Physicians, like many investors, may be missing out on the financial benefits of investment portfolio diversification.
Why is portfolio diversification so important? The recent COVID-related market drop demonstrated that diverse portfolios came out ahead. That’s because asset classes—eg, stocks, bonds, cash, and commodities—that are winners in one year often sink to the bottom of the heap in future years, according to a recent analysis by Morningstar. Holding a variety of asset classes guards against being overly exposed to an area that falls out of favor, authors wrote.
Ideal diversifiers would rise in value when the US stock market goes down. Building a diversified portfolio can be challenging because the relationship between two assets, known as their correlation, shifts over time. So which assets work best at ensuring diversification? MDLinx has amassed some advice from financial experts to help answer this question.
Diversified portfolios outperform
The recent COVID-19-driven stock market drop helps illustrate why diversification is so valuable. The equity market plummeted 35% between February and March 2020, but most fixed-income holdings held up well, authors wrote. As a result, a basic portfolio mix of 60% stocks and 40% bonds would have come out about 13 percentage points ahead of an equity-only portfolio during the market drop. Which were the best assets in the bear market? Cash and short-term Treasuries (aka government bonds) held their value, while longer-term Treasuries posted gains.
Cash and high-quality bonds best
Assets often touted for their diversification benefits—including real estate investment trusts (REITs), smaller-cap stocks, lower-quality bonds, and certain commodities—have often moved more in tandem with the broad US equity market than expected. Therefore, investors seeking out the benefits of diversification may want to reconsider these options.
The bottom line? “Keeping a healthy dose of short-term, high-quality bonds, as well as cash, looks like the safest approach to building a portfolio that can hold up in a variety of market environments,” the authors wrote.
To learn more about investment do’s and don’ts, read Physician retirement myths debunked on MDLinx.
Consider your goals
When it comes to diversification, it all depends on what a physician is trying to achieve, according to Naveen Malwal, an institutional portfolio manager at Strategic Advisers LLC, a Fidelity Investments company, who gave an exclusive interview to MDLinx. It helps to start by considering the timeframe when the money will be needed, and invest accordingly.
Funds that will be spent within a year or two on a mortgage down payment or home remodeling project require a highly conservative investment strategy, primarily cash and bonds. For a child’s education fund that is not needed for a decade, that would dictate a mix of conservative and growth-oriented bonds and stocks, Malwal said. “If you’re in your 30s or 40s and the funds are for retirement, you have a 20- to 30-year timeframe. With that kind of a runway, you’re more likely to benefit from a heavier investment in stocks.”
Look beyond the United States
"For better or worse, investors often begin with a foundation of US equities,” Morningstar authors wrote. “So, it is likely that most investors could use other holdings that would help balance their US equity exposure.” In fact, the US stock market makes up about 56% of the global market, while the remaining 45% are international stocks, according to Statista.
Malwal agrees: Many investors gravitate toward their own country’s stock market because they’re the companies they grew up hearing about and involve products they use every day.
“But where are the opportunities? They are all around the world. For example, in the early to mid-2000s, international stocks outpaced the US. But it’s hard to predict what’s going to happen ahead of time, and so having both in an investment account can lead to smoother investment returns over time,” he said.
According to Malwal, a lot of physicians love to learn about investing, understand how it works, and get hands-on. “Many can actually do quite well for themselves. But at the same time they may take on some risks they don’t necessarily need,” he added. For example, some may have too-heavy exposure to just a few sectors of the market or a handful of stocks they heard about on the news. This past year, investors who were too heavily leveraged in technology may have missed out when the travel, airline, and retail industries came roaring back after a COVID-related meltdown. He also sees inexperienced investors chasing investments that have done well in the past, losing sight of new opportunities.
Think long term
So should investors adjust their portfolios in response to recent concerns about rising inflation and the US stock market being overvalued at the moment? “Our perspective is more long term than that,” Malwal said. “Where does this person need to get to over the next 5, 10, or 20 years? That’s what should drive most of the decision-making process. If they need to reach retirement goals, we focus on that, first and foremost.” He may make small adjustments at the margin based on the news flow, or the economic and geopolitical situation, he added. Learn more about considering using the big picture to guide your portfolio strategy on MDLinx.
When inflation is a concern, it can be useful to add some exposure to commodity funds that invest in energy, industrial or precious metals, or agriculture. “By and large, though, stock investments have historically been the key drivers of growth. So diversified portfolios of stocks and bonds can help physicians reach their financial goals.”
For 7 physician-specific investing tips from financial planners, see MDLinx.