A summary of some of the poor financial habits of physicians and suggestions for improvement, including a more focused investment approach, better asset mix allocation, incorporating only when appropriate, investing wisely in real estate, using credit appropriately, investing in children’s education earlier, and avoiding the purchase of toys based on the belief that a high salary is equal to wealth.
As both a physician and investment adviser, Dr Curran has first-hand knowledge of doctors’ poor financial habits.
With my background in movement disorders, I have had plenty of exposure to habits and mannerisms that are very difficult to change, such as those seen in Tourette syndrome. I have always had the impression that the prevalence of Tourette syndrome among medical professionals is higher than average. This seems logical as the obsessive-compulsive characteristics that are frequently associated with Tourette syndrome would be very beneficial with the intense university study time required. But I have also wondered, is Tourette syndrome responsible for the habitually poor investing habits displayed by many physicians? In this article I have summarized some of these habits, which frequently manifest as delayed retirement and longer work hours.
Diworsification is a term that was introduced by Peter Lynch in reference to companies that tried to expand by acquiring and acquiring. The end result was loss of focus and poor productivity. Diworsification also affects many individual investors, but physicians seem to get the more protracted version. Many physicians simply have too many stocks in their portfolio. This is frequently the result of holding too many mutual funds or having the wrong type of mutual funds. For example, MD Management’s Canadian Equity fund has about 248 companies. It holds wonderful companies such as Patheon and MDS, but because of over-diversification these companies make up only a small fraction of the total fund’s value. A company’s share value could shoot to the moon, but it would have very little impact on the fund’s overall performance because of its very small exposure, that is, diworsification.
Repeated studies have shown the optimal number of equities for any portfolio to be 20 to 30. For a number of reasons this is next to impossible for most large mutual funds. In fact, this is one of the main reasons I advocate investing in individual stocks over mutual funds once a portfolio reaches $100 000. Most physicians’ portfolios need more focus and simplification, which allows for the added bonus of being able to recognize the individual companies that are owned. Familiarity breeds less trading, and less trading equates to buy-and-hold, which is a good habit.
The term asset mix allocation refers to the balance of bonds to equities to cash in a portfolio. It has been shown that choosing the correct asset mix is substantially more important than individual security selection. This makes sense as markets reward different types of securities at different times. For example, for the last 24 months bonds have been up and stocks down.
I find it very difficult, if not impossible, to get a good handle on the asset mix in many physician portfolios where the core investment vehicle is mutual funds. Fund managers have flexible mandates on the holdings, and even though the stated focus might be “Canadian equity,” many of these funds will hold preferred shares (which are fixed-income products) or even bonds and varying amounts of cash (5% to 10%) for redemption purposes.
Equally difficult is getting a good handle on the portfolio foreign content and country diversification. This is because Canadian mutual funds are allowed up to 30% foreign content, even though it is a Canadian fund. This allows for quite a variation in portfolio foreign content. Similarly, knowing how much exposure you have to the US versus Europe versus Asia is hard to determine when the core holdings are mutual funds because of the flexible foreign content rule.
Many physicians have six or more mutual funds, so you can see how nightmarish managing asset mix, country diversification, and foreign content can be. Another problem is that fund managers from different companies do not communicate with each other about Dr Bob’s portfolio, which means that asset allocation plays a secondary role to security selection. The solution for those with portfolios greater than $100 000 is to minimize the mutual fund habit and again turn to individual stocks and bonds so as to optimize diversification of asset mix and country mix.
Incorporating the medical practice has been a poor investment habit for many physicians. This was true before the new rules about family trusts were invoked and is even more so since that change. As a simple rule of thumb, a medical practice should not be incorporated until most of the personal debt has been eliminated, for example, university, mortgage, and personal bank loans! Interest on personal non-deductible debt is very costly and physicians would be further ahead paying this off first rather than leaving money in the corporation for tax benefits. This means that for most physicians, incorporating should be on the back burner until at least age 40 to 45.
Once this debt is paid off, however, physicians should avoid falling into the ego trap of incorporating for the sake of incorporating. The “Inc.” does not stand for Dr Incredible.
