Undoubtedly, many Americans have been suffering through one of the worst economic crises in recent memory.
Though many economists claim that the recession is over, the most recent legislative changes (and those to come) are sure to impact most doctors in the form of reduced reimbursements, increased employee benefit costs, and increased taxes on income and investments.
Although the economy may get better for most Americans while getting worse for most doctors, you can fight back by investing wisely. Doctors who take the time to understand today’s risks - and who are willing to address those risks - do not have to be afraid of investing.
In today’s market, there are no "free lunches" like there were with the dot-com and real estate markets of the mid-1990’s and early 2000’s.
You and your advisory team need to be prepared to navigate your way through the new tax minefields that have been laid for wealthy investors. Some tax increases have already been adopted, others will be phased in over time, and still more will be discussed this year and in years to come.
After all, healthcare reform is going to cost money, and the current administration has made no apologies for its plan to tax higher earners to pay for it.
Other hurdles include the United States’ dependence on foreign oil, debt service obligations from behemoth deficits, and a weak dollar - all fundamental threats to our nation’s fiscal health.
Savvy investors recognize that the marketplace will not change any time soon. They must focus their investment strategies on dealing with these challenges and mitigating the risks associated with these threats.
Most investors understand that portfolio diversification is a key consideration to reducing some of the risk of loss in a portfolio. In historically volatile markets, mitigation of loss is not a luxury - it is a necessity.
Most investors who thought they were adequately diversified have looked at their statements at some point over the last two years and noticed very significant dips in their account values. That’s because they made the mistake of diversifying within the stock market. What these investors suffer from is called market risk. When economic factors cause a precipitous drop in the entire stock market, practically all stock investors suffer at some level.
What many experienced investors don’t understand is that diversification needs to go far beyond the diversification of securities like publicly traded stocks and bonds or bank deposits.
Proper diversification, especially in a highly volatile market like the one we are experiencing today, must also be across investment classes. A balance of domestic and foreign securities, real estate, small businesses, commodities, and other alternative investments, for instance, would prove less risky than holding the majority of your investments in real estate and securities.
For doctors who can’t build or participate in surgery centers or other profitable healthcare investments that they can help make more successful, another popular investment strategy is to take advantage of different investment programs that are not publicly traded (i.e., not on the New York Stock Exchange or other exchange).
The term "alternative investment" covers a broad range of investment strategies that fall outside the realm of traditional asset classes:
• Gold and other precious metals
• Commodities, including but not limited to oil, natural gas,
wheat, corn and copper
• Foreign currencies
• Non-traded Real Estate Investment Trusts (REITs)
• Leasing funds
• Oil and gas drilling programs
A well-diversified portfolio should consist of individual investments that behave differently. To help guide your diversification decisions, use correlation, a statistical measure of one investment’s performance relative to another.
Asset classes can be positively or negatively correlated or have no correlation at all.
Though diversification does not eliminate the risk of investment loss, adding assets with low correlation to the existing assets in your portfolio may soften the impact of market swings because they do not all react to economic and market conditions in the exact same manner.
Given recent market conditions, many physician investors have been attracted to non-traded real estate and oil and gas programs because they offer a certain level of stability.
Most of these programs are sold to investors at a flat price (for example, $10 per share) during the offering period. An advantage to these programs is that their performance is not correlated with any particular market or index, making them an additional form of diversification.
Holding non-correlated offerings can help reduce the volatility roller coaster of a traditional portfolio. Note that alternative investments should be an additional allocation in your portfolio, not a substitute for proper allocation.
Another significant benefit for physicians in the higher income tax bracket is the potential tax benefit an alternative investment program can offer. Some programs offer tax deductions on the initial investment. Others pay tax-efficient dividends. Some programs offer both. For example, there are oil and gas drilling programs that offer tax deductions on the initial investment due to intangible drilling costs, and tax deductions on the program’s cash flow due to depreciation and depletion allowances.
Dividends from REITs and leasing funds are often only partly taxable to the investor. These tax efficiencies vary by program and from year to year.
It is important to note that one of the advantages of a non-traded offering is also a disadvantage.
There is typically no market for shares of these programs. As an investor, you are expected to hang on to the security for the life of the investment - which can be as long as four to 10 years. This can make your investment relatively illiquid.
In addition, these programs are not without risk. You could invest in an oil and gas drilling program that finds no oil. You will get a deduction, but you may not get much of the initial money back.
Like any other investment class, some offerings are more aggressive than others, and none make any guarantee about future performance.
There has never been a better time to focus on investment risk management and tax reduction planning.
For physician investors seeking ways to diversify traditional stock and bond portfolios and reduce portfolio volatility while possibly reducing unnecessary taxes, non-traded investments are an attractive alternative.
Jason O’Dell ([email protected]) is a founder of O’Dell Jarvis Mandell and author of Investing Secrets for Physicians. Kim Renners is the director of wealth management for OJM Group. Sign up for a free newsletter on Advanced Asset Protection, Tax and Investing at ojmgroup.com. For a free copy ($5 S/H) of For Doctors Only: A Guide to Working Less and Building More, call (877) 656-4362.