Want to manage your wealth like a pro? Start by checking your ego at the door and avoiding these five classic financial planning pitfalls.
As an emergency physician you’re supposed to diagnose everything, cure everybody immediately, satisfy everybody, kiss up to hospital admin, have zero wait times, and smile while you’re doing it. Perfection is the name of the game. Failure is not an option. We do all of these things remarkably well.
But with investing it’s a completely different story. It’s night and day. It’s Dr. Jekyll and Mr. Hyde. Most EPs make huge investing mistakes. I’ve reviewed a ton of physician investment portfolios and here’s what I’ve found.
Mistake #1: Living like royalty
You might be proud of your six figure salary but – and I’m just going to be blunt – a lot of EPs can’t seem to add. They live like they have a seven figure salary. Many of you are living beyond your means, spending when you should be saving, and focusing on achieving sky high investment returns. The fact is that the amount you save is way more important than your investment returns in the first half of your career. It’s not until you’ve built up a seven figure portfolio that investment returns take over. If you’re making $300,000 a year and you’re not saving at least $50,000 annually, what are you thinking? You don’t have a pension. Social Security is tenuous. Where do you expect your retirement income to come from?
Mistake #2: Swinging for the fences
2008 was one of the best lessons you can learn in your investing lifetime. That should now be your gauge for risk. If you couldn’t handle investing in 2008, you took too much risk in your investments. That generally means that you had too much of your portfolio in stocks. Even now most physicians haven’t learned their lesson. “It can’t happen again” is the attitude. Wrong! There is ALWAYS lots of risk in investing and the worst risk is the risk you don’t know.
Here’s a rule of thumb you should use from now on: expect a 50% loss in the stock portion of your portfolio over a one year period from time to time. So if you have a 100% stock portfolio, expect to lose half of it in one year at some point. Realize this means than even with a 50% stock portfolio you should expect to lose 25% in one year.
Mistake #3: Rolling the dice
I love going to Vegas. I usually take $1000 for the week and win or lose I’ve scratched my gambling itch. But I don’t gamble with investments. The problem is that many physicians and their financial advisors do exactly that – gamble with their retirement. What’s worse is that they don’t know it. It’s like going to the craps table and thinking that there’s some way to beat the game. Maybe it’s the way you flick the dice, or the combo of numbers you bet on, or whatever. Fellow EPs, the house always wins in the end.
At least with craps you can always roll the dice again. But you can’t retire a second time. So what’s the difference between gambling and investing? Gambling hinges on hope: “I hope that I buy the winning lottery ticket.” Investing hinges on expectations: “I expect a rate of return for the amount of risk I’ve taken.” Gambling has an expected loss. Investing has an expected gain (though not guaranteed). With gambling you get nothing (lose everything) for something (the capital you part with). With investing you expect something (a gain) for something (the capital you supply).
Here are examples of how you or your financial advisor are gambling with your investments: buying individual stocks or bonds, buying sector funds, buying individual asset classes, buying individual commodities, picking the winning mutual fund manager, shorting stocks, buying inverse funds and timing the market. Instead, invest by capturing the return of the market through low cost diversified mutual funds.
Mistake #4: Putting one egg in one basket
You’ve always heard the phrase “Don’t put your eggs in one basket.” It makes perfect sense, and yet I meet a lot of physicians who have incredibly concentrated investment portfolios; their entire retirement relies on just a handful of stocks. Or worse yet, a big bet on just one stock. Even if you’ve got a dozen or so stocks, most physician portfolios invest in the same asset class. So if you’ve got GE, Apple, Bank of America and few other household names, that’s not a diversified portfolio. The academic studies show that it’s the type of investment – or asset class – that primarily determines the fluctuations and returns in your portfolio, not the individual stocks.
A related problem I’ve noticed is the illusion that having a large number of mutual funds equates to having better diversification. Financial advisors play this game all the time to make you think they’re doing something. But if all the mutual funds are invested in the same asset class, all you’re doing is adding more fees and unnecessary complexity.
So broaden your horizons. Add some international stocks. Mix in some bonds. Get rid of the clutter and hold many eggs in many baskets.
Mistake #5: Inflating your ego
You graduated at the top of your class in high school and college, studied hard in med school, and got into a competitive specialty. That’s impressive, but being smart and being a smart investor are two completely different things.
Unlike practicing medicine, hard work in investing does not necessarily translate into higher returns. You or your financial advisor can research a company’s balance sheet, read economic headlines, monitor the Fed’s every move, and track unemployment numbers. Then you or your advisor might think you can pick the “winning” stocks and money managers and adjust your portfolio. You KNOW with certainty what will happen...until it doesn’t.
Do you really believe you or your advisor know something the market doesn’t already know? You have no unique knowledge of any stock, bond, ETF, mutual fund manager, or any other investment that isn’t known already. Institutions control 90% of trading activity in the stock market. Your buy order for 10,000 shares of Citigroup won’t even move the market by one-millionth of a dollar for even a split second.
It’s called overconfidence. It’s what most physician investors look at in the mirror everyday. And it’s one of the biggest killers of your investment return.
One More Mistake...
Look I’ve made these investing mistakes myself. It’s one thing to make a mistake and learn from it. But it’s entirely foolish to repeat it. That’s the worst mistake of all.
Setu Mazumdar, MD practices EM and he is the president of Lotus Wealth Solutions in Atlanta, GA www.lotuswealthsolutions.com