We are still in the first quarter of 2018 and already we’ve seen enough stomach churning volatility in the stock markets to last the whole year. The month of January was euphoric, with both the Canadian and US market indexes hitting new highs. Then February crashed the party, sending stocks tumbling very hard and very quickly. This roller coaster ride have many investors wondering how to position their investments for the future and questioning how this will affect their dreams of retirement.
Rather than reverting to fear and panic, it is important to remember that the fundamentals of investing have not changed. The recent stock market gyrations should be a catalyst to examine and refocus your investment plan. To help you reach retirement in style, let’s review some investment rules that have proven successful over the long term.
Rule #1: Start with an Overall Plan
One of the most common questions we receive from dentists is “how much do I need to retire?” Of course, the answer is different for everybody – but it always starts with a plan. Right now is a great time to define your retirement goals. What is your optimum retirement age? What do you want to do in retirement (and how much will that cost)? Do you have some financial backup to pay for medical bills or long term care? With help from your financial advisor, come up with a retirement dollar figure to shoot for. This will give you a concrete target which you can bas your savings and investments. For some dentists, it may mean they can save less or choose more conservative investments. For others, it may be a wake-up call to save more, invest differently, retire later, or
change their expectations. Regardless of which camp you are in, a roadmap is essential to meet your long term goals.
Rule #2: Understand Risk and Reward
We all know that risk and return are intimately connected. If you want to maximize your returns, you invariably expose yourself to more chance of loss. To put risk into context, let’s look at two extreme cases of risk and reward:
Oscar decides that he can’t wait to build up his retirement savings. He wants big returns for his money and chooses to use his retirement savings to buy Lotto Max tickets. For each play, Oscar has approximately a 1 in 28,000,000 chance of taking home the $55 million grand prize and immediately realizing his retirement dream. It’s possible, but highly unlikely. On the other hand, Oscar’s chance of walking away with nothing is 5 times out of 6. The odds for a complete loss greatly outweigh that of a spectacular win. Although it is tempting to take on more risk to reach for outsized returns, Oscar has to be aware of how a loss will affect his future.
Felix is Oscar’s friend from dental school. Early in his career, he put all his savings into three dotcom startups and was burned when all three went bankrupt in the tech crash. He vowed never to lose on his investments again. For the past 17 years, Felix has invested in bank issued GICs. His present portfolio of one-year GICs average 1.6% while inflation is running at 2%. Felix has virtually eliminated the chance of losing money, but the growth of his savings will not be enough to support his retirement.
For many investors, the temptation of a jackpot or a fear of loss clouds the real objective of investing – that is, to find a balance between risk and return to give you the best chance of reaching your retirement goal. Start with your retirement target and an estimate of how much you can save per year. Then work backwards with your financial advisor to build the proper mix of growth stocks and safe holdings to reach that target.
Rule #3: Know Your Time Horizon
In the short term, the stock market is a crap shoot. With the proliferation of 24 hour news and the rise of market analysts on BNN and CNBC, the price of equities can and will be swayed by a thousand things – little of which has any bearing on the health and value of the companies that make up the market.
In the long term, however, good businesses will show their worth with increasing profitability, higher revenues, and good management of debt. This will be reflected in the stock price.
Investing in equities means knowing your time horizon – how much time you have before you need the funds. For a time horizon less than 3-5 years, it is very difficult to predict the direction of the market. Therefore, sticking to conservative, less volatile investments will get you there in a predictable fashion. For longer time frames, more risk can be taken to maximize returns. You will have more time to even out the irrational volatility of the markets and allow your portfolio to grow due to fundamental factors.
So what is your time horizon? It’s longer than you think. These days, retirement can last for 30+ years and your savings need to keep up with your longevity. For retirees, I usually recommend keeping two savings pools: Pool A would hold cash and safe investments to cover 3 to 5 years of living expenses while Pool B would hold more volatile investments that have a greater potential of long term growth. This way, you are not worried about withdrawing funds from your investments if stock markets take a temporary dip. In the longer term, gains from Pool B would be used to replenish Pool A.
Rule #4: Have a Philosophy… and Stick To It!
There are more styles of investing than there are brands of composite resin. Each philosophy has its pros and cons and each will do well in some conditions. The trick is to find one that you believe in and stick with it. If your philosophy is well thought out and is based on sound principles, it will likely do well for you in the long term.
I am partial to dividend growth companies. Quality businesses trading at reasonable prices that have positive cash flow, pays a dividend, grows their earnings and have a history of increasing dividend rates. It has performed well for me over time but it certainly has not been the leader every year – and that’s OK since I am in it for the long term.
The media will always be crowing about the latest and the greatest. Their job is to create hype and attract viewers. Your goal is to be strong and stay on track. Regardless of your investment philosophy, resist the urge to chase after the latest winners. More often than not, by the time you catch them, they will be on the way down.
Rule #5: Don’t Time the Market
There is a natural tendency to jump to safety when things are going poorly and leap in when times are good. Although this works well when following sports teams, it is not effective when it comes to investing.
Market timing involves two decisions – jumping out of the stock market at a high and then jumping back in when the market bottoms out. Sounds simple enough in theory but it is virtually impossible in practice. Many market timers are paralyzed by the fear of making the wrong decision that they end up missing out on significant market rallies. In the long term, successful investing is more about the discipline to stay invested rather than the brains (or the luck) to time the market.
A good strategy is to invest on a regular basis, through both up and down markets. This will help to smooth out the short term volatility of the stock markets. This “dollar cost averaging” technique also applies to investing a large sum of money (ie: from the sale of a home or practice). Breaking up the investment into smaller tranches over a period of time will help to even out market bumps.
The fallacy of market timing is well summarized by the legendary investor Peter Lynch:
“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”
Rule #6: Be an Automatic Saver
Investing well is only half the battle. Saving money on a regular basis is equally important to achieving your retirement goals. Most people spend first and save whatever is left over. Unfortunately, our spending habits tends to keep pace with our income, so no matter what we earn, we are left with very little (if any) savings at the end of the day. A better way to build out your long term savings is to invest a predetermined amount every month, before you have a chance to spend it. This takes away the monthly “savings” decision and keeps you on a consistent track. Within a short time, you will not even notice the decreased income – your spending will automatically adjust to what is available.
Rule #7: Don’t Forget Taxes
For dentists, taxes are a significant concern. Proper tax planning can make a huge difference in achieving your retirement goals.
Tax advantaged programs such as RRSPs, TFSAs, corporate savings, IPPs, RCAs and insurance based vehicles can all help to minimize your tax burden now and in retirement. Work with your accountant and financial advisor to understand how different investments are taxed and to help allocate your assets in an efficient manner. After all, at the end of the day, it’s not about how much you make, it’s about how much you keep.
Dr. Wilson Chen is a Financial Advisor with Raymond James Ltd. The views of the author do not necessarily reflect those of Raymond James. This article is for information only. Raymond James Ltd. member of Canadian Investor Protection Fund.
About the Author
Dr. Wilson Chen, BSc., DDS, CFP, FMA received his DDS from Western University in 1992 and over the past 23 years, has built a patient-centered, family practice in Hamilton. In 2014, he sold his practice to take a more active financial management and business advisory role for his dental clients and their families. Wilson is the only practicing dentist in Ontario to hold the Certified Financial Planner (CFP) and Financial Management Advisor (FMA) designations. Wilson can be reached at wilson.chen@raymondjames.ca.
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