Incorporating makes financial sense only if $15 000 to $20 000 per year is left in the corporation as an investment. The main advantage of incorporating is to shelter growth at a lower corporate tax rate, which is then paid out later in life when you are in a lower tax bracket. If you do not leave money in the corporation, you lose because of very high accounting bills associated with maintaining the corporation. It must also be appreciated that when your accountant gives the thumbs up to incorporate, there is some potential conflict of interest. An accountant may be hard pressed to give unbiased advice, because your bill (his or her salary) can quadruple with incorporating.
Finally, as an aside, you should never incorporate for the sole purpose of availing of yourself of “some of the great universal life insurance benefits”—there are other ways to build wealth and lower your taxes.
Real estate is another area where doctors continue to display poor investing habits. This ranges from buying the wrong type of real estate (limited partnerships), buying overly expensive real estate (their own monster homes), or not buying the right type of real estate. The following is my take on why most physicians should consider owning commercial real estate. There are a number of reasons for my bullish attitude, and they are reinforced at the present time with equity markets in a tailspin and mortgage rates at record lows.
Self-employed physicians should consider buying their own commercial building instead of renting or leasing an office. (If you are mainly hospital based, this may not apply.) Certainly, there is office setup and carrying costs, but some of these costs will be retrieved upon selling in the future, and many are acquired with leasing or renting as well. As this is an appreciating investment, the 25% down payment (through a credit union) will be earned back, plus capital appreciation if the building is held for 5 years or more.
The financial advantage of a physician owning his or her own building is that if it can accommodate other commercial tenants (or residential suites) the practice can be housed at a monthly carrying cost that is substantially cheaper than renting or leasing. In fact, if you do a bit of homework and follow the commercial market (or get a realtor to do this) you can frequently house your medical practice with no monthly carrying cost! This usually requires a bigger building (about 6000 to 9000 square feet), which allows for two to three other tenants. I realize that some readers may not want this type of investment because of the potential “rental hassle,” but commercial renting with triple net coverage is virtually hassle free. As a second lower-cost choice, I recommend a smaller building such as an older renovated home that allows space for you and another professional who rents from you.
The analogy that I use to reinforce my logic on buying an office building is the automobile. We all know that it is financially wiser to buy your automobile than to lease it, and this is a depreciating asset. The same logic applies for an office, especially because it is an appreciating asset. Additionally, the “passengers” will be paying a portion of the gas and maintenance.
Another reason to look at real estate is that borrowed money is very cheap by historical standards, which increases the odds of balancing the monthly statement and allows the mortgage to be paid off quickly. The interest on the mortgage and the property tax is deductible, as are most of the maintenance costs. As a bonus, with a couple of tenants, some home office expenses can be written off, for example, a percentage of heat, light, phone, painting, furniture, landscaping, and so on.
Real estate also adds diversification to your holdings, which decreases portfolio risk and volatility. Another big bonus of real estate income is that it counts as earned income that can be used to create RRSP contribution room. For those who plan to retire early but would like to still avail themselves of RRSP contributions to shelter and defer taxes, this is the way to do it.
Another good reason for physicians to consider owning commercial real estate is because it can be a great supplement to retirement income once the property is paid off. Real estate and the future cash flow from rent also tend to be good inflation fighters.
Bank credit abuse is an annoying and costly habit that physicians inflict upon themselves. Banks are quite fond of physicians because they know no matter how much they loan, they will always get the principal back, plus interest and fees. If physicians are late with the payment, no problem—the bank just adds another fee (overdraft) and the doctors simply work longer and harder.
Banks abuse physicians by lending large amounts of money in the form of credit. By allowing access to such easy money early in a medical career, the banks create a convenience that is very easy to become addicted to. Credit is essentially a form of leverage that can be a wonderful tool when used properly (for example, real estate investment), but unfortunately most physicians use credit and leverage in the wrong way. One definition of leverage is “seeking to magnify percentage returns on an investment by using borrowed funds.” This implies borrowing money to put toward appreciating assets. But physicians have a nasty habit of borrowing money to buy depreciating objects such as big boats, big trucks, big motor homes, and so on. Because credit is so readily available, docs quickly reach their credit limit with all the “comfort products.” Unfortunately, when the opportunity appears to buy appreciating investments, they can’t afford to!
