Guest User

December 14, 2023

Episode 283: When Volatility is Risk, and Introducing The Money Scope Podcast

Guest User

December 14, 2023

Today’s episode features a series of in-depth segments, and includes a visit from our two favourite Marks; Mark Soth (aka The Loonie Doctor) and Mark McGrath! To kick things off we break down volatility and investor behaviour by looking back at our conversation with Scott Cederburg and what his research demonstrates about the topic. We then hear from Mark Soth about the project that he and Ben have been working on; the soon-to-be-released Money Scope podcast. Find out what you can expect from their financial curriculum, like the topics they’ll be covering and how the structure of their episodes is specifically designed to educate. Next up we have our Mark to Market Segment, with Mark McGrath providing a detailed overview of everything you need to know about physicians incorporating. We then cover a recap of our conversation with Gerard O'Reilly, before sharing our thoughts on why this episode is worth multiple listens. Following that you’ll hear Cameron share his review of Brave New Work: Are You Ready to Reinvent Your Organization? by Aaron Dignan, along with his key takeaways from the book. Finally, in our after-show section, we discuss some of the fantastic guests we have coming up, our recommended reading to prepare for those episodes, community updates, plus a few other goodies!

Key Points From This Episode:

(0:02:06) The biggest takeaways on volatility and investor behaviour from Scott Cederburg’s research; unpacking performance chasing, return gaps, fund expense ratios, and more.

(0:14:13) An overview of the project that Mark Soth and Ben have been working on, the Money Scope podcast; why they started it, what it covers, and who it’s for.

(0:19:12) Details on Money Scope’s format and the supplementary case study episodes.

(0:26:32) Our Mark to Market segment on physicians incorporating; a rundown of the complexities, common misconceptions, and benefits to be aware of.

(0:33:30) How much you should be retaining in a corporation to make it worthwhile.

(0:37:58) A look back at our conversation with Gerard O'Reilly and why this episode is a must-listen.

(0:40:10) Cameron’s review of Brave New Work: Are You Ready to Reinvent Your Organization? by Aaron Dignan, along with his top takeaways.

(0:46:23) Our after-show section; guests to look forward to, recommended reading, community highlights, and more.

Read the Transcript

Ben Felix: This is the Rational Reminder Podcast, a weekly reality check on sensible investing and financial decision-making from two Canadians. We’re hosted by me, Benjamin Felix and Cameron Passmore, portfolio managers at PWL Capital.

Cameron Passmore: Welcome to Episode 283, another great week, another week with just you and I, Ben. What a couple special guests. For a change, why don’t you tee up the first part of the intro?

Ben Felix: The main topic is volatility and investor behaviour. That’s an important topic because of our episode a couple of weeks ago, talking about Scott Cederburg’s new paper and our episode next week with Scott, I won’t give it away. But volatility investor behaviour is important in the context of those recent and upcoming episodes. Then, we also have a special announcement, which I’m pretty excited about, which is about a new podcast we have coming out. The first episode will be released Friday of next week, and every Friday thereafter for some number of weeks to be determined, I guess. We’re joined today by my co-host for that podcast, Dr. Mark Soth, also known as the Loonie Doctor, who has been a guest on Rational Reminder before. But Mark and I have been hard at work, developing a podcast with more of a Canadian tilt to it than we can afford with Rational Reminder, because Rational Reminder’s audience is so global.

Cameron Passmore: Excellent. Then, we also welcome our other favourite Mark, Mark McGrath is back again this week with Mark to Market. There’s a dovetail with your conversation about the new podcast. Mark’s going to be talking about the benefits of physicians incorporating. We will also look back at the episode we had with Gerard O’Reilly, who is the co-CEO and CIO of Dimensional Fund Advisors. We’re also going to take a look at a book that I love that I know you will love, Ben, called Brave New Work: Are You Ready to Reinvent Your Organization? by Aaron Dignan. Then, of course, we’ll have the after show for those of us that stick around. Anything else?

Ben Felix: Nope. I think that’s good. I think we can go ahead to the episode.

