Investing: It's All About Making Your Money Work

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.

Individual Securities

Individual stocks and bonds afford greater control. For example, you can buy bonds that mature in the precise year you need the cash. Or you can target specific attractive stocks-perhaps you know a company that makes a promising new medical device or drug. Individual stocks also offer a tax advantage, as you can delay paying taxes on capital gains until you sell. If you don't know much about investing but want to learn, a good option is to join an investment club. The National Association of Investors Corp. (810-583-6242) is the umbrella group for thousands of local stockpicking clubs.

The flip side is that individual securities also mandate heightened responsibility. With the speed at which stock prices can change these days-sometimes rising or falling by more than 25% in a day-you have to keep a watchful eye on your portfolio. "If you really enjoy [practicing] medicine and psychiatry, there isn't enough time to become a great expert in specialized fields of investing," says Chaffin, who primarily sticks with mutual funds.

Fredman believes it's easier to mess up trying to select individual companies. "With individual stocks, it's too easy to speculate on what you hope will be the future Microsoft and wind up losing a bundle." He too favors mutual funds.It can be especially challenging and expensive to buy and monitor dozens of individual stocks, especially those in certain categories such as embryonic domestic firms or foreign corporations, as information on these companies can be hard to obtain and trading costs may be steep. You can get instant diversification in such exotic areas, including real estate, by investing in a single mutual fund.

Funds

Funds also offer other benefits that are difficult to come by with individual stocks and bonds. These include the ability to reinvest dividends into additional shares and the ability to switch money from one fund to another with a phone call-two services typically offered at no cost. While brokers might try to interest you in hiring a professional money manager to oversee a customized portfolio of individual stocks-assuming you have investible assets of $250,000 and up-you probably won't enjoy significantly better results than with mutual funds. The latter are highly visible portfolios counting millions if not billions of dollars; consequently, they attract the best managerial talent.

Deciding Who'll Help

Another key decision you must make involves seeking professional help on another level. Should you hire a broker or financial planner to draw up an asset-allocation plan, dispense advice regarding specific investments, monitor your holdings and tell you when to sell? You can save fees doing it yourself, and no adviser will ever have more concern for your money than you do. Conversely, good advice can be worth the cost. Whitson believes medical doctors in general and psychiatrists in particular typically don't make model investors. "[Doctors] know their fields well, but when they get a little information in another area, they think they can do anything," he says. "Psychiatrists are there to help clients make decisions, yet it may be difficult for them to make decisions on their own."Your decision on seeking professional advice also hinges on whether you have the willingness, ability and time to manage a portfolio.

More than half of all mutual funds traditionally have been purchased by people seeking advice and willing to pay a sales charge or "load." The rest are bought by do-it-yourselfers dealing directly with no-load families such as the Vanguard Group in Valley Forge, Pa.; T. Rowe Price Associates in Baltimore; and Fidelity. If you decide to work with a broker, ask for referrals from friends and colleagues. Then interview several and check the disciplinary record of each by contacting your state securities department or the National Association of Securities Dealers (800) 289-9999. You also can get referrals through professional groups such as the National Association of Personal Financial Advisors (847) 537-7722. Also, find out how your adviser gets paid-by commissions, a flat fee or both. "We feel fee-only advisers are better because they offer more objective advice," says Whitson.

One final note involves retirement plans. Needless to say, there's a huge incentive to defer taxes whenever possible since this allows for faster compounding. Plus, you can reduce your taxable salary by the amount you kick into a workplace retirement plan. "Everyone needs to understand the importance of having a retirement plan," says O'Neill. If you run your own practice, a retirement program also can help you attract and retain good employees.

The range of retirement programs is sizable. Here, it probably is wise to seek help if you have authority to establish a plan at your company. So-called 401(k) plans, Keoghs, SIMPLE retirement accounts and other programs each offer different wrinkles when it comes to how much money you can invest, in what manner, at what cost and with what administrative burden. These are examples of "defined-contribution" plans, which set limits on how much you can sock away in any given year.

"Defined-benefit" programs are another option-usually costlier to administer but allowing you to sock away more dollars each year. "Defined-benefit programs can be good for people who haven't done a lot of retirement planning," says Mark Luscombe, a tax analyst at CCH Inc., a tax-information firm in Riverwoods, Ill. "You can set one up later in your career and still put away a pretty good sum for retirement."

The key is to get started. "It's tremendously important to keep adding to a pension fund," says Chaffin. "Sadly, many psychiatrists I know haven't done so."