropriate for an equity portfolio or fund, similar charges may offset the advantages of a managed bond portfolio. With managed bond portfolios, real bond returns have limited long-term potential, because returns are ultimately based on interest rates. For example, if a 3% real (i.e., after inflation) return is expected, 200 basis points in fees may produce a negative after-tax result: 3% real return minus 2% fees minus 10% taxes equals a negative 9% total return.fp-book22

Sales Charges

Mutual funds (and some private portfolio managers) charge sales charges to sell or “distribute” the product. Investors who buy funds through the advice of brokers or “commission based” financial planners will pay a sales load. The many combinations of sales charges fall into three basic categories: front-end, deferred (or back-end), and continuous.

Front-End Fees

Front-end fees are a direct assessment against the initial investment and are limited to a maximum of 8.5%. They usually are stated either as a percentage of the investment or as a percentage of the investment, net of sales charges. For example, a 6% charge on a $10,000 investment is really a $600 charge to invest $9,400 or a real charge of 6.4%. Many low-load funds charge in the range of 1% to 3%. Rather than pay brokers or other purveyors, these fund companies or sponsors use the charges to offset selling or distribution costs. Although rare, some funds charge a load against reinvested dividends.

Deferred Charges

Deferred charges (or back-end loads, or redemption fees) come in many forms. Often, the longer the investor stays with the fund the smaller the charge is upon fund redemption. A typical sliding scale used for deferred charges may be 5-4-3-2-1, where redemption in year 1 is charged 5%, and redemption in year 5 is charged 1%; after year 5, there are no sales charges. Sometimes deferred charges are combined with front-end charges.

Redemption Fees

Certain quoted redemption fees may not apply after a period, such as one year. Funds often use such fees to discourage the trading of funds. Frequently, these charges are paid to the fund itself rather than to the fund management company; or broker. Long-term physician investors actually benefit from this fee structure; short-term shareholders who redeem shares bear the additional liquidation costs to satisfy redemption requests.

Continuous Charges

Continuous sales charges, known as 12b-1 fees for the SEC rule governing such charges, represent ongoing charges to pay distribution costs, including those of brokers who sell and maintain accounts, in which case they are known as “trail commissions.” The fund company may be reimbursed for distribution costs as well. In the prospectus, funds quote 12b-1 charges in the form of a maximum charge. This does not mean that the full charge is incurred, however. For example, a fund with a .75% 12b-1 approved plan may actually incur much lower expenses than .75%. Compared to front-end charges, a .75% per year sales charge of this type could be more costly to investment performance, given enough time.

Sales Loads

Portfolio managers can charge sales loads as well, usually in the form of a traditional WRAP fee arrangement (the investor pays a broker an all-inclusive fee that covers portfolio manager fees and transactions costs). No-load funds can be purchased through brokers or discount brokerage firms. The broker charges a commission for such purchases or sales.

Management Advisory Fees

Private account managers and mutual funds charge a fee for managing the portfolio. These fees typically range between 25 and 150 basis points. Bond funds tend to charge in the range of 25 to 100 basis points, and equity funds charge 75 to 150 basis points. Fees charged by private account managers usually are higher because of the direct attention given to a single doctor client. These managers do not pass along additional administrative costs, however, because they pay them out of the management fee. These management fees come in many forms. Tiered fees can charge smaller accounts a higher fee than larger accounts. Mutual funds often charge “group fees”: a fund family may tier its fee structure to encompass all funds offered by the fund family or by a group of similar funds (such as all international equity funds). Performance fees, although subject to SEC regulations, may be charged as well. A performance fee may be charged if the manager exceeds a certain return or outperforms a particular index or benchmark portfolio.

Administrative Expenses and Expense Ratios

Most private managers are compensated with higher management fees, as mentioned above. Therefore, many private accounts usually do not incur separate administrative expenses. Some management firms charge custodial fees or similar account maintenance fees. Mutual funds incur a number of administrative expenses, including shareholder servicing, prospectuses, reporting, legal and auditing costs, and registration and custodial costs. Mutual funds report these expenses and management fees as an expense ratio—the ratio of expenses to the average net assets of the fund. Expense ratios also include distribution costs or 12b-1 charges.insurance-book10 

Brokerage Commissions

Almost all buyers and sellers of securities incur brokerage commissions. Private “wealth managers” usually provide commission schedules to prospective physician-investors or current clients. Some private managers charge higher management fees and a discounted commission schedule, while others charge lower fees and higher commissions. These combinations of management and commission fees make comparison of prospective managers’ cost structures a difficult task. Most portfolio managers obtain research from brokerage firms, which can affect the commission relationship between broker and manager. Reduced commission schedules exchanged for information are known as “soft dollar costs.” Mutual funds may negotiate similar reduced commission schedules. In this regard, more-competitive brokerage firms can charge lower fees to investors. Commissions are not part of the expense ratio, because they are a part of the security cost basis. Firms with higher portfolio turnover are more likely to have higher commission costs than those with low turnover. Asset class impacts such costs as well. For example, small-cap stocks may be more expensive than large-cap stocks, or foreign bonds may be more expensive than domestic bonds.