***

Cameron Passmore: Okay. Episode 283. Let it going, Ben.

Ben Felix: All right. Volatility and investor behaviour. We covered Scott Cederburg new paper in an episode a couple of weeks ago. That created a lot of discussion in the Rational Reminder community and elsewhere. Then, we have Scott coming up next week. That conversation, it strengthened the conclusions that we came to in the episode where we discussed this paper.

Cameron Passmore: Oh my gosh. God is so good. Shameless plug, it’s an incredible conversation. He’s just so great at presenting it.

Ben Felix: That episode is something to look forward to. We do talk about investor behaviour in the episode with Scott. But I wanted to spend some more time on it today, just because there’s a lot of talk in the recent episode, and the one with Scott about stocks being a good asset class for investors, including people in retirement, and leading up to retirement, and all that kind of stuff. Wait to the episode with Scott before you disagree with me on that, if you feel the need to. We looked for every way possible that bonds make sense for retirees with Scott. What about this? What about this? What about this? He always had an answer.

However, I think it’s important to talk about behaviour. To reiterate, one of the big takeaways from Scott’s research is that despite the volatility of stocks, they have provided better retirement outcomes, measured a whole bunch of different ways than bonds. But his model assumes – I mean, what did he say to us? Something funny about how the people in his model do exactly what he tells them to, behave like data, not like people. But of course, people in real life have this persistent tendency to get into investments after they’ve done well and out after they’ve done poorly, which causes a pretty significant gap between investor returns and investment returns.

That performance chasing is, like I mentioned, a second ago. I guess it’s persistent. It’s everywhere. We had Itzhak Ben-David on talking about one of his papers on performance chasing and mutual funds. Performance chasing, it’s this constant feature of financial markets that explains the aggregate flows to mutual funds, and it explains the flows across funds, and it holds for both actively managed funds and index funds. It’s a real thing that happens everywhere to gauge the cost of those timing decisions that investors make. We can look at the difference between the time-weighted returns of funds or asset classes. That’s like the index returns that you see reported everywhere are time-weighted returns. We can compare those to the dollar-weighted returns of the investors in those funds or asset classes. So those dollar-weighted returns are affected by the timing of the cash flows, whereas, the time-weighted returns are not.

There are a bunch of papers that have looked at this in a bunch of different ways, and they’ve all found pretty similar results. The performance gap in aggregate for equities is somewhere between 1.5% and 2%, depending on the data source we’re talking about. So a bunch of different papers on this, and they’re all in that range. That means, investors are earning somewhere between 1.5% and 2% less on average in stock markets than the actual time-weighted returns of the stock markets.

When we see, whatever, the stock markets delivered a 7% return, investors on average have captured around 5% of that due to their timing of exposure to stocks. So they’ve had more money invested before bad returns, and less money invested before good returns, basically. The gap is much larger in aggregate, 1.5% to 2%. But that gap is larger for more volatile funds, it’s larger for more specialized funds, and more speculative funds. An industry-specific fund is going to tend to have a bigger gap or industry-specific funds in general are going to tend to have a bigger gap. More volatile funds are going to tend to have a bigger gap than that 1.5% to 2%.

One paper looks at the NASDAQ from 1973 to 2002. They find a gap of 5.3% between the index return and the investor dollar-weighted return over that period. Big gap. In Morningstar’s paper on this that they do every year, for sector funds, they find a gap of 4.38% over 10 years. So again, pretty significant. There’s another paper looking at broad equity styles, and they find the return gap for growth-oriented funds. It’s around 3%, whereas about. 1.3% for value funds. That’s interesting on its own as a totally separate observation.

That kind of suggests that performance chasing has been more damaging for investors and growth funds than in value funds. Growth investors are more aggressive performance chasers in that sample.

Ben Felix: Not that surprising.

