How Does Your Financial IQ Measure Up?

Physician's Money Digest

What's Your Investing IQ?

A recent survey of 750 doctors by found that just 2% took a financial course in medical school. In short, most busy doctors are in serious need of help when it comes to understanding personal finance issues. To help, in the coming months we will reprint sections of the new book, (Career Press Inc; 2003) by Carrie L. Coghill, CFP®, and Evan M. Pattak.

In diversifying your portfolio, it's best to invest in:

• 2 classes of assets.
• 4 classes of assets (which include real estate).

In investing, the whole often is greater than the sum of its parts. If you spread your investments over as many asset classes as possible, history shows that your holdings as a group are likely to outperform any of the individual investments.

Multiple-Class Study

Asset Allocation—Balancing Financial Risk

When Roger Gibson undertook a longitudinal study of multiple-class investing for his book , he was able to flush out the safety-in-numbers theory. From 1972 to 1998, he found that portfolios featuring 4 asset classes outperformed those with 3 asset classes; 3-asset-class portfolios did better than those with 2 asset classes, which themselves produced greater returns than single-asset portfolios. The figures show that more asset classes tend to yield greater return over time.

This was mirrored in the category of volatility/risk. Four-asset-class portfolios experienced less volatility than those with 3 asset classes, and so on down the line, underscoring the heightened risks that come with undiversified holdings.

Allocation models and the amount you invest in major asset classes and subclasses should be based on your goals and risk tolerance. For example, a conservative investor with the objective of asset accumulation could adopt this allocation:

60% fixed income (20% high-yield corporate bonds, 20% corporate bonds, 20% government bonds)

• 40% equity (10% international stocks, 10% real estate, 20% US stocks) An aggressive investor with the same goal might implement this allocation:

20% fixed income (10% high-yield corporate bonds, 10% government bonds)

• 80% equity (20% international stocks, 20% real estate, 40% US stocks)

Creating a Design

Before you adopt the "more asset classes are better" theory, keep several caveats in mind. This approach can work if your asset subclasses are not strongly correlated. It won't do much good to select multiple asset classes that move up or down together. Check out the correlation coefficients of assets within the portfolio and understand the potential impact of macro forces and other factors on the asset classes you select.

Also, think long term. If you consider only a brief period, your comparative performance could be different, and you might be tempted to consider a single-asset-class portfolio. But remember the risk you take in doing so. Over time, investing in multiple asset classes lowers risk and, as Gibson's figures show, can produce significantly higher returns.

Recognize that investing in multiple asset classes usually means putting your faith and cash in assets with which you may not be familiar. Rather than dismissing unfamiliar asset categories, get familiar with them.

Reprinted with permission of the publisher from What's Your Investing IQ? © 2003 Carrie L. Coghill and Evan M. Pattak. Published by Career Press, Franklin Lakes, NJ. All rights reserved. To order the book, call 800-227-3371 or visit www.careerpress.com.