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Join Scott Kyle and Patrick Fischer, authors of The Compound Code: An Expert Guide to Trading Stocks & Options. We’ll explore how stocks and options can be utilized to generate income, enhance returns, and provide downside protection. Gain valuable insights into the world of stocks and options trading and discover practical strategies for leveraging options with dividend-paying companies.

Scott Kyle and Patrick Fischer are authors of The Compound Code: An Expert Guide to Trading Stocks & Options.

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Transcript

Kevin Pho: Hi, and welcome to the show. Subscribe at KevinMD.com/podcast and get CME for this episode by clicking on the CME link in the show notes. Today we welcome Scott Kyle and Patrick Fischer. They are authors of The Compound Code: An Expert Guide to Trading Stocks & Options. Scott and Patrick, welcome to the show.

Scott Kyle: Thank you so much. A pleasure.

Kevin Pho: All right, so I’m going to ask each of you to briefly share your story and journey, and then we’ll jump right into your book. Scott, why don’t you go first?

Scott Kyle: Scott Kyle here. I grew up in the Midwest, went to school in Boston and eventually made my way to California. While I was in school in Boston, I actually met Warren Buffett, who inspired me to become a financial advisor. I really liked the way he thought about investing: keeping things simple and really focusing on high-quality businesses. So I started my career here in La Jolla, California, and I’ve been a financial advisor for the last 25 years.

Kevin Pho: All right, Scott, let me ask you: We have an audience of clinicians here, and I’m sure you have some clinicians in your clientele. What are some of the most common questions you get asked by that clinician clientele?

Scott Kyle: Sure. We actually have a lot of doctors. The way I look at it is that if I broke my nose or my arm, I suppose I could spend a couple of years studying how to fix it, but I’m probably better off going to someone who’s an expert at what he or she does and has decades of experience. Similarly, when it comes to managing money, we often don’t know what we don’t know, or we don’t have the emotional makeup to stay on track. I’ve never been very good with blood, so I know I wouldn’t be a good doctor, but my brain is very much wired to manage money and to help people with their money.

So really, the most important thing to talk to clients about, and for them to ask, is: What are our goals here? What’s the purpose of the money? Do we need to pay the mortgage this month? Do we need to fund our kids’ college in 10 years? Do we need it for retirement in 20 years? Basically, ask those key questions, just like with health: What are my health goals here? To lose weight? To improve my heart? Et cetera. Then set a plan to achieve those goals, and of course monitor it on an ongoing basis.

Kevin Pho: All right. And Patrick, just briefly share your story and journey to where you are today.

Patrick Fischer: Unlike Scott, who’s a Midwest kid, I’m a California kid. I actually met Scott when I was an undergrad at UC San Diego, studying math. My first job out of college was actually with Scott at the predecessor to Coastwise, which was a hedge fund, so we’ve been friends and colleagues for over two decades. After spending nearly 10 years on the institutional side, I came back to the wealth management side to rejoin Scott’s firm, so it’s very much a homecoming for me.

Kevin Pho: All right. And Patrick, again, among your clinician clients, and I’m sure clinicians make a lot of mistakes when it comes to financial management, what would you say is the biggest mistake you see physicians make when it comes to wealth and asset management?

Patrick Fischer: Oh, Kevin, that’s kind of a loaded question. But what I’ll say is that, whether it’s a clinician or someone who is very scientific, I think some clients and some investors have a tendency to overthink things, and also a tendency to try to do something when sometimes the best thing is to do nothing at all. So when you’re looking at investing, whether it’s a specific position or your financial plan, as Warren Buffett says, it’s better to look for the haystacks than the needles in the haystacks. It’s more important to really know what you’re trying to do, look at the long-term goals and make sure you’re making progress toward them, and not always try to do things and tinker from day to day, because then you can end up chasing your tail.

Kevin Pho: All right, and when you say tinkering, what’s an example of that? What do you see physicians do when it comes to tinkering with some of their financial plans?

Patrick Fischer: When it comes to tinkering, it’s consistent in the clinician space as well as others: People will hear things on the news, they’ll read something in a journal, they might talk to a friend who has a position, and maybe they’re also a clinician, so they take advice from them. It’s just a tendency to want to do stuff when nothing needs to be done.

