My kids and I train in karate together. They also compete while I mostly cheer them on and unofficially coach. Our favourite aspect of karate is likely the sparring. That is where you don pads (in my case full body padding) and square off against an opponent. The goal is to try to hit the other person while avoiding getting hit yourself. This isn’t the Cobra-Kai dojo from The Karate Kid where they actually try to hurt each other, but more like tag with some umpfh. That said, my daughter is a particularly vicious competitor which gives me warm fuzzy feelings as I contemplate her approaching the age where she may start dating.
Successful sparring has many parallels to successful investing where you are competing against other investors while constantly being stalked by the taxman. To be successful at sparring, you need to:
- Be proactive rather than reactive.
- Use a variety of the tools at your disposal (hands/feet/elbows/head).
- Employ a variety of techniques (different types of punches, kicks, alternate techniques).
- Analyze and adapt as the situation changes.
- Train & compete.
Be a proactive investor rather than a reactive one
It is far superior to form a plan and execute it first than it is to wait for your opponent to initiate, forcing you to block or evade and attempt to counter. When it comes to punches, “It is better to give than to receive”. In sparring, the person who controls the fight usually wins. Same with investing. This has a few components:
- You should formulate an explicit investment plan or “investment policy statement” – and put it in writing. Putting it in writing not only makes it clear and concrete, but you can refer back to it. That is vital to ground yourself when gripped by emotions in the heat of battle. This is to minimize behavioural risk – doing dumb things because of your emotions. It is a huge factor in why investors often do worse than predicted with their investments.
- You need to execute the plan. One of the biggest factors for investing success is time spent with your money in the markets. Of course, you don’t want to just charge in blindly without knowing what you are doing in an attempt to strike first. I have tried that and learned what it is to “eat a sidekick” – that is when you charge in and the more experienced person casually lifts their foot and you impale yourself on it. That experience also taught me that 40 year old ribs are more crunchy than springy. On the other hand, you don’t want to be paralyzed thinking of all of the things you could do. As put by White Coat Investor, there are 150 portfolios better than yours. A fellow Canadian physician finance blogger, Dr. Networth, has put together a high level summary of resources for getting into passive index investing. Don’t waste too much time trying for the perfect plan – make a good plan and strike.
- The beauty is that a basic plan is sufficient for when you are starting out. It isn’t until you build a larger portfolio that you need to start getting into more complex moves and “combos”.
Use A Variety of the Tools (Account Types) At Your Disposal
In both sparring and investing, diversification is a key component for success. Your basic tools in karate sparring are your hands and feet. Apparently, head-butts, elbows, and ear biting aren’t allowed (sorry Mike Tyson). Using your hands is often the easiest for more senior karateka (like me) when you start sparring – as you warm up thereby regaining some flexibility in your hips; then you can bring in the flying feet. The same can apply to investing. The different account types are like your hands and feet.
- Your portfolio punches. The Tax-Free Savings Account (TFSA) and Registered Retirement Savings Plan (RRSP) are probably the account types that most people are familiar with and get started in. You can start a TFSA when you are 18 and an RRSP when you are 18 and earning income. A TFSA is a good place for a resident physician to start. A common misconception is that TFSAs and RRSPs are a product that you buy (like a GIC or a mutual fund). However, they are an account type that you put products into that you buy. I describe the rules governing these account types in the TFSA 101 and RRSP 101 posts. These tax sheltered accounts should generally be a priority to max out. However, they are limited in size relative to what a high income professional likely needs to save on an annual basis. You need to add in some kicks.
- Portfolio kicks. As you grow your portfolio larger than your tax sheltered registered accounts, you should diversify into more account types. The main account types here would be a corporate account within your CCPC and a “taxable” or “cash” account. These accounts require a bit more experience to use optimally, since they are subject tax nuances, but are incredibly powerful when used properly. Just like kicks.
- Special moves. When you are using your standard tools well and have your opponent reeling, it is optional but really cool if you have some “special finishing moves”. Like in the classic Mortal Kombat video games. This could be some insurance products in very specific circumstances: trusts, or some alternative investments like real estate. These all require expertise to execute properly.
Why bother using multiple account types? Why not just use “the best one”?
