I’ve been investing since high school when I first read “Rich Dad, Poor Dad” as a Grade 9 student. Though this book has largely been discredited, it got me started investing in the stock market.
Because I did not know how to start investing I sought out a financial advisor. Unfortunately, they recommended a series of actively managed mutual funds with high expense ratios and back-end load. It took a few years but I eventually realized my investments were underperforming and decided to take action.
Towards the end of high school I sold all my mutual funds and took the hit from back-end load fees. I then made my first foray into the world of index investing and invested into the only Canadian index funds available: TD e-series. I kept my money in these funds for several years throughout university and until I started medical school.
The allure of individual stocks
The problem I discovered with index investing is that it is boring. Having my money sit in the index funds not doing anything started to make me feel restless. I wanted to invest in individual stocks because I knew I could “beat the market”. Looking back, I should have followed the advice “don’t just do something, sit there”.
Entering medical school I made the decision to sell all my index funds and invest in individual stocks. My thinking was to test my skills out against the overall market for the next 5-6 years to see if I could beat it. As you might expect, my returns did not do better, and in fact did worse. Those biotech stocks never seemed to quite work out!
However, long-term I still see this as a positive development. If I had never tried out investing in individual stocks, I would have always wondered “what if I COULD beat the market”. Having tried to beat the market, that itch has now been scratched. It made me realize that proper individual stock selection is a difficult undertaking. To do it properly requires spending significant amounts of time reading through annual reports, regulatory filings, and accounting statements. I realized that I could spend this time trying to leverage and advance my career or spending it with family.
How should a physician invest?
The question then is how should a physician invest, if not in individual stocks?
The short answer is: index investing
Stock market indexes are a list of companies that meet certain criteria; for example the TSX-60 is the 60 largest Canadian companies and the S&P 500 is the 500 largest American companies. There are other indexes for specific industries, company sizes, and geographies.
Index investing involves purchasing shares of each company that belongs to an index. Rather than actively trying to pick and choose the “best” stocks, this type of investing simply holds the stocks that belong to an index at a given time.
The reason why this type of investing is better for most investors is as follows:
- Investors underperform the market with individual stock selection for both psychological and analytical reasons
- Physicians are not excluded from this group either! Being good at medicine does not make us good at stock picking
- Therefore, diversification, which involves holding a collection of stocks across a broad range of industries is important
- Mutual funds, which has a fund manager selecting individual stocks, tend to perform about the same as the overall market
- However, these funds also charge a 1-2% management expense ratio which results in worse overall returns
- Therefore, your best option is to buy a collection of stocks with a low management expense ratio (i.e. an index fund)
How to index invest?
As Canadians we have less options available for index investing than our American counterparts.
Our two options are:
- Buying an index mutual fund such as the TD e-series
- Buying an index fund through an exchange-traded fund (ETF) on the stock market
Option 1 is better if you have less money available and want to consistently contribute small amounts of money. Unfortunately, index mutual funds in Canada tend to have higher expense ratios and there are fewer options for selecting the index you want to invest in.
Option 2 is better if you have larger amounts of money to invest, because purchasing an ETF on the stock market exchange will involve a commission to buy the ETF (~$10). However, the expense ratios on these ETFs tends to be lower, and there are more options available for you to choose. You can design your portfolio exactly how you want.
In the next post on the investing series I am going to talk more specifics about how you should divide your money between stocks and bonds and the impact being a physician has on your investing.
How do you invest your money? Do you use ETFs or index funds? Individual stocks?