Savvy investors must learn from past two years, adjust behavior accordingly

Key Points

If you're like most Americans, you feel less secure about the U.S. economy than you did 18 months ago. Certainly, this is justified.

While we may be technically out of the recession, our dependence on foreign oil, behemoth deficits and the weak dollar are fundamental threats to our national fiscal health and investment marketplace, and these threats are not going away soon.

For this reason, it is crucial that savvy investors, including physicians, learn from the past two years and adjust their investment behavior accordingly. This article touches on a few thoughts in this arena.

Most savvy investors understand that portfolio diversification is a key consideration in reducing some of the risk of loss in a portfolio. In historically volatile markets, mitigation of loss is not a luxury - it is a necessity.

Though most knowledgeable investors who thought they were adequately diversified also lost almost half of their portfolio over the past two years, there is an explanation. Most investors were diversified within the stock market with holdings in various sectors. What these investors suffered was market risk: As the entire market came crashing down, so did all investors within the market.

What many experienced investors don't understand is that diversification need not be limited to securities such as traditional stock and bond investments or bank deposits. Proper diversification, especially in a highly volatile market like the one we are experiencing today, must also be across investment classes and not just within a class (such as securities or real estate).

Creating a balance of domestic and foreign securities, real estate, small businesses, commodities and other alternative investments would prove to be much less risky than holding the majority of your investments in real estate and securities (which is what most doctors do).

Since most doctors who contact us are either very successful already and want to fine-tune their planning, or they want to know the secrets of the more financially successful, it may not come as a surprise that many of our physician clients have taken a more active interest in surgery centers, medical office buildings and other healthcare-related real estate. This strategy apparently contradicts the idea of achieving portfolio diversification by avoiding any investments within the healthcare arena.

One strategy of portfolio diversification for doctors is to avoid all healthcare-related investments. The theory is that doctors already have so much income related to healthcare that they should not invest in healthcare-related investments.

Unless a doctor has a very good reason to think that a particular company will excel in its arena, this theory suggests that doctors typically avoid healthcare stocks. For doctors who have the ability to personally influence the success of a surgery center or "medspa," this is obviously an attractive investment.

Alternative investments

For those doctors who can't build or participate in surgery centers or other profitable healthcare investments, a popular investment strategy is to take advantage of different investment programs that are not traded on a public exchange such as the New York Stock Exchange. Non-traded real estate investment trusts (REITs), leasing funds, and oil and gas drilling programs are a few examples. As with any investment, there are pros and cons for each type of offering.

Given recent market conditions, many physician investors have been attracted to non-traded programs because they offer a certain level of stability. Most of these programs are sold to investors at a flat price - for example, $10 per share - during the offering period. An advantage to these programs is that their performance is not correlated with any particular market or index, making them an additional form of diversification. Holding non-correlated offerings can help reduce the "volatility roller coaster" of a traditional portfolio. They should be an additional allocation in your portfolio, not a substitute for proper allocation.

Another significant benefit for physicians in the higher-income tax brackets (which are sure to increase as government bailouts and the upcoming budget ranges in the multiple trillions) is the potential tax benefit an alternative program can offer. Some programs offer tax deductions on the initial investment. Others pay tax-efficient dividends. Some programs offer both.

For example, there are oil and gas drilling programs that offer tax deductions on the initial investment due to intangible drilling costs and tax deductions on the program's cash flow due to depreciation and depletion allowances. Dividends from REITs and leasing funds often are only partly taxable to the investor. These tax efficiencies vary by program and from year to year.