The solution is to focus on long-term goals and use the credit, but avoid some of the comfort products early in life and instead allow leverage and compound growth to work in your favor with appreciating assets. In case you missed the earlier mention, one of the best ways to use leverage to your advantage is by investing in real estate. This product usually appreciates over time, the other tenants pay the monthly carrying charge, the asset does not usually drop precipitously in value such as the equity markets can, you only have to put down 25% (versus 50% for stock margin accounts), and you have a great retirement nest egg that also provides a hedge against inflation. Using bank credit in this fashion will allow you the opportunity to build tremendous wealth over 10 to 15 years.
Children’s education fund denial is probably one of the most common reasons for delayed retirement among physicians. It is imperative that you prepare for this major cost well in advance if you plan to retire before 60. In my book Prescription for Wealth I outline the different methods that can be used to pay for children’s university education. If you are looking to face education payments 10 to 15 years down the road, one option is to expect to pay between $60 000 to $80 000 for a 4-year program. The second option is to pay a little each year starting early in the child’s life so as to let compounding work for you. By investing $125 per month at 9% to 10% you will meet your goal with a cost of only $30 000. The third option is to invest a lump sum early in the child’s life. This method will cost you about $15 000 per child.
I advocate using both the Registered Education Savings Plan (RESP) and in-trust account. For the RESP you might consider contributing only $2000 per year so as to receive the free Canada Education Savings Grant (CESG) money. But it is unlikely the RESP will be large enough to support anything beyond a 4-year university program, so I recommend using an in-trust account for any contribution above the RESP. The in-trust account also has additional flexibility in terms of the amount of contribution and the unlimited use of the funds in case the child decides not to go to university.
With the education of an average family of three children costing $60 000 each, you can see why delayed retirement can occur. If your children also decide to do post-secondary education, the total cost for all three children will be about $360 000! These numbers are probably on the conservative side as I expect to see more downloading of costs to students and their families as cash-strapped governments try to divert more money to Band-Aid the upcoming booming health care costs. The bottom line is that you need to exercise some short-term pain (savings) for the long-term gain (early retirement).
“Toys-R-Us” could be the home banner for many physicians. As mentioned earlier, many physicians are quick to accumulate depreciating toys very early in their careers, which robs them of the opportunity to buy appreciating, wealth-building investments later. In their excellent book The Millionaire Next Door, Thomas Stanley and William Danko review the downside to “short-term gain for long-term pain.” It is very hard to get ahead financially if you accumulate large amounts of depreciating debt at an early age as this negates the opportunity to buy investments, which in turn prevents the magic of compounding. Physicians must appreciate that a large salary does not equate to wealth. There needs to be more focus on diverting some cash away from the toys and into appreciating investments earlier rather than later. At some point the cash cow will stop producing and then you have to live off what you have banked.
Financial success is possible for most physicians, but is does require having a written blueprint as a guide. You should demand a written investment plan and financial plan from your adviser. Without them and regular monitoring, most physicians are simply rolling the dice with their retirement.
This article is for informational purposes only. The statements contained herein are based on material believed to be reliable, but are not guaranteed to be accurate or complete. This information is not intended to provide individual financial, tax, or investment advice. Particular investment or trading strategies should be evaluated relative to each individual’s objectives. National Bank Financial is not liable for any errors or omissions in the information, or for any loss or damage suffered.
1. Lynch P. One Up On Wall Street. New York, NY: Penguin Books, 1990. 320 pp.
2. Curran T. Prescription for Wealth. Vernon, BC: Crowne Rock Publishing, 1998. 287 pp.
3. Danko W, Stanley T. The Millionaire Next Door. New York, NY: Pocket Books, 1998. 272 pp.
Terry Curran, MD, FRCPC
Dr Curran works as an investment adviser with National Bank Financial and is the author of Prescription for Wealth and Second Opinion. He also practises neurology part-time at the BC Interior Movement Disorder Clinic in Vernon, BC.
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