Retirement Planning for Physicians
Though investment options are virtually unlimited, we have chosen to address the four primary investments we see physicians successfully use:
Most physicians use “the market” as their primary vehicle for wealth accumulation. When we say “the market,” we are referring to publicly available investments that tend to trade easily. For example, you may have heard of small caps before. This refers to investing in small companies. Large caps are large companies. The market is not limited to only investing directly in companies. Instead, money from one investor can be grouped together with money from another investor to gain access to more investment choices with less cost. This is known as a mutual fund. Many market components can be used to diversify investments. Simply put, diversification means spreading your assets to multiple investments so that risk is reduced without necessarily reducing growth potential. This works because many types of investments are not highly correlated with one another so that when one is going down in value, others may be going up in value.
When using the market, a physician should focus on asset allocation, low expenses, and tax efficiency, rather than on trying to pick the hot stock or mutual fund of the day. The following table shows many of the various segments of the market available for investment, as wellas, historical returns of each of these different types of investments. (29)
Many doctors and dentists receive their income through ownership in a practice. From an investment standpoint, many of our clients earn better returns by investing in their practice than they likely could with other investment choices.
For this reason, many practice owners primarily use the market as a means of diversifying and protecting the wealth they have already created in their business. They often invest more conservatively in the market than our non-business owner clients because they are not relying on the market to create wealth. Their business handles this function. Instead, the market simply serves as a means to protect the wealth that their business has already created.
Real estate became a hot investment during the stock market downturn in 2001 and 2002. From 2001 through 2006, many people entered the real estate investment world, only to see their property values decimated between 2007 and 2008. This is not to suggest that real estate is always a bad investment, rather, that successful investors in the real estate market are usually those that treat it as a full-time career. They invest for a living in residential, commercial, and/or developmental real estate, and they earn a good living doing so. The point is that you probably need to choose which one you want to be–a real estate tycoon or a physician–because it would be rare to see someone who is great at both.
Rental property is not often the easy lottery ticket to wealth that infomercials promote it to be. Owning one or two rental properties can quickly turn into a losing proposition. Consider the example of a client who made a profit of only $150 per month after paying for his mortgages on two properties. All it would take is one month without a tenant, or a large repair, for the entire annual profit to be eroded.
We question the logic of investors who get into real estate as a hobby or for the chance to make a quick buck. Why take on the headaches and the risk of leverage in the real estate industry? This return could often be matched with far more conservative investments that do not involve the use of debt. Instead, we advise physicians to avoid direct real estate investments outside of the scope of their normal business unless they want to take on another full-time job. Instead they should consider the market as their primary wealth driver.
The good news is that investors can still gain great exposure to real estate without taking on the risk of debt–or additional work. This can be accomplished through the market by acquiring investments called Real Estate Investment Trusts (REITs). REITs function like mutual funds where investors pool their resources. Commercial property, mortgages, and other real estate investments can be purchased in bulk with a share of the profitability (or losses) returned to the investor, with no additional work or debt required. REITs are considered to be the most efficient way to achieve broad diversification in the real estate industry. (35)
Many physicians believe that this is a great alternative to active involvement in real estate projects outside the scope of their medical practice. We agree philosophically. Unless the individual real estate deal comes as part of the package with your practice ownership, it is probably best to leave it alone.
Several other distracting opportunities exist for physicians outside of the normal stock market–primarily because most medical specialists qualify as “accredited investors.” An accredited investor is one that has a net worth in excess of $1 million (excluding a primary residence) or has income in excess of $200,000 to $300,000 per year. The income component alone qualifies most physicians as accredited investors. (30)
Why does this matter? Because accredited investors have access to investment options that are prohibited from being sold to the general public because they are considered to be too risky.
Many physicians are excited by the concept that they have access to investment opportunities that others do not. The relevant question again is: Does it matter? The short answer is that your status as an accredited investor means very little, but your status as a properly credentialed physician could mean much more. To clarify, it will help to understand the various exotic opportunities out there.
Unlike mutual funds, hedge funds are able to bet against the market (called “shorting” the market), and they are also allowed to borrow against your money to seek larger returns.
Does it work? Consistent studies suggest not. There is no evidence to support that hedge funds perform any better than should be expected from random chance or luck. This is largely in part due to the high fees charged by hedge fund managers, typically ranging from 4.26% to 6.52% per year. (36)
Private equity deals fare no better, and the risks are much greater. Venture capital, leveraged buyouts, and mezzanine financing deals require substantial risk on the part of the investor. You give up liquidity, diversification, and transparency for the chance of a big payoff. What do you stand to gain from this? Studies show the payoff is not worth the risk. The returns gained through private equity dealings are no better than those provided by investing in small cap (company) publicly traded stocks. (36) In other words, historically speaking, you would have gained the same returns with more liquidity, diversification, and transparency.