Cameron Passmore: We can see it. One comment before we continue is that I have seen people mention that these return gaps could be just a natural feature of markets, just based on when cash flows happen, and not a sign of investor error. Since the cash flows are happening for whatever other reasons. But one of these papers tried to address that. They had estimates of P values for the return gaps using bootstrap tests under the null hypothesis, that the difference between the realized-dollar weighted and time-weighted returns is not statistically different from the difference between a random-dollar weighted return, and the realized-time weighted return.

They’re looking at, is the return gap observed from actual flows, statistically different from the return gap that would be observed if flows were random. They find that it is statistically different in the test. Because I’ve seen that kind of argument many times. We don’t know whether these return gaps are real, is it just random? Another really interesting point that comes out of a lot of this research is that return gaps are monotonically increasing with increasing fund expense ratios. Fund expense ratios are often used as a proxy for investors’ sophistication. Less sophisticated investors tend to invest in higher-fee funds. Because the return gaps increase with expense ratios, it suggests that this is a sign that it is likely to be errors, because less sophisticated investors are ending up worse off from this phenomenon.

Another one of these papers looks at when timing errors tend to happen. It finds that they occur both investing at the wrong time. So putting money into the market at the wrong time, but also selling at the wrong time. So the error happens on both sides. But selling at the wrong time seems to contribute more, a little bit more, but still more to the overall performance gap. Now, on volatility, and this is really important when we talk about stocks. If we say stocks are well volatile, they’re not super risky in the long run, or they’re less risky than bonds in the long run. That’s one of the things we got from Scott too, he said this a few times.

I’m not saying that stocks are not risky, they’re still very risky. They’re just less risky than bonds in his samples, in the data that he’s looking at. But, anyway. For saying that stocks are less risky than bonds, despite their higher volatility, I think it’s important to understand how volatility is related to the return gaps that we’re talking about. Some more volatile funds within each category. So Morningstar looks at this and one of the other papers, I have looked at this too. But they take all the categories of funds, and then rank them by volatility within the category. Again, it’s in most cases, fairly monotonic relationship where funds of higher standard deviations have increasingly large gaps between fund and investor returns. These are important and increasingly so for volatile funds.

Now, fees get so much attention, and I’m not minimizing the importance of fees. They’re obviously super important. But these that are suggesting that investors are losing more on average, or around the same in Canada, whatever, say it’s a 2% average mutual fund fee. Investors losing about the same or more depending on the volatility of the last class. We’re talking about these inopportune timing decisions, then they’d pay to own a traditional commission-based high-fee active fund. So I just think these are really important data to keep in mind when we’re talking about how great stocks are as long-term investments, while investors may be giving up a lot of those benefits to bad behaviour.

One of the papers actually that I looked at for this, it looks at a bunch of different fun styles, but it has a lot of commentary on how investors in value funds have not captured a value premium. So the value premium of their sample period was positive, but investors in value funds underperformed a buy-and-hold investor in the market because of their timing decisions. It is important when we talk about how there’s this equity premium, there’s a value premium. To capture it, you have to be disciplined, and behave well, and patient.

Cameron Passmore: So when the premium arrives, you got to be there to capture it. So tracking error tries bad behaviour.

Ben Felix: For premiums for sure, but the show is up for stocks too. It’s just, people chase performance. That could have been the segment. People chase performance and that’s bad, and it’s worse with more volatile assets. It shouldn’t be surprising though, when we look at the other literature on investor psychology, I guess. Investors tend to have high return expectations when model-based expected returns are low, and valuations are high. And low subjective return expectations when model-based expected returns are high, and valuations are low. When expected returns are measurably to the extent that we can measure expected returns when they’re measurably high.

If you ask an investor what they think future returns are going to be, their subjective estimate is going to be low, and then vice versa. When expected returns are low, investors are going to tell you that they think future returns are going to be high. It’s basically an extrapolationer. When returns have been good reasonably, people think returns will continue to be good in the future, but that’s often not the case. There’s a paper from Rob Arnott that looks at this. It’s titled, ‘The Folly of Hiring Winners and Firing Losers’. There are other papers on this too. It’s a big thing. In the world of institutional investing, there’s this sort of notional three-year cycle of hiring, firing managers. Institutions will often hire a manager that has done well recently, and allocate to them, and then review it in three years.