Total Cost Approach

To arrive at a relevant comparison of fees among funds and managers, and to see what the total effect of fees on investment performance is, analyze the various charges on a net present value basis. Begin with a given investment amount (e.g., $10,000) and factor in fees over time to arrive at the present value of those fees. Present the comparisons in an easy-to-use table.

Sources of Fee Information

Consult the mutual fund prospectus for fee information. The prospectus has a fund expenses section that summarizes sales charges, expense ratios, and management fees; it does not cover commissions, however. Expense ratios usually are reported for the past 10 years. Commission or brokerage fees are more difficult to find. The statement of additional information and often the annual report disclose the annual amounts paid for commissions. When the total commission paid is divided by average asset values a sense of commission costs can be determined. Private wealth managers disclose fee structures in the ADV I filed with the SEC. Managers must disclose these fees to potential and current clients by providing either ADV Part II or equivalent form to the investor.

Reporting Services

Reporting services, such as Morningstar and Lipper, provide similar information from their own research of mutual funds. These services can be extremely beneficial, because fee information is summarized and often accounted for in the reports’ investment return calculations. This helps the investor and planner make good comparisons of funds. Information services that cover private managers provide information, primarily about management fees.

Assessment

To the extent that online trading, deep discount brokerages, lack of SEC and FINRA oversight, and the recent financial, insurance and banking meltdown has affected the above, it is left up to your discretion and personal situation. Generally, all fess are, and should be, negotiable.

Disclaimer: Both contributors are former licensed insurance agents and financial advisors.

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The Great Depression of 2008

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Understanding EESA

[By Staff Reporters]

On October 3, 2008, President Bush signed into law the Emergency Economic Stabilization Act (EESA).  It contained significant provisions that will not only impact the financial sector but is a truly “global” law aimed at establishing the stability and reliability of the American banking system and its posture to the world community.

While presenting a speech on the issue in Tampa, Florida, on Saturday, October 11, after a precipitous drop in the stock market the day before, President Bush at 8:00 a.m. (EST) held a press conference with the G-7 Finance Ministers behind him attempting to, once again, quell the fears of the global business community as to a concentrated global effort to “right the ship” of state.

Medical Professionals; et al

Physicians, healthcare administrators, financial advisors, iMBA firm clients, printer-journal subscribers to www.HealthcareFinancials.com and our Executive-Post readers seem to be all asking the same question: are we entering into another “great depression.” To answer this, one needs to review the events leading to this worldwide financial debacle.

Not the Same 

First, this is nothing like the depression of the 1930’s.  The institutions and causes are substantially different.  To prove this your self, just read the seminal work by the economist, John Kenneth Galbraith, “The Great Crash“, and the dissimilarities to the present global situation will be striking.

Second, a little known fact, but two prime catalysts were the principal culprits in this crisis.  One is a financial vehicle called credit default swaps (CDSs) and the other is a generally accepted financial accounting rule known as “mark-to-market”.

Investment Banking Meltdown

At the beginning of 2008, the United States had five major investment banking houses.  By October it had only two remaining.  What brought this major change was the so-called sub-prime debt problem.  But this is the deceptive label given it by naive journalists.  In reality, it was a worldwide market of 54 Trillion (this is not a typo – say again, 54 Trillion) dollar CDS market that collapsed.

Cause and Affect 

How could this happen?  Greed is the short answer but the business expediency of setting up a CDS is largely to blame.  Here’s how it worked.

Example: 

A party would by phone or email enter into a credit default swap contract with a bank.  This could be for an actual debt, e.g. sub-prime obligation or hedging on a non-owned instrument (cross-party) obligation.  Payment of premiums ensured the default.  In the event of default of the obligation, the bank, e.g., Lehman Brothers, would satisfy the contract.  It is a significant fact in these transactions that there was no federal or state regulatory body supervising them. Why?  Because these contracts were not per se securities and, thus, no oversight was necessary.  Of course, the facts belie this assertion — to the tune of 54 Trillion dollars!

Financial Accounting

Then there is the financial accounting rule that required businesses — including financial institutions — to mark their assets, i.e., sub-prime mortgages, to market value.  In a declining market this would require the creation of an unrealized loss on the bank’s books causing investors and others to view the bank as less solvent. 

Assessment

This accounting rule, endorsed by the International Accounting Board in London and enunciated in its International Financial Reporting Standards (IFRS), is also applied overseas.  French President Sarkosy stated that the rule is rescinded in France and the recent EESA of 2008 in the United States requires the SEC to decide whether to suspend it as well.

Conclusion

The DOW fell to 8,519 yesterday, the NASDAQ to 1,615 and the S&P to 896; all medical professionals are anxious. And so, are we entering into another great depression? Please vote.

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