By David B. Mandell, JD, MBA & Jason M. O’Dell, MS, CWM

As of October 2013, the Dow, S&P 500 and NASDAQ have all regained or surpassed the values they held before the 2008 stock market crash. While this climb has taken nearly five years, most investors, including physicians, ambulatory surgical center owners and executives, have not forgotten how disconcerting the crash was at the time.  Moreover, many market prognosticators are predicting another market pull-back, with some commentators seeing a decline as much as 20-30 percent.

Given the ever-present potential for another crash, we wanted to present three ways to potentially mitigate stock market risk in the following article.  How you utilize this information and incorporate it into your investment planning may shape how your portfolio handles the next significant market downturn.

Background

For the purposes of this article, we are going to review how market risk can affect your investments and potential ways to mitigate the risk. However, the true value of your portfolio is determined by more than just its raw return or value at any one time. Inflation, taxes and the time value of money are important considerations when evaluating the real return on any investment.

Before discussing how to deal with market risk, we must first define it.  For the purposes of this article, we define market risk and investment risk as the potential risk to the value of your investments decreasing due to a systemic overall stock market decline.  This is not the risk of a particular fund, sector, or even security losing value—but rather an entire market decline.

When it comes to this type of systemic market risk, the three potential ways to handle it are:

(1) avoid it;

(2) manage it; and

(3) transfer it.

Avoiding Market Risk

The first way to avoid market risk is to simply stay out of the game and keep your potential investment capital in cash or cash equivalents such as money markets or CDs. The benefit of this approach is that you avoid market downturns.  Clients who held a significant amount of their investment capital in cash in 2008 avoided the tremendous loss of value brought about by the down-market.

Obviously, the problem with avoiding market risk by using cash is that you also forego the opportunity for upside appreciation or even decent interest payments. In fact, since the downturn, interest rates have been close to zero for checking accounts, short-term CDs, and other cash equivalents.  When one also factors in inflation, you can quickly see that such market-avoidance asset classes actually provide a negative “real return.” In other words, the purchasing power of the funds in cash actually goes down over time — as low interest rates cannot keep pace with inflation. Thus, while you are avoiding market downturns, you pay a significant price — by forfeiting all of your upside potential and losing value to inflation over time. Investors who stayed in cash the last few years after being scared off the market by 2008 have missed out on much, or perhaps all, of the ride back up.

Managing Market Risk

The second way to deal with market risk is to manage your portfolio through it – either on your own or with professional money managers/investment advisors. Either way, the goal is the same — to achieve maximum return, given a targeted level of accepted risk. Typically, both individual investors and seasoned professionals try to reduce risk through the time-honored practice of proper diversification and asset allocation. This process of investing in diversified portfolios is done every day for tens of millions of Americans and by much of the investment community.  In fact, our firm manages over a quarter of a billion dollars in this context.

While managing risk is common, it is not a perfect science. Many investors learned painfully in 2008 that common approaches to diversification are not foolproof.  What were considered at the time ‘market hedges’ like hedge funds, real estate and other asset classes, actually lost significant value along with the market.  Many investors learned this lesson and have since paid greater attention to more significant diversification going forward by utilizing alternative asset classes to a greater extent to further diversify and manage their investment risk.

Transferring Market Risk

The final way to deal with market risk is to transfer the risk to another party.  Unfortunately, this method of dealing with market risk is underutilized by most physician investors, healthcare executives, and the investing public at large. The principals of transferring risk are more complex than avoidance and managing market risk.

Essentially, there are two common insurance products that transfer investment risk tothird parties: 1) cash value life insurance and 2) annuities.

With both of these product classes, you can transfer the risk of a market downturn to the insurance carrier and still participate if the market increases in value. We will drill down a bit into the life insurance product by reviewing “equity indexed life insurance.”

What is Equity Indexed Life Insurance?