In a lot of cases, there’s data on this, and a lot of cases, they will have done poorly. But managers who have done well recently will tend to own assets that have higher valuations, which then their future returns tend to be lower. Whereas, managers who’ve done poorly will tend to own cheaper assets, and therefore, their three-year returns on average, in aggregate are going to be a little bit higher. That causes all kinds of problems in manager selection, but it’s the same kind of thing as performance chasing. Assets that have done poorly recently will tend to be cheaper. And assets that have done well recently will tend to be more expensive.

I think all that highlights the importance of having a portfolio and an investment strategy if it’s a style that we’re talking about or whatever. But you can stick with you have to be able to live with your portfolio’s volatility. And in particular, based on some of the data there, the downside volatility, and to avoid getting distracted by attention-grabbing recent returns, which is a whole other – I didn’t talk about the ARK example. But Kathy with ARK fund is – in terms of that return gap between the fund return and the investor return, that’s got to be one of the biggest gaps ever. There’s a Morningstar article that analyzes that. Anyway, I just think that context about how volatility tends to affect people. In the data, we know, it’s a real phenomenon that happens all over the place in all different styles, but increasingly so in more volatile assets. Which of course, we know, stocks are.

I absolutely love Scott’s research on lifecycle asset allocation. I think it has the potential. Obviously, we need to spend more time on it, thinking about it, but it has the potential to change how we think about asset allocation. But there’s still a massive behavioural constraint that just cannot be ignored in any of those discussions.

Cameron Passmore: And he agreed with that.

Ben Felix: You can’t disagree with it. Scott has interesting comments there, too. Cliff Asness has made these comments too that if we could just smooth the reported returns that investors see, they might be better off.

Cameron Passmore: Launder the volatility.

Ben Felix: Launder the volatility, exactly. Should we change regulations on how retirement accounts are reported on?

Cameron Passmore: The frequency of reporting?

Ben Felix: We talked to, I think Robert Merton about that, as well, other than thinking about it. Anyway, volatility matters as much as we might like to say that it doesn’t.

Cameron Passmore: This is the perfect setup to next week’s conversations. That was awesome. Okay. Are you ready to go over to our conversation with the Loonie Doctor?

Ben Felix: I’m ready and very excited. Let’s go.

***

Cameron Passmore: All right, Mark Soth, great to welcome you back to the Rational Reminder podcast.

Mark Soth: Thanks for having me back.

Cameron Passmore: It’s great to have you and Ben join to discuss what you guys have been up to. So off the top, what are you guys up to?

Mark Soth: We’ve been working on a big top-secret project since the early spring. So we’re pretty excited to actually finally be launching it. We’ve been working on what really amounts to a personal finance and investing curriculum directed at Canadians. That’s the big project.

Cameron Passmore: What is it called?

Mark Soth: It’s called the Money Scope. I actually came up with the name. I work as a physician, so I was actually fishing something at someone’s lungs one night. Shortly after, Ben had talked to me about the idea of the podcast, so we came up with the idea of the Money Scope, which we use these flexible video cameras to go down inside different body parts and take a look at things. That’s what we’re going to do with our finances. We’re going to take a deep dive inside personal finance for Canadians, and shine a light on like a scope does.

Cameron Passmore: Where did the idea come from? Were you guys just chatting and it came from that inspiration?

Ben Felix: No. We noticed, Cameron that our audience had become so non-Canadian. It’s still lots of Canadians, but it’s less than 50% of our downloads come from Canada now. But there are lots of interesting topics that are very specific to Canadians, and particularly for Canadians who have corporations. That’s something that we do a lot of work on for clients at PWL. Somebody in the Rational Reminder community asked if we could have Mark back on to talk about that topic. That’s like, it’s not relevant to so much of our audience. I don’t really think it makes sense to do. But it gave me the idea that maybe Mark would do like a mini-series on that.

