As doctors, we all know that when we care for an informed patient, the conversation is more meaningful, and the patient can make a more informed decision about their care.
The same is true in the investing world. We are all very busy, but it is important we understand some basic financial terms so when we are either picking our own stocks or mutual funds or talking with a financial advisor, we can make better investment decisions.
Here are ten key terms every doctor should know before ever making an investment or meeting with a financial advisor.
Alpha: Alpha measures an investment’s performance relative to a benchmark index. It indicates whether an investment has outperformed or underperformed the market. A positive alpha suggests that the investment has yielded higher returns than expected, while a negative alpha indicates underperformance. Doctors should aim for investments that consistently generate positive alpha to maximize their returns.
Beta: Beta quantifies an investment’s sensitivity to market movements. A beta of 1 indicates that the investment moves in line with the market. A beta greater than 1 signifies higher volatility than the market, while a beta below 1 indicates lower volatility. Doctors should consider their risk tolerance when choosing investments with the appropriate beta value to align with their financial goals.
Diversification: Diversification involves spreading your investments across different asset classes, industries, and geographic regions. This strategy helps reduce risk by minimizing the impact of a poor-performing asset on your overall portfolio. Doctors should diversify their investments to achieve a balance between potential returns and risk mitigation.
Asset allocation: Asset allocation refers to dividing your investment portfolio among different asset classes, such as stocks, bonds, and real estate. Finding the right mix of assets is crucial, as it can significantly impact your portfolio’s performance and risk. Doctors should align their asset allocation strategy with their investment goals, time horizon, and risk tolerance.
Compound interest: Compound interest is the magical phenomenon of earning interest not only on your initial investment but also on the accumulated interest over time. Doctors should embrace the power of compound interest by starting to invest early and letting their investments grow over the long term.
Risk tolerance: Risk tolerance is the level of risk an investor is comfortable taking on. As doctors, understanding your risk tolerance is essential to select investments that align with your personality, financial situation, and goals. Assessing your risk tolerance helps prevent making hasty investment decisions during market fluctuations.
Liquidity: Liquidity refers to how easily an investment can be converted into cash without significant loss of value. Doctors should consider the liquidity of their investments, especially for emergency situations or unexpected expenses. Balancing liquid investments with long-term growth opportunities is key.
Expense ratio: The expense ratio represents the percentage of an investment’s assets used to cover management fees, administrative costs, and other expenses. Doctors should aim for investments with lower expense ratios, as high fees can eat into their returns over time. Vanguard and other low-cost index funds are good examples of investments with favorable expense ratios.
Yield: Yield is the income generated by an investment, usually expressed as a percentage of the investment’s value. It’s particularly relevant for income-generating assets like bonds and dividend-paying stocks. Doctors should consider their investments’ yield to assess their income potential.
Market capitalization: Market capitalization (market cap) is the total value of a company’s outstanding shares of stock. It’s used to classify companies into different categories: large-cap, mid-cap, and small-cap. Doctors should understand market cap when diversifying their stock portfolio across different company sizes and growth potentials.
Ignorance can cost you in your investing decisions. But the flip side is knowledge can empower you to make better financial decisions and pick the right financial advisor.
Amarish Dave is a board-certified neurologist with over 20 years of experience in both neurology and active stock investing. In addition to his medical career, he holds a background in business from the University of Michigan and has successfully passed the SIE exam administered by FINRA. Dr. Dave is founder, FiscalhealthMD.com, a website dedicated to educating doctors at all stages of their careers, ranging from residents to retirement, about financial planning.