How to get out alive, Part 4

by Rick Willeford, MBA, CPA, CFP

Welcome to our continuing series on“How To Get Out of Dentistry Alive,” at least financially. The October DE® column focused on “how much” you need to be financially independent. In December, I discussed “How To Get There,” with a focus on Doctor at Work and Money at Work. April’s topic was “Winning the Loser’s Game,” arguing that “active” investing is not in your best interest.

After helping dentists for more than 30 years, I am fully aware that many - and probably most - of you feel out of your element when thinking about business and financial matters. After all, you signed up to be a health-care provider, not a business leader. I can live with that ... and I have many successful clients in that same boat. (See my article, “But What If I am Not A Business Person,” in the March 2003 edition of DE.) Every financial advisor has to cope with that reality, similar to the ongoing battle you endure to get your patients to floss!

So, what to do? For most of you, regardless of whether you are a saver or a spender, a neophyte or a wizard in financial/business matters, you need to have knowledgeable advisors. But you do have to know enough - or at least have an inkling ­- about whether or not your advisors are serving you properly. A superficial knowledge is not sufficient, and certainly relying on an advisor’s “bedside manner,” club or church affiliation, fancy office, or slick marketing won’t cut it. Unfortunately, even the person’s “reputation” may not be reliable, because you don’t know how qualified your buddies are to have a critical opinion.

Remember, to a lay person, all dentists are pretty much alike clinically. You know better, of course. But keep in mind that you may fall into the same trap as your patients and think that all other professionals are basically alike -whether they are accountants, lawyers, financial advisors, etc. Believe me, there are “butchers” in every profession. You are not qualified to spot them. They either can be incompetent, dishonest, or both. But they are surely “nice,” or they could not stay in business!

Think about how you would tell a patient moving to a new town to choose a good dentist. There is no foolproof way, assuming you don’t personally know someone to recommend. It’s the same dilemma in your quest for good advisors. “Asking around,” checking credentials and references, and listening for reputable names to keep popping up are about the best you can do.

Checking your instincts and ability to communicate with a candidate are important. My point is that these are necessary conditions, but they may not be sufficient. But you have to start somewhere, and that’s the best you have for now.

However, in the financial advisory area, specifically, you do have a simple tool to monitor your advisor’s performance. It’s called a “Performance Report.” If you are paying someone a fee or commission to handle your money, that person should give you such a report at least annually, if not quarterly. This report will show you how well your investments have performed over the past one, three, and five years ... and possibly longer. The report should also tell how your performance compares with recognized benchmarks, so you have a basis for comparison. And, you have to compare apples to apples regarding your stated risk tolerance level.

Don’t let your eyes roll back into your head yet - this is fairly simple. You can understand this, so let me explain. Once you have the background I will present in this column, ask your advisor to explain your specific performance report to you. Use this as a test to see if your advisor is shooting straight with you ... and if your advisor understands what he or she is telling you!

To begin with, I am not referring to the monthly report you get from your custodian or brokerage firm (Schwab, Merrill Lynch, etc.). That is more like a monthly bank statement. It tells you the current value of your account, what assets you hold, and what buy/sell activity has occurred during the month. Instead, the report I am referring to is, typically, a separate report that specifically refers to “performance” over a period of time - the rate of return your investments has achieved. This does not include growth that is the result of your adding more money. (I had an actual case in April where a dentist showed me a letter from his advisor that said the dentist’s return was about 8 percent. It turns out that 10 percent of the account “growth” was new money added by the dentist, and that the investment performance was minus-2 percent! I think it was Mark Twain who said, “There are three kinds of liars: liars, damned liars, and statisticians.” So watch out!)

I am astounded by the dentists who have substantial accounts (i.e., more than $100,000) who have never received such a report. At that level, you should demand a report. Any respectable advisor should be pleased to provide that. In fact, it should be a huge red flag if you have to ask for it!

What if you are told your account was up 10 percent last year? Should you be happy? The fact is, you can’t tell in a vacuum. You might be pleased ... until you hear that the investment accounts of all your friends were up by 20 percent! You need to know your performance “compared to what.” There are at least two factors that affect the comparison: 1) asset classes and 2) risk. (Hang in there, this is not going to be difficult.)

If your advisor tries to get away with simply telling you that you “beat the market” last year and that you should be happy, demand an explanation. First, he or she should explain what is meant by “the market.” If your advisor says that the S&P 500 is being referred to, then either your advisor is stupid ... or he or she thinks that you are. Although the S&P 500 is familiar because it is tracked on the evening news, it is essentially a list of the 500 largest companies compiled by Standard & Poor’s. This would represent the “asset class” of large growth stocks, but it certainly does not represent the 8,000-plus other public companies.

To make matters worse, the S&P 500 calculation is a weighted average, based on a company’s value. So the 50 highest-valued companies comprise about 60 percent of the calculated index. This means that if a company the size of GE sneezes, it is said that the rest of the S&P 500 catches a cold. This is hardly “the market.”

In addition, the S&P 500 has not performed well in the last five years, at least not until the last quarter of 2006. So everybody “beat” the S&P 500 during that time ... or at least they should have. But that’s like bragging about beating a 90-pound weakling!

Instead, if your advisor is properly practicing “asset allocation,” you should have some stocks/funds invested in other asset classes - small growth, large and small value, international, etc. Each of those asset classes has its own benchmarks. These are the benchmarks to which your performance should be compared.

Then you have to know how much risk the advisor took to get his or her investment returns. If all your funds were invested in “risk-free” government bonds and gave you a return of 10 percent (unlikely!), that would be preferable to getting a 10 percent return through investments in risky company stocks. You should expect a lot more return in exchange for taking more risk.

I met with a dentist last week who was pleased with his 8 percent return for 2006, especially since he thought he was primarily invested in bonds and CDs. When I showed him that his advisor had him fully invested in stocks and that such a mix returned about 21 percent for some other portfolios I had seen, he suddenly was not that happy. He had been exposed to the risk, but had not received the reward.

A responsible advisor should help you determine a “risk tolerance” profile. He or she may call it by another name. (We ask our clients to choose between whether they want to “sleep well” now or “eat well” later. You can have varying degrees, but you can’t have both.) You should write down your decision so you can both refer back to it. You can change it at any time. Meanwhile, it gives your advisor some direction as to how to invest your funds. We call this your “Investment Policy Statement,” but it can go by other names.

Raymond “Rick” Willeford, MBA, CPA, CFP®, is president of Willeford Haile & Associates, CPA, PC, and Willeford CPA Wealth Advisors, LLC. As a fee-only advisor, he has specialized in providing financial, tax, and transition strategies for dentists since 1975. Willeford is the president of the Academy of Dental CPAs, a consultant member of AADPA. Contact him by phone at (770) 552-8500, or by e-mail at [email protected].