I have been to tournaments where the top kids in sparring use the same move over and over to win. The classic move is the “leg pump machine gun” where they basically balance on one leg and chase the other kid around the ring pumping their kick until one connects. It is comical to watch, yet incredibly effective against beginners. However, you never see it happen at the more advanced levels. Why? Because when you know it is coming, it is incredibly easy to counter and no longer effective. Counter it and the one trick wonders are often at a loss as to what to do and get clobbered.
You do want to use your optimal account type, but you don’t want it to be your only one:
- Each account type has pros and cons. Using them together allows you to put them together into combinations that help compliment their strengths and compensate for their weaknesses. It is like in sparring, where you do a kick at long range and then move into close range with a series of punches aimed at different targets. Attacking with a combination of moves that are effective at different ranges and aimed at different targets is much more effective than any of those moves alone. We will explore how to build good financial combos into an integrated portfolio later in this series.
- If you use the same move repetitively for everything (even if you are really good at it), it is not going to be long before your opponent figures that out and out-maneuvers you. The biggest opponent that we need to worry about in this regard is the tax-man. The CCPC was a very effective tool for tax deferral, tax reduction, and flexibility in planning for major expenses like retirement or a kid’s education. Corporations were used as a mono-strategy by many professionals and that approach was just recently targeted, reducing its effectiveness, and leaving those people scrambling. Having multiple account types helps you to diversify against political risk or tax risk. It also gives you more flexibility to adapt to unexpected changes, whether from a tax law change, a change in CRA interpretation of the law, or something else that life throws your way.
Employ A Variety of Techniques In Your Accounts (Diversification of Asset Classes)
Even with padding and being careful, I invariably injure some part of my body once in a while from sparring. So, while being able to use both punches and kicks is important, it is also important to have a variety of those techniques using your left and right appendages in case of injury and from a number of angles to be most effective. That said, my injury rate has dropped substantially in the past year. I would like to say that it is due to improved skill, but I think it has more to do with my wife telling the teenagers with whom I sometimes spar that if she had to mow the lawn one more time because my ribs got bruised that they’d be dealing with her! I am not too proud to use all of the psychological advantages that I can get.
Just like a variety of accounts help to diversify against political/tax risk, having a diverse set of assets within those accounts helps to diversify against other risks.
- Having different types of assets that react differently to different market conditions helps to decrease volatility (large fluctuations in price). Decreasing volatility is important because it helps control the strain on your emotions and enables you to stick with your plan. It is also important to smooth out your returns when you approach or reach the stage of drawing from them. High volatility during the draw-down phase of a plan increases the risk of running out of money due to a bad sequence of returns. Examples of different asset types would be stocks, bonds, preferred shares, and alternative investments.
- Having a group of stocks in many companies rather than in a few different companies helps to minimize against the risk of any single company doing poorly (individual security risk). Yes, you can buy stock in multiple companies to do this. However, it takes about 60 stocks to eliminate individual security risk (specific risk). To do that properly would require a very large portfolio and likely a significant investment of time and effort to monitor, rebalance, and maintain it. The most cost and time effective way to get that diversification is via exchange traded funds (ETFs). Actively managed funds (like mutual funds) also do that, but at a higher cost that they usually cannot consistently make up for. I recently did a head to head evidence-base review of passive vs active managed funds.
- Having ETFs covering different geographic regions helps to diversify against regional risk. Even if you eliminate specific risk with a large fund, there is still non-specific market risk. This is hard to eliminate because world markets do tend to be correlated. However, diversifying into multiple global markets can help mitigate it somewhat. Canada only represents 4% of global markets, but Canadians famously have about 74% of their portfolios in the Canadian markets. There are some reasons to hold more Canadian maple than our share of the global market, but not 74%! Holding ETFs in the US (the world’s biggest market), Europe, Asia, Canada, and Emerging Markets helps to diversify against regional risk.
- Related to regional risk is currency risk. While we live our daily lives in Canadian dollars (CAD), there are other more major currencies in the world. When buying ETFs tracking foreign markets, you can often get a version hedged against the CAD – meaning that they don’t get the added fluctuations from different currencies. There is usually a small cost for that hedging. Personally, I leave my ETFs unhedged since I have plenty of CAD exposure with my Canadian holdings and it gives my portfolio some diversification against currency risk. I also enjoy vacationing in the US frequently, so having some US dollar accounts makes sense for me.
