Investing in Healthcare Stocks to Offset Healthcare Risk

A reader writes in, asking:

“What would you think about buying a healthcare mutual fund to reduce the risk of healthcare costs rising as I age? Or in a similar vein, what about buying stock in long term care facilities to reduce the financial risk of needing long-term care?”

In short, I would say that that idea makes no sense.

There is no particular reason to think that the performance of a healthcare mutual fund will be highly correlated to your personal healthcare costs. Nor is there any reason to think that the performance of a collection of long-term care stocks will be highly correlated to your personal need for long-term care.

In other words, neither one can function anything like an actual insurance product that directly reduces your out-of-pocket costs for care.

A line of thinking that I’ve seen from many investors is that healthcare stocks are in for several years of excellent performance because our aging population will cause healthcare companies to experience strong profits over the next couple of decades. And such stocks are therefore a safe holding for retiring baby boomers.

But as we’ve discussed here in the past, the performance of a given stock is determined by how that company’s earnings compare to the market’s expectations for that company’s earnings. So a company (or industry) can have good earnings growth over a given period, yet experience poor stock performance if the earnings growth isn’t as good as the market expected it to be.

For example, Morningstar reports that Vanguard Health Care Fund has a P/E ratio that’s about 25% higher than that of Vanguard Total Stock Market Index Fund. In other words, based on their current earnings, the Health Care fund is significantly more expensive — presumably because the market already expects the stocks owned by the healthcare fund to have higher earnings growth than the average stock in the U.S. stock market. So it’s entirely possible that healthcare stocks experience high earnings growth yet still perform poorly because the earnings growth isn’t as high as expected.

In summary, healthcare stocks — like stocks in general — are risky. And holding them as a way to reduce risk (including the risk that your personal healthcare costs will rise) is nonsensical.