When investing, the how depends on the why.
Many people ask questions like “Is now a good time to invest?” or, in some form, “What is the best investment?”
There is a saying that goes something like “The best time to invest was 20 years ago. The second best time is now.”
As for the second question, if I knew that answer I wouldn’t be writing this post. But what I can do is give you guidance on how you should be investing if I know why you are investing in the first place no matter what stage of your career you are in as a physician.
One of the reasons we need to know why is because we need to know how much and when you need it. As a result of knowing this, we can begin to develop an understanding of how much and what types of risk you can accept.
Let’s first understand the types of risk as they relate to the purpose of your investments.
Inflation Risk – This is the possibility you lose purchasing power over time due to inflation. This is why avoiding the market by hiding in cash may not be as safe as you think it is.
Credit Risk – This is the possibility a company, government or municipality you loan money to in the form of a bond is unable to pay you back.
Market Risk – This is the possibility a company you purchase ownership of through equity markets is worth less or worthless when you are ready to sell.
Unsystematic Risk – Your risk involved with a specific company or industry. You can reduce unsystematic risk through diversification.
Systematic Risk – Your risk involved with the entire financial system. You cannot reduce the systematic risk of your investments.
You cannot avoid risk, but you can choose how much of each type you are willing to accept.
So, how do you choose?
If you are an early-career attending physician planning on using the money as a home down payment, losing purchasing power to inflation over 6 months by not investing will not derail you. But if you needed to sell stocks early this Spring, it may have.
If you are a resident physician investing for retirement, the fluctuations of the stock market matter less to you (assuming it doesn’t cause you to make impulse decisions). The only time the value of the account matters is when you need to take money out. So, in this instance you can accept more market risk in exchange for a high probability of a greater investment return compared to cash or bonds.
Emphasis on probability. If we look at how often cash (One-Month T-Bills) or bonds (Long-Term US Treasuries) outperform stocks (S&P 500) even over longer periods of time we will see it does happen. However, you will notice the longer the time frame, the higher the probability stocks will outperform. Of course, past performance does not guarantee future results.
The easiest way to reduce your risk is to diversify your investments.
It may be probable that stocks will outperform over the next 20 years, but that doesn’t mean having all your eggs in that basket is the best approach.
As human beings we are wired to make poor money decisions. In periods of normalcy it’s easy for us to understand these concepts, but how about when your account was dropping sharply nearly all of this March?
Daniel Kahneman’s book Thinking, Fast and Slow, talks about how we are wired to fear loss more than we appreciate gain. In periods of sudden stress, we can experience fight or flight and make impulse decisions. This was meant to protect us from danger back in the Stone Age.
As a physician you probably know this, but it is important to remember when making investing decisions. This part of the brain is called the amygdala; it is the fast part of our brain responsible for memory consolidation, fear, and emotional responses. I don’t need to tell you that emotion and money don’t mix well.
When we are making decisions around money, we want to be using our frontal lobe, which is the slow part of our brain responsible for planning, organization, and logical reasoning. It’s easy to use the frontal lobe in a relatively normal period of time, but how do we access this slow, logical part of our brain when we are stressed?
What is 3×4? You solved that pretty fast right? Remember, the amygdala is responsible for memory consolidation, turning new things learned into long term memory.
What is 742×76? You can probably do the math on a mental piece of paper, but you needed to access the slow, logical part to answer that problem.
How can you use this information?
If you feel compelled to do something because you are experiencing fear of loss, try playing out a multi-step scenario before you make your decision. I would encourage you to think in terms of probabilities. Here’s what this may have looked like in March 2020:
- How is this virus going to impact the economy?
- What is the probability this will be permanent?
- What is the probability the negative impact of the virus will be reduced at some point in the future?
- If I sell now, what is my signal to buy back in?
- What is the probability I can time this in my favor?
- If the market goes above the price I sold at, at what point am I willing to be “wrong” by buying back in at a higher price?
Just by going through a simple mental exercise like that, you can begin to think more logically about the situation. Maybe you arrive at a place to move 10% of your stocks to a theoretically safer investment like bonds or cash. Maybe you miss out on some gains. That’s a whole lot better than selling all your stocks in March and seeing the market recover so quickly with no plan.
You know markets don’t go straight up, so don’t make the inevitable downturn an unrecoverable loss.
Asset allocation is not the only important piece.
Your planning around asset location should be thoughtfully constructed.
Certain account types offer tax benefits. Depending on your situation, a tax deduction may be worth more now than a tax-free withdrawal later or vice versa. Some accounts like 529 plans and HSAs can offer tax benefits on the way in and the way out.
After knowing the benefits of different account types, you can begin to match up which vehicles to use to get to each destination. In each different vehicle, you can have an investment mix designed for that specific goal.
You can see how knowing why you are investing is a prerequisite for knowing how you should be investing. It’s not as simple as saying if you’re a young physician, you should be investing this way.
Allegheny Financial Group is a Registered Investment Advisor.
Securities offered through Allegheny Investments, LTD, a registered broker/dealer. Member FINRA/SIPC.