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Financial Thoughts 2010 Douglas Carlsen, DDS

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We all know that the S&P 500¹ lost money from 2000 to 2010. However, few are aware that if a 50-year-old dentist invested $500,000 in January 2000 in the Vanguard "moderate" tax-deferred model portfolio seen in Table 2, and added nothing over the years, he would end up with $874,000 in January 2010.¹ All that was necessary was to reinvest all dividends and rebalance once a year. This was a do-it-yourself free plan, docs!

If this same dentist had invested $30,000 per year into the plan, he would have ended up with $1,275,000 in January 2010.

How did our hypothetical dentist react to the huge drops in 2002 and 2008? He ignored them. So why the dire reports from all the media "experts"? Unfortunately, many so-called gurus tried to time the market in 2002 and 2008, lost much client money, and are now fishing for new clients. It's that simple.

Below, I offer a summary of lessons learned from the market mayhem and methods we all can employ to reap future rewards.

Lessons Learned
1. Modern Portfolio Theory (MPT) and buy-and-hold strategies work: MPT posits that when various uncorrelated assets are combined in a portfolio, return is improved and risk is lowered. The widely diversified asset classes with low fees found in index funds today offer the investor the opportunity to see investment dollars grow over time without the steep tops and bottoms found with non-diversified holdings.

Buy-and-hold is a long-term investment strategy based on the view that in the long run, financial markets give a good rate of return despite periods of volatility or decline.

Yes, buy-and-hold MPT devotees with a 50/50 mix of equities/fixed income saw their portfolios shrink by around 20 percent during 2008, yet by proper rebalancing and buy-and-hold strategy, almost all are back to their mid-2007 totals.

On the other hand, many non-diversified, market-timing doctors saw a more than 50 percent drop in assets in 2008, and sold off their stock funds in early 2009 when the market was low, then waited too long to harvest 2009's big gains.

2. Say no to complex investment products: David Swenson, portfolio manager for Yale's endowment fund, says, "When the sophisticated provider of financial services stands toe-to-toe with a naïve consumer, the all-too-predictable conclusion resembles the results of a heavyweight champion and a ninety-pound weakling. The individual investor loses in a first round knockout."²

If you ever cross Accumulators, Booster-plus notes, Buffered Notes, Principal Protected Notes, Reverse Convertibles, STRATS, or Super–Track Notes, run away as fast as possible!

Just before the 2008 market crash, Jason Zweig, neuroeconomist and author of Your Money and Your Brain, a great read for dentists, interviewed Warren Buffet. He said he didn't care about the economy or what it would do in the next few years. When asked for specific investment advice for young individuals Buffet said, "I would just have it all in a very low-cost index fund from a reputable firm, maybe Vanguard. Unless I bought during a strong bull market, I would feel confident that I would outperform… and I could just go back and get on with my work."³

3. Avoid leverage: Hedge funds, or any fund with a cost structure that charges two percent of assets under management and 20 percent of profits, encourages risk taking. You know what happened with Bear Stearns and Lehman Brothers!

What Can You Do Now?
  1. Allocate your assets broadly per Modern Portfolio Theory. To own the whole market, U.S. and Inter-national, creates the highest possibility for gain and the lowest risk in the long run.

  2. Practice buy-and-hold. Do not try to "time the market," based on the direction you think it might be headed. This is how many dentists lost large sums of money over the last two years. Avoid Tactical Asset Allocation as well, a form of market timing.

    Burton Malkiel, author of A Random Walk Down Wall Street, recently said, "[As for] trying to time the market, just don't do it. People who try invariably get it wrong. Look at active managers in Q1 2009. They held record amounts of cash just as the market was taking off. If they were investment gods, they would have gone into cash in 2007 and be fully invested in early 2009. Instead, they did the reverse."4

  3. Keep costs to a minimum. Work with a financial advisor who uses a discount broker, such as: Fidelity, E-Trade, TD Ameritrade, Charles Schwab, TradeKing, Scottrade, WallStreet-E, Firsttrade, Just2Trade, Muriel Siebert, Optons- Xpress, Zecco, WellsTrade, Bank of America or USAA.

  4. Be wary of full-service brokers such as: Edward Jones, Raymond Jones, UBS, Morgan Stanley Smith Barney and Wells Fargo Advisors. Along with commissions and high management fees, brokers are not held to the same fiduciary duty to act in the client's best interest as are the discount brokers.

    That said, many of my coaching clients are doing well with the traditional brokers, even with the high fees and commissions. I don't suggest they change if all is stable with a reasonable asset allocation, timely monitoring and stable returns. New investors, though, should be directed to the better products and lower fees of the discount brokers.