So, I floated the idea to him, and he was open to it. And then we talked about what we wanted to do. We decided, like Mark said earlier, that we would make basically a curriculum so that it’s sort of full spectrum of good, high quality, personal financial decision-making targeted at Canadians with probably high incomes in general. Then, we do a bunch of topics on corporations specifically.

Cameron Passmore: This idea was in your plan path, right, Mark?

Mark Soth: That was one of the interesting things is that, Ben brought this up to me. It was funny, because we’ve been working on a lot of parallel projects where we both see there’s some kind of pragmatic question to answer, which usually, you can’t find the answer to. So it means you have to do a bit of a literature review, and then make a mathematical model to try to solve it. So we were doing a lot of that in parallel. We liaised with that. Then, when he floated the idea of doing this podcast, it was funny, because I’ve been working on building a curriculum from start to finish on my blog.

Ben’s actually been working on curriculum too, so shared documents. They were basically almost identical in terms of the format, structure, topics covered, the way we approached the issues. This just seemed like a great opportunity where we could actually do all of that at once. By having us do it together, it’ll be even better because Ben brings all of his knowledge with the investment side of things in as a financial professional in the academic literature. Then I come at it from sort of an end-user perspective, and I have an academic slant to the way that I approach things too, but I’m coming at it from the other end.

We both end up actually in the same spot, but we come at it from different approaches. That works out really well in terms of the content. There should be something in here for everybody. There’s someone who’s just learning about personal finance, we go through the basics. And then, someone who works with personal finance, and decision making all the time. Like an advisor is going to find stuff in there too, because we talk about a lot of these dilemmas, and nuances as well. So we cover the whole gamut with –

Cameron Passmore: I think that’s really important to highlight that this is not solely for physicians.

Ben Felix: Mark has that perspective. So it comes up in examples that we talked about, and things like that, because he’s lived it and he sees what his colleagues are doing. But it’s definitely for anybody. We do allude often to situations that people with higher incomes will find themselves in. There’s a bit of a slant toward that just as a general concept. But even still, the first few episodes are on the relationship between money, and living a good life, and setting objectives, and financial independence. That’s relevant to anybody. In later episodes, we do get into things that are more niche, but the episodes on investing, and on asset allocation, those are universal. I think anybody will find value there.

Mark Soth: We actually took high income out of the tagline for it, because really, incomes actually just one side of the equation. I grew up in a family with a moderate income. But we were careful about how we spent our money. And because of that, we were in a strong financial position, and a lot of the investing in a tax, personal taxable investment account, and deciding how do you want to allocate your time because you’ve controlled how you manage your money. We faced all of those issues as a family too, even though we didn’t really have a particularly high income. So I think this is really relevant to everyone.

In terms of the physician piece, that’s the perspective I come from, but I think a lot of us actually face exactly the same issues, whether we’re physicians, some other kind of professional business owner, or an employee, even. It’s all a lot of the same issues.

Cameron Passmore: Tell us about the format of the podcast.

Ben Felix: This is Mark’s idea. We have a core episode where we cover a topic. We just lay out the information, and Mark and I present it together. So we’ll systematically talk through a topic like the basics of investing, for example, and then we add on a case episode. The way we’re going to do it is we’re going to release the core topic episode. And then if there’s a case, not all episodes have cases. If there’s a case episode, it’ll come out the following week. So it’ll be sequential like that. Then, the case episodes are a bunch of examples. We take a bunch of hypothetical scenarios that a person may find themselves in that’s relevant to the core topic that had been discussed in the prior episode, and we talk through what the person should do in that situation. It’s a really cool format.

Mark Soth: It’s cool, because it actually gets us to dig into some of those dilemmas that people face. We try to – either common situations that come up or common questions that we get asked. like one of the ones that we do is about – and that’s coming up a lot. Do I take out extra money from my corporation, take a tax hit. and try to pay down my mortgage more aggressively? Or do I just keep what I’m doing and let the corporation keep growing with tax-deferred investing? So there’s these kinds of dilemmas, and you’re not going to find those answers anywhere. So we try to tackle some of them with some numbers and talk about some of the variables involved.

