Many pharmacists understand the concept of portfolio diversification: the idea of not placing all your eggs in one basket. Diversification has always been one of the cornerstones of good investing. By choosing an appropriate mix of stocks and bonds, you are able to stick to a long-term plan that achieves your unique financial goals. So the question is: Are pharmacists using the best tools available to produce portfolios that are properly diversified for their unique situations?
Over the last ten years, portfolio diversification has evolved into a much more sophisticated and dynamic process. That’s hugely important because improvements to the basic building blocks of investing (like diversification) will have a significant impact on your investment success, given today’s low return environment. Getting the investment fundamentals right has never been more important, with interest rates hovering at the lowest levels seen in history.
Pharmacists Need to Incorporate “Knowledge Assets” into their Portfolios
Using advances in behavior finance and psychology, new tools have emerged that incorporate an investor’s “knowledge capital” into their long-term portfolio mix. These “knowledge assets” can best be described using an example: Consider a 35-year old pharmacist earning $100,000 a year in salary with $120,000 in an RRSP – 60% of which is invested in stocks, 40% invested in bonds. A traditional 60/40 asset mix may not be the best choice in this case.
Some investors have knowledge capital that is “bond-like.” Other investors have knowledge capital that behaves more like a stock.
By taking a more dynamic view, we can see that the largest asset for this pharmacist is the knowledge and skills that she effectively rents to her employer for $100,000 a year. Over a 25 year career, this pharmacist’s “knowledge asset” is worth well over $1.7 million in today’s dollars (1). Traditional investment techniques have historically missed this very real and significant asset.
Not only is it important to account for “knowledge capital” in your portfolio mix, it is also important to understand the characteristics of this asset in your unique situation. Some investors have knowledge capital that is “bond-like.” Other investors have knowledge capital that behaves more like a stock.
For example, an experienced pharmacy manager with significant seniority at her current job can reasonably expect a stable salary with modest raises in the foreseeable future. The knowledge asset for this established pharmacist behaves much like a bond, producing a steady income stream. By contrast, a young relief pharmacist may expect his income to be volatile year-to-year, so his knowledge asset behaves more like a stock. Understanding both the expected size of your knowledge capital and its characteristics are crucial when incorporating it into your long-term asset mix.
Diversifying over Assets and Time
Your investment time horizon is still a key factor when it comes to portfolio diversification. By adding the concept of knowledge based assets, investors can create portfolios that are better aligned with their long-term goals. Most pharmacists invest over their entire working careers, so they can expect to make regular, ongoing investment contributions over a long period of time. This gives way to the benefits of “time diversification” where you can contribute and dollar-cost average across investments over time.
Time diversification also encourages a more disciplined (and less emotional) long-term investment perspective, which makes it easier to take advantage of rebalancing opportunities. This perspective would have encouraged buying stocks in 2008 and 2009, when all stocks became relatively “cheap” after the credit crisis. (This period turned out to be the perfect time to purchase stocks.)
Investing fundamentals will always remain the same, but the tools that allow us to implement those fundamentals have improved significantly over the last ten years. Pharmacists now have access to diversification tools and techniques that produce better portfolios given their unique situation. These improvements have a significant impact on investment success, especially during the current low return environment. Pharmacists need to ensure they have the latest tools in investment management to improve the chances of achieving their financial goals.
(1) The dollar value of the “knowledge asset” in this simple example is calculated using the present value of $100,000 paid over 25 years, using a discount rate of 3%.
