Know the Importance of Portfolio Balance

The investment doctrine most often touted by financial planners is investment balance, also called asset allocation. These are really technical terms for "don't put all your eggs in one basket." The concept is a staple of effective retirement planning.

Many physician-investors, however, seem to exhibit more of a herd mentality—abandoning a mix of stocks, bonds, and cash investments for what seems to be "hot" at any particular time. After all, leaving funds in an investment class that isn't showing returns as high as another is difficult to do, and the tendency to shift everything to the highest producing class of investments is tough to fight. Doctors who got caught up in the Internet craze and the wild markets a few years back, and who are now talking about how they got "killed" when the bottom dropped out, are evidence of this.

RISK TOLERANCE

With the current volatility and uncertainty in the market, many physician-investors are now rethinking their asset allocation strategies. But how much should you have in bonds, and what can you expect from a more balanced allocation? Several factors should influence your decision, and over time your allocation may change as your need for safety of principal and income changes.

The way the market has behaved over the past few years has changed many doctors' attitudes toward their risk tolerance. The advantage of including both stocks and bonds in your portfolio is that when one category is declining, the other will hopefully offset this decline. And over the past few years, this is exactly what happened.

While the S&P 500, which is an unmanaged index approximately representing the stock market, posted losses of 11.9% in 2001 and 9.1% in 2000, long-term government bonds saw total returns of 3.8% in 2001 and 21.5% in 2000.

One way to assess the percentage of bonds that should be in your portfolio is to look at how holding various percentages of stocks and bonds would have affected the average return on your portfolio. For example, over the 20-year period from 1982 to 2001, the S&P 500 had an average compounded annual return of 15.7%, while long-term government bonds had an average compounded annual return of 11.5%.The single largest loss sustained in any of those years was 11.9% in 2001 for the S&P 500 and 7.5% in 1999 for long-term government bonds.

The table demonstrates the average annual return and the largest 1-year loss if various percentages of stocks and bonds were held over this period. Although past performance is no indicator of future results, this table should give you an idea of how mixing both stocks and bonds can affect your portfolio and address your risk tolerance. A rule of thumb here is that if you want the greatest odds of succeeding, you should be willing to withstand larger potential losses.

YOUR TIME FRAME

It's said that "timing is everything," and this is of particular importance when investing. If you have a longer time horizon for certain funds (eg, retirement money), you may be able to weather more risk and volatility for a potentially larger return. Physician-investors with shorter time horizons (ie, 5 years or less) should be wary of allocating too much to stocks. Regardless of your time frame, you should have a mix that makes you feel comfortable.

RETURN NEEDS

The emphasis you place on income vs growth is likely to change over your lifetime, but many doctors fail to revisit these needs and adjust their holdings accordingly. When a need to begin generating a stream of income is on the horizon, a plan to begin shifting your allocation should be initiated.

In short, those looking for higher potential returns should probably allocate more to stocks, keeping in mind that potentially larger losses can go with that, and if the timing of liquidating investments is not well thought out, you may find yourself getting out at the worst of times.

Many physician-investors are now willing to accept a more reasonable, steady return over time, and no longer lament missing the boat when the markets are on the upswing because they had some of their nest egg tucked away in bonds. Many doctors have learned their lesson over the past few years. Sadly, many others never will.

Patrick J. Flanagan is a financial planner in

Point Pleasant, NJ. He welcomes questions or

comments at 800-969-0899. He is a registered

representative affiliated with First Montauk Securities

Corp, member NASD/SIPC. Any opinions

expressed herein are the author's and do not

necessarily reflect the opinions of First Montauk Securities, its

officers, directors, or affiliated registered representatives.