Kevin Pho: All right, so let’s talk about the book both of you wrote. It’s titled The Compound Code: An Expert Guide to Trading Stocks & Options. So Scott, tell us a little about the book and how it came together.

Scott Kyle: Sure. I’ve been investing for nearly 40 years, and I’ve been a professional investment advisor for over 25 years. During that time, I’ve both made a lot of mistakes myself and witnessed others, our clients as well, either about to do something that could have been a mistake, which hopefully we kept them from doing, or making mistakes outright. So while it is incredibly satisfying to serve the several hundred clients we have around the country, it’s nice to be able to communicate the lessons we’ve learned, as advisors and as individual investors, to a broader audience. I’ve written three other books, and I asked Patrick to join me to write this one. We spent basically the last couple of years putting down on paper all the things we’ve learned over several decades, so we could share them with a wider audience.

Kevin Pho: Well, Scott, I hear from a lot of clinicians, especially in these physician finance Facebook groups, that, as you know, they don’t get a lot of education when it comes to financial literacy. So let’s go to the very basics. If a physician client comes to you and says, “Please manage my money,” where would you direct them? What’s the first thing you would start them out with?

Scott Kyle: Again, it’s like going in for a health checkup. The first thing is basically to get some basic information: Where are you today in terms of your assets, your liabilities and your cash flow? Because quite often, even people who are extremely good at what they do in other fields aren’t always organized when it comes to their financial life. So make sure they’re well organized and have a clear picture of where they are today. Then, as we talked about before, talk about what their goals and needs are going forward, because really, the process of investing is to satisfy future needs. Those needs might be 30 years down the road, or they might be three days down the road, to pay the mortgage. So you connect where you are today with where you want to go. Now, things will always change. Things will come up, just like with your health; you may accidentally break an arm, so we need to adjust for those changes. But having a clear sense of where you are and a plan for the future is really the foundation of any good investment program.

Kevin Pho: And Patrick, as it relates to your book, tell us some of the main points that would resonate with a clinician audience.

Patrick Fischer: I think, to Scott’s point, one of the most important questions you want to ask yourself is, “When do I need my money back?” That’s a basic financial planning question, because from there you’re going to get a sense of how much of the money should be invested in stocks versus bonds, versus perhaps paying off student loans, if you’re a newly minted doctor. Then, once you get into security selection, you can start to think about things like dividend-paying stocks and using covered call options to generate income, particularly if you’re later in your career and looking to generate income.

Kevin Pho: Give us some scenarios that you commonly see physicians come to you with, in terms of stocks versus options and where you would start them with asset allocation. Just take us through the basics, and maybe walk through a couple of real or hypothetical scenarios clinicians would commonly come to you with.

Patrick Fischer: Sure. A clinician could come to us with a scenario where the salary is probably pretty good, but they might have some student debt they need to pay off, so they need to allocate money toward that. They’re really looking to us to help manage and optimize, from a financial planning perspective, how to allocate the capital. Once we’ve figured out how to do that, and how much to put down on a monthly basis to pay off the student debt, or it could be a mortgage or something like that, it’s really a function of how long they plan to work versus when we should start to look to replace that income with call options and dividend-paying stocks. I think that’s a very common scenario, where we’re really looking to make sure the time horizon is set appropriately, so we can allocate capital to replace the income they’ll need when they retire.

Kevin Pho: All right, so Scott, your book is about both stocks and options. A lot of my audience may not know what options are, so just give us a primer on what exactly an option is.

Scott Kyle: Sure. Options really serve a few different purposes. Just like in surgery, a knife can be dangerous in the wrong hands, or it can be lifesaving, so options can be risky, or they can be used in a very conservative way. We use options in the latter, conservative way. So what purposes do options serve? As Patrick mentioned, they can serve to generate lots of income. They can also serve to reduce portfolio volatility, to make the ride less bumpy, and they can provide some downside protection, or hedging.

