McGaunn & Schwadron CPA Needham: advice for Veterinary Practice owners on how to allocate their investment portfolio to best support and profit from their business without putting their own personal finances at risk.
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AAHA Economic News: What Role Should Your Veterinary Practice Play in Your Investment Portfolio?
1. June 2010
What Role Should A Practice Have in Your Investment Portfolio?
By Mark J. McGaunn, CPA/PFS, CFP
Abstract:
We are reminded of the unpredictability of stock and bond market returns on not only a monthly, but even a daily basis. Just look at the
momentary plummeting of the Dow Jones Industrial Average (DJIA) on May 6, 2010 by 997 points. While the vast majority of investors
don’t rely solely on the DJIA to anchor their own retirement, veterinary practice owners need to balance their global investment portfolio
to protect it from untoward events, and manage their practice like the investment it is.
Article:
It would seem that we can jump to an immediate “yes” or “no” when asking whether your veterinary practice should play a role in your
investment portfolio. The answer is not that simple. In the investment community, each manager has their own strategy, complete with
opinions on diversification, Modern Portfolio Theory (MPT), asset class composition and structure, and whether they follow active,
passive or a combination of the two strategies. It’s not a plain vanilla formula, much as investors would like it to be.
Let’s discuss two relevant investing ideas before we get to the ““yes” or “no” answer we are searching for.
Every investor is searching for investments with high return and low volatility. We are often disappointed in that endless search. Modern
Portfolio Theory is one of the most important and influential economic theories dealing with investment construction. Developed in 1952
by Harry Markowitz, the 1990 Nobel Prize winner in economics, the theory states that it is unacceptable to look at the risk and reward
characteristics of a single stock, rather one should consider the characteristics of multiple stocks. Owning multiple stocks allows
investors to maximize the reduction in portfolio risk by diversification. Markowitz recommends portfolios whose returns are not too highly
correlated with your own personal income (i.e. your veterinary practice). I explain it to clients as “resisting the temptation to bury all one’s
dog bones in a single hole!”
Markowitz showed that investment construction is not about pure stock selection, but about choosing the right combination of stocks.
Stocks with different risk/reward characteristics can minimize the impact of one stock’s potential loss versus the rest of the portfolio’s
gain.
According to Warren Buffett, MPT is just as it says, a “theory,” and not absolute. He waits for out-of-favor investments to rise to
greatness. Not employing diversification in order to sidestep portfolio volatility would mandate investing in a single stock, quite a gamble
for veterinary practice owners already invested in a concentrated set of asset classes (“micro-micro” cap healthcare and commercial real
estate).
Another school of investment thought is that of “black swan” events. These were described by Nassim Taleb in the 2007 book, “The
Black Swan.” Taleb regards almost all major scientific discoveries and historical events as black swans, as they lie outside of regular
expectations, produce extreme impacts, and make us rationalize their occurrence after happening.
Taleb doesn’t attempt to predict black swan events, but advises investors to build portfolio robustness against negative black swans and
exploit positive ones. Taleb’s 2009 Boston speech gave many examples of black swan events hitting the investment community (Long
Term Capital Management’s hedge fund implosion in 1998, Madoff’s Ponzi scheme, 9/11, etc.).
How do these investment theories relate to the role of your own veterinary practice in your asset allocation model? As I stated before, it’s
not a simple answer.
One tenet of retail investment management is that you must be able to readily assign value to an investment in your portfolio. A
colleague from the CFP Board of Standards Council on Examinations, David Shen, CFA, asset allocation and risk manager for
Washington University’s endowment (5th largest in U.S.), opines that illiquid asset classes such as private equity and operating
businesses like veterinary practices are particularly difficult to value as portfolio investments. A Veterinary Industry Exchange-
1.
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