Daniel Chaffin, M.D., says he has never been at the top of the physician pay charts. That's why the solo practitioner in San Rafael, Calif., decided long ago to pay close attention to his finances. He dutifully put money in a retirement plan each year, avoided speculations, and focused his attention on growth-oriented stocks and stock mutual funds. The result: A seven-digit retirement account, additional investments on the side and, in short, financial security for himself and his wife as he nears his 70th birthday. "You have to make your money work hard, be astute and pay attention to your finances," Chaffin says.
Such sound advice is timeless, but it's especially relevant for younger psychiatrists facing the prospect of having their financial wings clipped a bit by managed care. Fortunately, people in their 30s, 40s and even 50s have plenty of time to build up a substantial nest egg if they, like Chaffin, make use of tax-sheltered retirement plans and growth investments. What investment success also requires is common sense, vision and enough patience to let time work for you.
The time part is critical because the really big wealth-building years typically don't occur early on. They come after 10 or 20 years, as a result of compounding. Consider that a $10,000 yearly investment growing at 10% annually would be worth roughly $61,100 after five years and $159,400 after a decade. But keep investing for another 10 years and the account swells to $572,000. After 40 years, it would top $4.42 million. That 10% figure is significant because it's roughly the rate at which the Standard & Poor's 500 index-a grouping of 500 blue-chip American stocks-has risen over the past 70-odd years, assuming all dividends were reinvested along the way. Smaller stocks have returned even more on average, while bonds have achieved significantly less.
"If you might not retire for 20 or 30 years, it's essential to have a strong weighting in equities," says Andrea O'Neill, a retirement-planning specialist at Fidelity Investments in Boston. The problem is that stocks are more volatile than bonds, not to mention "cash" investments such as Treasury bills and certificates of deposit. A bad year in the stock market could see prices plunge by 30% to 40% or more. For this reason, most people wouldn't want to stake their entire nest egg in stocks, especially one particular variety.Diversification
What's needed is an asset-allocation approach, whereby you apportion your dollars among different types of investments. Key building blocks include cash, bonds, large U.S. stocks, small U.S. stocks and foreign stocks. Each of these ingredients behaves differently over time in response to economic currents. The result is that a well-diversified portfolio can deliver smoother and often higher returns over time than will staking everything in one area. When one type of asset might be falling, another category could be rising.
According to a landmark study several years ago, asset allocation is the most important determinant of investment success, much more so than picking the right stocks or bonds, making adroit market-timing moves or other factors. "The main thing is to get the right proportions of different asset classes," says Albert Fredman, a finance professor at California State University, Fullerton and coauthor of three investment books.
The trick is doing just that. A suitable portfolio will take into consideration your objectives, time horizon, tax bracket, current income needs and more-especially your risk tolerance or ability to stomach fluctuations. While there's no substitute for experience in this regard, it's wise to take a few risk-tolerance tests of the type that are widely available through brokerages and mutual-fund companies. Such quizzes are free and even can be downloaded from Internet sites operated by various companies. Financial advisers administer such tests to new clients as a tool in gauging their risk tolerance during face-to-face meetings. But it's hard to assess one's tolerance until prices actually drop. "It's a gray area," says D.R. Whitson, a certified financial planner at Wealth Accumulation Ltd. in Phoenix. "You have to try to get inside a client's head."
After you have formulated a plan, it's wise to jot down your thoughts in an investment-policy statement, which can be as simple as a one-page summary of your objectives, return expectations, attitude toward risk, time horizon and the like. Refer to this statement over the years to make sure you're adhering to your original game plan. Update key sections when your personal circumstances change.
With an asset-allocation policy, it's fairly easy to fill in the blanks with specific investments. A key decision is whether to pick individual stocks and bonds, professionally managed portfolios such as mutual funds or perhaps a mix.