A basic example is what’s called a covered call. A covered call means you buy a good stock, Pfizer, Abbott Labs, Coca-Cola, whatever it may be, and that stock in and of itself could pay a dividend, so it could be a source of income. Most dividend-paying stocks pay dividends every quarter, or every 90 days. Then what you do is what’s called selling a call against that stock. Let’s say Coca-Cola is trading at $60 a share, and you sell a call at $65 a share that expires in six months. In selling that call, you immediately get cash, the premium, credited to your account. So it’s an immediate form of income, or cash to your account, which you can then reinvest in a money market or fixed income. If the stock stays below $65 before the time of expiration, which in this case would be six months, then the option expires worthless, which sounds bad, but it just means you’ve collected all the premium, and then you could sell another call for additional premium. Or, if the stock rises above the strike price, in this case $65 a share, then you’d be obligated to sell the stock at $65. But going into it, you’d be perfectly happy selling at $65, because between the price going up from $60 to $65, plus the dividends you collect, plus the options premium you collect, that would be a very satisfactory return; that could be a 15 or 20 percent annualized return. So it’s just a way of saying, “I’m willing to give up a little bit of upside in exchange for more downside protection and very steady, reliable income.”

Kevin Pho: And Scott, at what part of their financial life are we talking about? Early investing, or investing later on in life? Along the spectrum of where a physician could be, when should they consider options as part of their investment portfolio?

Scott Kyle: That’s a great question. While we do have decades of experience using options, options aren’t right for everyone. They’re really a tool to fit a particular circumstance. Let’s say you have a very long time horizon: You’re a new clinician with a retirement account, in your 30s, 40s, maybe early 50s, and you’re really looking to grow that account. There’d be no reason to use options, because you don’t need the income from that account. That account is really meant for your future self, 20 or 30 years down the road. But there are other scenarios where you need income, either to cover existing expenses because your income doesn’t satisfy your expense structure, or because you’re living off your assets. For example, we have a doctor who sold her practice and generated a nice nest egg, and then she decided to retire. Unfortunately, even though interest rates have gone up, they’re not high enough to generate enough income to support her lifestyle. So by buying dividend-paying stocks and then selling calls, we’re able to generate double-digit income for her, allowing her to pay her bills. So really, the bottom line is that options are typically best used when you need additional income to satisfy your needs.

Patrick Fischer: The only thing, Kevin, that I would add is that the other piece about options is that each options contract represents 100 shares, and you wouldn’t want any individual position to represent more than a few percentage points of the overall portfolio. So you need to have a certain asset base for options to make sense, because otherwise you’d end up with 100 shares of one stock in the portfolio, and even though it could be a great options position, you’re not diversified from a portfolio management perspective.

Kevin Pho: So Patrick, I wanted to ask you about your approach to picking stocks. Obviously, there’s a spectrum, from individual stocks all the way out to total stock market index funds. When you read a lot of these finance groups that physicians read, sometimes the simplest thing is just to use one of those total market index funds. So tell us your basic approach that physicians should know about when it comes to equity allocation.

Patrick Fischer: Sure. On the equity side, there’s no hard-and-fast rule, but generally speaking, if the portfolio is under $300,000, roughly speaking, you might be better served being in ETFs or index funds, because you’re able to get broad diversification, whether that’s something like SCHD, which is Schwab’s dividend-paying ETF, or something as simple as SPY, which is the S&P 500 index. Those are great solutions for someone who is still building up their asset base. When you get to a portfolio that’s, say, north of $500,000, that’s when you can start to think about looking at individual stocks. That goes into the conversation of whether we’re looking for dividend-paying stocks to generate income, or for growth stocks. Perhaps the clinician’s spouse or partner already works at someplace like Google or Facebook, so they’ve got plenty of exposure to the tech space. You want to think about the overall portfolio of the household when you start to look at individual stocks. So there really isn’t a specific guideline, but those are the rough metrics we use.

Kevin Pho: And Patrick, to follow up on that, what are the pros and cons of including those individual stocks once your assets go above a certain level, versus just staying in a diversified index fund?

Patrick Fischer: I think the pros and cons really come down to diversification. From the diversification perspective, you can’t beat having index funds and ETFs; they’re certainly a great solution. Once you start to look at individual stocks, you have the potential to outperform, but you also have the liability and responsibility of doing the research, knowing the positions and following the positions. Again, I think the plus side is that once you have individual stocks, you can find liquidity in them and trade call options to generate income.

Kevin Pho: All right, so Scott, tell us what type of physician should be managing their money themselves. I know you’re biased in terms of recommending a financial advisor, but there are some questions physicians can ask themselves to determine whether they have the right personality and mentality to manage their money themselves, versus engaging a financial advisory firm.