David Swenson, famous for his outstanding track record managing Yale’s endowment fund, had these remarks for individuals considering private equity deals:
Understanding the difficulty of identifying superior hedge fund, venture capital, and leveraged buyout investments, leads to the conclusion that hurdles for casual investors stand insurmountably high. (37)
Exotic investments are not worth the risks they pose. Unfortunately, being an accredited investor is not as advantageous as it sounds. Normal exotic investments do not add as much value as hoped, but your credentials as a physician (not your income), might sometimes grant you access to excellent investment opportunities not afforded to the general public. An increasing trend for physicians is to hold ownership interests in surgery centers, ancillary services, and hospital syndications.
We find it much more logical for physicians to attempt to outperform the market when they can directly affect the outcome. Ancillary services can generate additional income for you– ultimately meaning that you do not have to rely as much on seeing more patients to maintain a similar income stream.
Many ancillary services may be available, depending on your specialty. The idea behind investing in ancillaries is that because you are referring out the business, you might as well get paid for the additional work to be done. When physicians ask what ancillary services they should consider offering, we ask them what business they are referring out the door the most. That is probably your best place to begin strategizing.
Hospital syndications are also increasing in popularity with healthcare reform underway. Ownership of a hospital gives you access to some of the profits. The requirement that you be a physician who has credentials at the hospital keeps the public from gaining access to the investment opportunity. Hospitals sometimes treat physician ownership as a means of doing profit sharing, whereby you get to participate in the profits of the place you already do the work. When a physician considers ownership of ancillary services, we ask him or her to address three issues up front:
- Does the opportunity have a good business model that makes sense, and does the financial data support it?
- What is the exit strategy for the future in the best-case and worst-case scenarios?
- Is the return worth the risk?
To clarify the first issue, it is helpful to examine the financial ratios of the service in question in order to get a feel for how those compare to what would generally be expected for a similar business.
The financial ratios are the diagnostic tool that helps you measure whether or not an opportunity makes good business sense. You need to know what the difference between a good ratio and bad ratio is—or hire someone who does.
The exit strategy is something you want to consider anytime you enter into a business relationship.
- How do you plan to sell your shares of the hospital syndication?
- Will the buyer of your medical practice logically also want to acquire the ancillary business you have established?
- What could happen to the value of your ownership if Stark laws are increased, and you can no longer own any portion of an ancillary service?
The best business opportunities are those that offer little risk in terms of how the exit strategy will impact you personally. Finally, if the above questions have reasonable answers, the last step is to determine whether the potential reward is worth the risk. A general rule is that it is not worth the loss of liquidity on any of these services, unless you expected to earn 15% or more on the investment returns.
A surgery center that returns only 8% in profit each year would not be worth the risk, unless you had reason to believe that your group’s involvement would increase surgeries enough to increase the profit margin to the 15% minimum requirement.
In summary, exotic investments available to the general public are rarely a good opportunity, but direct access to additional revenue on work you are already generating can often be very profitable. This might be the best exotic investment it makes sense to pursue. Diversification remains paramount, so we would not want to see more than 15% to 25% of someone’s investments tied up in these types of investments. Instead, the open market offers the best long-term opportunities to be properly rewarded for the risks that you take.
(29) All returns are in U.S. dollars. Data was taken from a reliable source, but we cannot directly attest to its accuracy. The portfolios referenced above are for illustrative purposes only, and are not available for direct investment purposes. Performance above does not make adjustments for expenses associated with the management of an actual portfolio. 80 year data not provided in the chart indicates an asset class that was not tracked during that time frame. (45) (30) $200,000 from a single individual or one earner in the family, or $300,000 if combining both spouses’ incomes. (35) Swedroe, Larry E. and Kizer, Jared. The Only Guide to Alternative Investments You’ll Ever Need. New York, NY: Bloomberg Press, 2008. (36) Swedroe, Larry E. The Quest for Alpha. Hoboken, NJ : John Wiley & Sons, Inc., 2011. (37) Swensen, David. Unconventional Success. New York, NY: Free Press, 2005. (45) Dimensional Fund Advisors. Matrix Book. Austin, TX : Dimensional Fund Advisors, 2011.