  5. Be careful with any insurance investment products. Most provide great earnings for the salesman and poor long term benefit for the dentist. Only buy if you fully understand all the complexities of the product and purchase through a noninsurance-based planner, through a reputable brokerage like Vanguard.

    Example: the ADA Members Retirement Program is a deferred group annuity contract issued by AXA Equitable Life Insurance Company. Being an annuity contract, it may have higher fees and less liquidity than similar non-annuity retirement vehicles available through the discount brokers or fee-only financial planners. A full prospectus is available at www.axa-equitable.com/ada/invest.html.

  6. Stay tax efficient with index funds and exchange traded funds (ETFs). Index funds and ETFs have low turnover (few sales) and thus generate fewer taxable dividends than actively managed funds.

  7. Avoid actively managed funds. There is no credible evidence that active management provides better returns than passive investing. If you disagree, read Hulbert Financial Digest5 regularly.

  8. Rebalance once a year. Always rebalance to your risk tolerance. If your portfolio is 60 percent stocks and 40 percent fixed and the market takes a dive, as it did in 2008, you might end the year with 40 percent stocks and 60 percent fixed. Wise investors rebalanced at the end of 2008 to buy stocks on sale and reap profits from fixed investments.


Investing In 2010 and Beyond
None of my early retiree colleagues have suffered much since 2000. Why? Any money they will need access to in the next five to 10 years is safely held in an income portfolio similar to Table 1. Their long-term holdings are in buy-and-hold widely diversified portfolios similar to the holdings in Table 2.

For income you will need in the next few years, the model portfolio (Table 2) from Merriman Advisors' Fund- Advice Web site at www.funadvice.com is a good example.

For a longer time period, academics advise a diversified portfolio of many equity-asset classes, both in fixed income and equities. The following model portfolio is for the tax deferred portion of your assets.

FundAdvice also has recommendations for your taxable portfolio. As you can see, different risk level is involved in the aggressive, moderate and conservative portfolios.

Burton Malkiel, in his new book, The Elements of Investing, provides an even easier approach to allocation of funds. He offers the following ETFs model portfolio for "one-stop shopping." It is for either tax-deferred or taxable long term holdings.

Malkiel leaves the percentages to the investor. 60/40 Total World fund to Total Bond Market fund is appropriate for many.

Other, equally effective "lazy" portfolios are available. Examples include Paul Farrell's MoneyWatch site at www.marketwatch.com/LazyPortfolio. Aronson's Family Taxable, Dr. Bernstein's Smart Money, Dr. Bernstein's No Brainer, and Coffeehouse. Most use Vanguard funds because of low fees and consistent return.

Note that this article is not intended to constitute financial advice. It is to be used for educational purposes only. There are many diverse views of investment strategies. This is only one. I do recommend reading any end-noted materials listed. Make sure to talk about your risk tolerance with your adviser before making any allocation decisions. Also remember to reallocate to your original asset class percentages on a regular basis.

Then go back to drilling and golfing. Put your energies into fighting insurance companies rather than speculating about the rise and fall of the market.

References
  1. Paul Merriman, "Lessons learned from the lost decade," FundAdvice web site, downloaded from www.fundadvice.com/articles/investing-basics/lessons-from-lost-decade.html
  2. William Reichenstein and Larry Swedroe, "Bear Market Grads: What You Should Learn From the Financial Crisis," AAII Journal, July 2009, XXXI, #6, p. 5.
  3. Murry Coleman, "Buffets Advice to the Berkshire Faithful: Buy Index Funds, Seeking Alpha web site, downloaded June 25, 2010 at http://seekingalpha.com/article/75563-buffett-s-advice-to-the-berkshire-faithful-buy-index-funds
  4. Patrick Collinson, "The index funds gospel according to Dr Burton Malkiel," downloaded on June 25, 2010 at http://www.guardian.co.uk/money/2010/apr/17/index-funds-dr-burton-malkiel
  5. go to www.hulbert-digest.com
Author’s Bio
Douglas Carlsen, DDS, owner of Golich Carlsen, retired at age 53 from private practice and clinical lecturing at UCLA School of Dentistry. He writes and lectures nationally on financial topics from the point of view of one that was able to retire early on his own terms. Carlsen consults with dentists, CPAs, and planners on business systems, personal finance and retirement scenarios. Visit his Web site: www.golichcarlsen.com; call 760-535-1621 or e-mail at drcarlsen@gmail.com.
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