Scott Kyle: Sure. One aspect of what we do as financial advisors is money management, but it really all starts with the financial plan, because you could have a good portfolio, objectively speaking, but it might not be right for you. It might not satisfy your circumstances. Again, I could walk into a doctor’s office, and they could put me on a treadmill and say, “Hey, you’re going to run,” but then I tell them, “Oh, by the way, I’m trying to gain muscle,” in which case that would be the wrong thing. So it all starts with a plan.

But let’s say someone does have a good sense of what their plan is, and now it’s time to manage the money, the portfolio within that broader plan. Then, like Warren Buffett says, it really comes down to the basics, and that is just making sure you don’t make some key mistakes. The mistakes you want to avoid are, first, not being well diversified. That’s why we say start with nice, broad index funds, and then, as your capital grows, start moving into individual stocks. Also, don’t try to time the market. It’s so tempting to say, “I’m going to dart in and out of the market,” but there’s just no data suggesting that anyone can be consistently successful timing the market. The way you mitigate market risk, in terms of short-term ups and downs, is to make sure that any money you have in stocks is money you don’t need for three years or more. That’s a rough rule; it could be longer than that. By definition, stocks do move up and down in the near term, although they tend to rise over long periods of time. Money you need in the near term, you would keep in cash and fixed income.

So it really starts with a plan. Make sure you’re well diversified; avoid that mistake. Don’t try to time the market. And the market will be down: There are corrections, meaning a 10 percent or greater decline, typically about once a year, and bear markets, defined as a 20 percent or greater decline, typically every three or four years. You don’t know when those are going to occur, but they happen on average. If you have a good plan in place, then there’s no reason to sell your stocks, because by definition that’s money for your future self, for yourself in five years or 10 years. We so often talk people off the proverbial edge of wanting to sell stocks at exactly the wrong time, in March 2020, during the pandemic, or in February 2009, during the Great Recession. And every time, six or 12 months later, not that long, they turn around and thank us for keeping them from making a huge mistake. Your future self would not only look back and say, “Thank goodness I didn’t sell,” but likely say, “I wish I had bought more,” because stocks do rise over time. So someone who’s looking to do it themselves should just make sure they have these basics in place and have the emotional makeup not to take action when action isn’t called for. Then go about your life. Hug your kids, treat your patients, go for a walk, and don’t follow it day to day, because you’ll drive yourself crazy, and, more importantly, you’ll make bad decisions when action is not needed.

Kevin Pho: We’re talking to Scott Kyle and Patrick Fischer. They are authors of The Compound Code: An Expert Guide to Trading Stocks & Options. Now I’m going to ask each of you for some take-home messages, perhaps from the book, that physicians can come away with. Patrick, why don’t you go first?

Patrick Fischer: My take-home message from the book is that it is never too late to invest in the equity market or the fixed income markets. It doesn’t matter if you are approaching retirement or even about to retire; your time horizon could still very well be 20, 30 or 40 years. So don’t think you’ve missed the boat, or the proverbial vote, because there’s always time to do so. Know what you know, know what you don’t know and, as you’re looking to start investing, always start with a financial plan.

Kevin Pho: All right, Scott, tell us your take-home messages.

Scott Kyle: The analogy I would draw, again with health, is this: Let’s say your goal is to lose 30 pounds, and the equivalent goal in the stock market would be to save for retirement in 10 years. If you work with someone, or do your own research, to know how to lose those 30 pounds in a year, and you stick to the plan, the probability of success is very high. What you don’t want to do is weigh yourself every three minutes and drive yourself crazy. So spend the time creating a plan; really put that time in up front. And I said it before, but I’ll say it again: Go live your life. Because if you’re beholden to every stock price movement, day to day, then it doesn’t matter how successful you are from a financial standpoint; you’re not going to live a happy, healthy life, because the stress associated with following the stock market can really affect your physical life as well. So create a plan, take the time, sit down, and then execute the plan. Do check in on it periodically, every six to 12 months, but don’t obsess over short-term movements in the stock market. It’ll really work against you, both financially and physically.

Kevin Pho: And the book is called The Compound Code: An Expert Guide to Trading Stocks & Options. Scott and Patrick, thank you so much for sharing your time and insight, and thanks again for coming on the show.

Scott Kyle: Thanks so much.

Patrick Fischer: Thank you, doctor. It’s been great. Thank you.