Like in sparring, investment risk can never be eliminated. However, by planning, diversifying, and proper honing of your skills – you can minimize it.
That brings us to the part about training. You need to practice in a safe environment with a teacher to develop your skills. That will also only take you so far and to really develop further, you need to actually enter the tournament and compete. If you don’t compete, then you don’t have a chance to win. In sparring, that is ok, but in finance not competing runs another risk – not making enough money investing to meet your goals. Nothing makes up for time training – don’t be tempted to try to circumvent that truth with short-cuts.
Use of performance enhancers (like leverage) magnifies potential return and risk.
It is tempting for many to try to get rich quicker by using leverage. Leverage could be a direct loan, such as investment loans or “margin” or hidden inside leveraged ETFs. Anabolic steroids to athletics is like leverage to investing. Steroids can increase growth, but you could also get disqualified and lose it all. If you use a loan to invest and lose money, you still owe the money from the loan. You could more than lose it all.
Risks are worth taking if you need to, but high income professionals do not need to take these risks. We are already like genetically engineered super athletes when it comes to financial potential. Doctors, dentists, and other successful business owners don’t need to take on extra risks. We mainly need to avoid common financial mistakes.
If you do decide to use leverage, then wait until you are experienced, and do a careful risk-benefit analysis. We did this recently when we decided to use the equity in our home as leverage for investing and income splitting with my lower income spouse. Make sure that you have good reasons, a clear plan, and commitment to follow through on the plan.
For the average person, the risk of losing buying power by getting returns on their savings lower than inflation (inflation risk) is probably their biggest threat.
Guaranteed Investment Certificates (GICs) or a “High Interest Savings Account” paying less than inflation as your only investment sounds safe, but it really only guarantees that you will slowly lose buying power – plus GICs are locked in. So… maybe not so safe.
Investing in some aggressive assets mitigates inflation risk by likely returning more than inflation over the long haul. There are other good ways to mitigate inflation risk. These include living well below your means which sets the bar low for the savings required to live off of and saving aggressively to slightly overbuild your nest egg. Living life to its fullest always requires some kind of risk and financially I prefer to balance those risks with a bit of each of those strategies. Being a high income professional makes that relatively easy.
Hopefully this motivates you to return to the dojo for more training in investing. Interested?…
Yes! Excellent… We will begin your training with waxing my motorhome.
Hello Dr. LD!
Excellent post! My advice is for all new docs to eliminate debts ASAP and save money first.
Unfortunately many docs are at the kindergarten level with money and the financial advisors know that. Docs fall prey too easily to thinking they are somehow special when it comes to money. And it is for this simple fact they often have their heads handed to them when they play in the “big sandbox”.
Absolutely Dr. MB! Paying debt is like an investment with a guaranteed return of the interest rate… in after-tax dollars. A loan at 5% is really like 10% if you are in the highest marginal tax bracket. Hard to beat that with a risk-free investment!
Wow! I had a picture in my mind what your trailer looks like, but that is a beast! Nice!
Good advice LD. I remember when I first started out as an attending and met with my accountant for the first time. At the time, his partners were recommending to their clients to keep everything in their corporate accounts, take only dividends (no salary) and forget about contributing to their RRSPs, TFSAs and RESPs. My accountant didn’t agree with his partners, and he advocated for me and his other clients to use all the tools at our disposal (b/c you never know what the gov’t will throw at you). This is consisted of a blend of salary/dividends, and to contribute to RRSPs, TFSAs and RESPs. I am definitely thankful that I have him as an accountant and not one of his partners.
I was fortunate that my accountant laid out the pros/cons of both options and gave me the same advice. I did start to worry when my friends were getting the “put everything in the corp advice” from their accountants. It goes to show that while they are professionals, they can differing opinions (just like doctors) and it pays to be an educated client. Hence, this blog.
We love the beast. I bought it used and renovated it with the “help” of my kids. I had occasional pangs of guilt at buying such a large depreciating asset, but it has honestly been some of the best money that we’ve spent for the family memories that it has given us already. Also, your reply in the comment section of your grading your financial progress as a physician article that knowing you are doing “ok” helps you to loosen the purse strings was balm for my conscience.