This is the Part 2 of the Canadian Physician Investing Guide and Part 1 can be found here.
In Part 1 I discussed why you should invest in index ETF funds. Because of the huge variety of index ETF funds, in this post I wanted to talk about the specifics of what you should buy.
Stocks vs Bonds
The two most common investments are stocks and bonds and your first decision is to determine how much of each of these you want in your portfolio. This is known as ‘asset allocation’.
Stocks: partial ownership of a company. They tend to be more volatile (prices go up and down more) and riskier (especially if a company goes bankrupt) but have higher returns.
Bonds: debt owed by a company/government. They are much less volatile and less riskier, but have correspondingly lower returns.
Stocks and bonds are treated differently in terms of taxes. When you own a bond you receive interest payments on the bond, and this money is treated as earned income. When you own a bond you may receive dividend payments, but the majority of return is through the stock price increase known as capital gains. These differences have important implications for where you hold them (tax-advantaged vs taxable accounts).
Most investors recognize that they should own both stocks and bonds. The question though is: how much stocks vs bonds should I own?
Employment as Physician
As physicians we spend our our 20s and into our 30s in school and training deferring our ability to earn money. Compared to other professionals (like engineering or accounting) we enter the work force later and with significantly higher debt loads (sometimes over $120,000). On the other hand, once we start earning income, our income tends to be strong, and we have very good job security (though this assumes you’re able to get a job, which is not a given!).
Delayed but high earning power and high job security inform how the Canadian physician should invest for FIRE.
Physicians = Bonds
People often discuss “investing” in education. However, what is not discussed is what kind of education/job you’ve invested in: stock or bond. This is known as your ‘human capita’ and should be incorporated into your overall investment plan. For example, if you are an investment banker working on Bay Street (the Canadian mini-Wall Street) your job resembles a stock: high risk, high reward with a possibility of going broke (laid off). Furthermore, your job prospects are strongly correlated with the overall stock market. In contrast, physicians are more like bonds: low risk, consistent reward, with low likelihood of unemployment. Physician jobs also have low correlation with the stock market.
Taking human capital into account, you should then adjust your overall asset allocation (stock vs bond split) to manage risk. If your job is stock-like, buy more bonds; if your job is bond-like, buy more stocks . Some financial planners even recommend that people with bond-like jobs, such as doctors, should consider using leverage to obtain more exposure to stocks. Personally, I would not recommend that given the risks entailed with leverage.
Human capital is one of the most important characteristics to take into account when determining your stock vs bond split. Two other factors to consider are: (1) your risk tolerance, and (2) age.
With higher risk tolerance you can have a greater percentage of stocks, and with lower risk tolerance you should have more bonds. Think of this as the ‘sleep test’ – what stock/bond split will allow you to sleep well at night?
The other factor – age – is an estimate for when you will need to start withdrawing money from your investments and when you may adjusting your stock/bond split to be more heavily weight with bonds to have less ups and downs. Some investors, like JL Collins, argue that this risk is overblown and advocate significantly higher stock allocation (like 100%) due to the risk of depleting your investments early because of low returns.
Stock/Bond Split for Physicians
Investing in your job as a physician is like investing in a bond. However, the other aspect of being a physician is the delayed earning power. This means, especially when starting out, physicians need to seek out higher returns due to starting late. Therefore, physicians should be lean heavily towards stocks.
For physicians during their working years (especially early or mid-career) I think that stocks should form 70-100% of their portfolio with bonds taking up 0-30% of their portfolio depending on your own risk tolerance.
My personal approach is to have a 90% stock and 10% bond split. This is because there is some evidence that a small amount of bonds can increase your returns. When stocks drop, you can sell the bonds (which hopefully dropped less) to purchase more stocks (which are now at a discount). However, down the road I could see myself shifting into 100% stocks as recommended by JL Collins.
The upcoming posts in this series will discuss which ETFs you should buy, the question of hedging our currency, what distribution worldwide you should have, and more!
Readers, is your job a stock or bond? How do you split your stocks/bonds?