Cameron Passmore: How many episodes it will run?

Ben Felix: That’s a great question, Cameron. We don’t know. We have somewhat of an idea. We have the rest of the episodes mapped out. We’ve recorded the first, I don’t know. How many topics will be recorded? Ten topics and then a bunch of those have cases.

Mark Soth: I think we’re up to around 16 episodes or so.

Ben Felix: We’re – what about? Two-thirds the way through all the content that we’ve had planned?

Mark Soth: Yes, I think so. We were very deliberate in how we structured this. As educators, you have to be very systematic in how you deliver content to people so that they can take where they’ve come to, and then build on that on to the next block, and then take that and build on to the next block. We’re probably going to be 15 to 20 episodes, just getting those basic building blocks. Plus, there’s cases that go along with that as well. I think, I wanted to say too. Some of these episodes are really long too. When we built this format, this is not something people are going to – at least, we hope, – listen to once and never come back to. This is one of those things where hopefully, you’ll be able to come back to it repeatedly. Each time you come back to it, you’re going to take something different away from it, depending on the stage that you’re at, and the relevance to your situation.

In addition to the podcast, this is actually really much more than just a podcast. There’s the video and the audio podcast part of it, but we’re going to have transcripts which we’ve indexed so they’re easily searchable. There’s links embedded into there to other resources if you want to go back and read some of the original papers that we reference. Or here’s someone who wrote the paper on Rational Reminder, there is a link to that episode. Or if you want to read about it with some funny memes, and stories, and flowcharts on the Loonie Doctor, then there’s links to the relevant Loonie Doctor articles that go along to the topic too. We’re trying to make a repository for people to have financial education that they can come back to you over and over again and easily find stuff.

Ben Felix: That’s really important. We do transcripts at Rational Reminder too, but they’re just these big blocks of text, and I think people still find that useful. But it’s not easy to find specific pieces of information. Mark and I put a lot of effort into the pages for the episodes, for each of these. We have one on, I think it’s the asset allocation episode is two hours long. We talked about it afterwards. We’re like, “Man, this is really long.” But then, we try to figure out what can we cut, and there’s just nothing. There is all important information, so we decided to leave it as is. But if you go to the webpage for it, the transcript is indexed to all of the relevant subsections. So you can go and search for whatever if you want to learn about one sub-topic on asset allocation, you can go and click through to that through the index and you can read it. But it also have the timestamps for the transcript if you want to skip to that in the content.

Mark Soth: Yes. I think our goal is someone who’s coming at this the first time, which is going to be a lot of my audience. That they just get a sense of what’s out there and what some of the big issues are. And then when they come back at other times, they pick up on some of the more specifics. And then, if someone who has been dealing with us all the time is going to be specifically looking for some of the neat little factoids and other nuances that we talk about, they can find that too. So we want it to be something that appeals to everybody.

Cameron Passmore: And even though you said, it’s targeting a Canadian audience, it sounds like it will be very valuable for people around the world.

Ben Felix: A lot of it is country-agnostic. Some of it is very Canadian-specific, even the one on investing, probably 90% of it is relevant to anybody, but 10% of it’s very Canadian-specific. But then, we also have episodes on investing in a Canadian private corporation. That’s very Canadian-specific, probably not relevant to somebody in Italy, but probably more than 80% of the content is not country-specific.

Mark Soth: Yes. A lot of the registered accounts in Canada have similar counterparts in other places.

Cameron Passmore: So it is called Money Scope. It’s an audio podcast. So it’ll be in a normal feed on its own or with the Rational Reminder feed?

Ben Felix: It’ll be in its own feed, and it’s going to have its own YouTube channel, which has already been created. And it does have a trailer for the podcast, which Mark created, and then Matt at PWL prettied it up, and added some clips from the actual podcast to it. I’ve watched it, I don’t know, probably 10 times. It’s really fun to watch. We’ll link that in this episode so people can go and watch it. But yes, it’ll be audio, video, and then, moneyscope.ca. Just right now, has a placeholder with a trailer there, but that’s where all the transcripts are going to be.

