Get the Facts Before You Go Alternative

Alternative investments havedifferent risk and returncharacteristics from traditionalinvestments (eg, bonds,stocks, and mutual funds). Therefore,their performance doesn'tparallel conventional investments.They provide an opportunity forprofit in any economic environment.If chosen carefully, they canalso enhance portfolio return whiledecreasing overall volatility. So,what are your common alternativeinvestment options? They are realestate, hedge funds, and privateequity investments.

REAL ESTATE POTENTIAL

The usual asset allocation recommendationfor real estate in a portfoliois 5% to 10%. There are 2 majorkinds of real estate ownership: realestate investment trusts (REITs) anddirect ownership. One type of REIT,the mortgage trust, historically tendsto default on loans as interest ratesincrease. Therefore, caution is advisedwhen considering REITs.

However, they can be a source ofincome in retirement that is easierthan rental income property. This isbecause they must pay out 90% oftheir profit in dividends. Over a 20-year period, the return on REITshas been better (12%) than directreal estate ownership (8%), but thiscan be explained by REITs'use ofdebt. Therefore, the real risk-adjustedreturn is higher for home ownershipand lower for REITs.

Physician-investors may want toconsider increasing home ownershipas a method of escalating realestate in their portfolio. A secondhome could provide significantenjoyment for you and your family.If it were rented out part of theyear, it could even "pay for itself"or make money. Direct ownershipof real estate gives an investor morepersonal control than investing inan impersonal REIT.

The downside of real estateincludes those pesky payments (eg,mortgages, taxes, maintenance, andutilities), their illiquid nature, andthe fact that real estate does notalways increase in value. The upsideis that real estate provides diversification, leverage (ie, using someoneelse's money in this low-interest rateenvironment), and tax benefits.Most of the time, if the real estate isa small portion of your total portfolioand you are receiving benefits inreturn, the advantages often outweighthe disadvantages.

HEDGE FUND GREENERY

Hedge funds are the "flavor ofthe year."At a time when investorsare looking for something otherthan stocks, hedge funds haveappealed to many. There are differentstyles of hedge funds. One ofthe most common is the "long-short"equity fund. This means thefund owns some stocks outright;these are the long positions. Therest of the portfolio is short, meaning"sold short."How do long-shortequity funds work?

Using this technique, money canbe made by borrowing stock, sellingit at a higher price (hopefully), andthen buying it back at a lower price.If all goes well, the long positionswill increase in value and the shortpositions will decrease in value. Thedifference in each position is whatthe fund will make.

If all doesn't go well, the shortpositions will go up instead of downand the long positions will go downinstead of up. Then, the loss is incalculable,especially if the fund isleveraged. If this happens, mostlikely the fund has taken a trim. Itwill either have to be closed or baledout by the government.

There are several ways to protectagainst losses. One way is to choosea fund that is registered. This meansit has some degree of SEC oversight.Funds that do not have thisdesignation are totally unregulated.Another way is to spread the risk.This is where the popular "fund offunds"comes into play. These fundsare composed of multiple hedgefunds (each almost certainly unregulated)in an attempt to diversifyand lower risk.

The bottom line:

Hedge funds arebest used in large portfolios (ie, $5million and above) and should be nomore than 5% to 10% of that portfolio.Hedge funds are expensive, illiquid,unregulated (unless registered),and use risky techniques to makemoney. This all can add up to a hedgebecoming a bush, and a small one, atthat. For more information on hedgefunds, visit www.nasdr.com/alert_hedgefunds.htm or www.sec.gov/answers/hedge.htm.

PRIVATE INVESTMENT RISK

If you are being asked to participatein a private investment offering,it means the salesperson suspectsyou are an accredited investor.An accredited investor is an individualwith $1 million in net worth or$200,000 in income. According tothe SEC, this means you are sophisticatedand able to evaluate investmentsthat the SEC does not scrutinize.Furthermore, reporting to theSEC is not required.

These investments are oftenrisky, with low liquidity and uncertainexit strategies. All of this addsup to an appropriate investment foran investor with a high net worth(ie, more than $10 million) who canhire someone to carefully scrutinizethe pros and cons of the venture.These investments are not a goodidea for most retiring physicians.

Home Alone

Remember the popular 1990'sJohn Hughes film, ?Well, hedge funds and privateinvestments can both be comparedto this comedy. In it, the youngestchild Kevin (played by the famouschild actor Macaulay Culkin)wakes up one December morningto find his parents and siblingsgone. Home alone and with noparental supervision, Kevin hasrule of the entire house.

Home Alone

Home Alone

Hedge funds and private investmentscan be likened to youngsters(like Kevin in ) withoutsupervision. They don't have SECoversight, which would be equivalentto parental input. That meansthey can get into mischief moreeasily. In the case of ,Kevin manages to get himself intoquite a bit of mischief. Therefore,investing in these entities requiresextra-special diligence.

Knowing the alternatives in anysituation offers the decision makermore options. The tricky part isdeciding if an alternative will bebetter than the original choice.When it comes to the market, youmay be more comfortable withyour traditional investments. However,sometimes change can begood. Alternative investments offeryou the opportunity for change. Ifyou're interested in these investments,remember to proceed withcaution. Weigh the options beforeyou go alternative.

Shirley M. Mueller is boarded

in neurology and psychiatry.

She was a practicing neurologist

until 1995. Since then,

she has retrained and is active

in the investment and financial

planning area. Dr. Mueller is a senior

wealth advisor at Star Wealth Management

in Indianapolis, Ind. She welcomes questions

or comments at mymoneymd@aol.com.