•  A life insurance policy is a contract between a policyholder and an insurer, where in exchange for payment from the policyholder (premium), the insurer promises to pay a beneficiary designated by the insured  a sum of money (benefit) upon the death of the insured person.

•  Cash-value is the value of the policy contract itself—i.e. the policyholder may make withdrawals of past premiums paid and take out loans against the total value of the death benefit.

•  A Universal life insurance policy combines permanent life insurance coverage and flexibility in premium  payments  (both lump-sums  and regular  payments)  with the potential for growth  of cash values by means of permitting the premiums  and cash value to function  as an investment  tool.

A unique feature of an indexed universal life policy is that it offers protection from market risk by way of a minimum guaranteed interest rate, or “floor” rate, usually, between 0-2%.  There will also be a corresponding “cap”, or maximum amount of interest credited to the policy during positive markets, generally ranging between 10–15%. The movement of value of the policy is dictated by a market index, like the DOW or S&P.

With this type of product, one can have market upside to the cap (i.e., 13%) but have protection against market downside by the floor (i.e., 0%).  In this way, one has transferred the market risk to the downside to the insurance company issuing the policy and yet still have upside participation. For this reason, many investors have begun to use this type of products within the diversified portfolio of asset classes.

These policies are not for everyone. The policies are best utilized in long-term plans due to the policies being illiquid.  Also, specialized indexed cash value life products are not out of the box policies with standard level death benefits. Rather, these policies are heavily customized predicated on the investor’s intentions. The key is choosing the right policy, tailoring it to the investor’s needs and being sure to work only with top insurance companies with the highest level of financial ratings.

Conclusion

Investors of all types, including physicians and healthcare executives, are looking to build their wealth while reducing exposure to downside investment and market risk.  This article lays out three basic strategies often employed to mitigate market risk.  For specific tactics within these larger strategies, we encourage you to work with advisors who understand how best to employ these concepts in a manner that fits with your risk tolerance.

 

 

David B. Mandell, JD, MBA, is an attorney and author of five national books for doctors, including FOR DOCTORS Only: A Guide to Working Less & Building More, as well a number of state books. He is a principal of the financial consulting firm OJM Group (www.ojmgroup.com) which works collaboratively with doctors and healthcare practices nationwide.  Jason M. O’Dell, MS, CWM is a principal of OJM Group as well.  They can be reached at 877-656-4362 or mandell@ojmgroup.com.

SPECIAL OFFERS:  For a free hardcopy of For Doctors Only: A Guide to Working Less & Building More, please call (877) 656-4362. If you would like a shorter free Kindle, iBooks or Nook E-book download of our “highlights” version, you can download it at www.fordoctorsonlyhighlights.com

Disclosure:  OJM Group, LLC. (“OJM”) is an SEC registered investment adviser with its principal place of business in the State of Ohio.  OJM and its representatives are in compliance with the current notice filing and registration requirements imposed upon registered investment advisers by those states in which OJM maintains clients.  OJM may only transact business in those states in which it is registered, or qualifies for an exemption or exclusion from registration requirements.  For information pertaining to the registration status of OJM, please contact OJM or refer to the Investment Adviser Public Disclosure web site www.adviserinfo.sec.gov.

For additional information about OJM, including fees and services, send for our disclosure brochure as set forth on Form ADV using the contact information herein.  Please read the disclosure statement carefully before you invest or send money.

This article contains general information that is not suitable for everyone.  The information contained herein should not be construed as personalized legal or tax advice.   There is no guarantee that the views and opinions expressed in this article will be appropriate for your particular circumstances.  Tax law changes frequently, accordingly information presented herein is subject to change without notice.  You should seek professional tax and legal advice before implementing any strategy discussed herein.

 

abeo

abeo Management Corporation (abeo) serves as a leading source of revenue cycle management and practice management with a specialization in anesthesia. The company leverages its people, processes, and software to serve independent practices, surgery centers, hospitals and healthcare systems with a scope of services that include billing, coding, transcription, practice management, and business consulting.

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