Cameron Passmore: Oh, I see. Okay. Then this links back to both the looniedoctor.ca as well as our site. Correct?

Ben Felix: Yes. Each episode has, at the end, it has all the references from all of the sources that we sourced throughout the podcast discussion, and it also has links back to relevant or related Rational Reminder episodes, PWL white papers, and Loonie Doctor blog posts.

Cameron Passmore: I love it. I think this is such a good idea. I think you guys, you’re going to kill it. I’ve not listened to any of it yet, but I can’t wait. I think it’s going to be fantastic. It sounds like it’s going to be very evergreen as well.

Mark Soth: Yes. That’s the intention. It’s a lot of work to do the researching and put these together. But if it’s evergreen, then we can always just keep referring back to that. And ultimately, it’s going to save time.

Cameron Passmore: Any final thoughts, guys?

Ben Felix: I’m excited when I asked Mark if he wanted to do this, I was like, 50-50 whether he’d say yes or no. When he said, “Yes,” it was super exciting, and then it’s been a lot of work. Like Mark said, we’ve put a lot of time into researching, and sourcing, and figuring out the best way to structure, and communicate all this information. So we spent together a ton of time working through the notes for each episode, and then recording is a whole other big chunk of time. So it’s a bit of a big-time commitment. We’ve had a lot of fun together doing it. I’m pumped for this thing to be released and to see how it’s received. Hopefully, people like it.

Mark Soth: We’ve gotten partway down the track, but we’ll happy to adjust as we get feedback on it. Where this scope gets driven to next, I think it’ll be determined by the users.

Ben Felix: That’s part of why I didn’t know how many episodes we’re ultimately going to do. Because if there’s a burning question that a ton of listeners have, after an episode, we’ll probably do another episode to address that. It’s a bit fluid, but we have a general idea of the curriculum, but I think how the audience responds is going to dictate where we go next.

Mark Soth: Yes. We’re building the hub and who knows where the spokes are going to go.

Cameron Passmore: Dr. Mark Soth, it’s great to see you. Super fun. I’m super excited. I’ve heard bits and pieces from Ben about this. I think this is going to be a phenomenal endeavour, so congrats to both of you guys.

Mark Soth: Thanks

Ben Felix: Thanks.

***

Cameron Passmore: All right. A perfect bridge from talking to Mark is now to go to Mark McGrath with this week’s Mark to Market, and couldn’t be a better transition. I don’t think between what Ben and Mark will be doing with new podcast and what you’re up to. So tell us what’s up this week for the Mark to Market.

Mark McGrath: We’re going to talk more about physician finance today, in the spirit of the new podcast that Ben and Mark Soth are launching, and having him on as a guest today. I thought it was an appropriate topic to discuss incorporation for medical professionals in Canada. We’ll talk a little bit about why you might want to incorporate a medical practice, what to look for when you’re making that decision, and just a very high level what the actual steps are to incorporating.

Ben Felix: Love it. We don’t play favourites, by the way. We have two favourite Marks, Cameron/ We don’t have a favourite Mark. Mark Soth and Mark McGrath are both our favourites.

Cameron Passmore: It’s true.

Mark McGrath: Very equitable. I appreciate that. Thank you.

Cameron Passmore: We’d love all Marks

Mark McGrath: I’ll take it. We’re tied for the first place.

Ben Felix: Yes, that’s right.

Mark McGrath: Okay. Medical practice incorporation in Canada. Why might you want to incorporate a medical practice? Last I checked, and this was a while ago. I think something like 70% of all physicians in Canada are incorporated. It’s been a while since I’ve looked this up, but a very high number of Canadian physicians are incorporated. So somebody can fact-check me on that. But last time I looked, I think it was around 70%. Very relevant. Lots of benefits, lots of complexities. The primary reason for physicians to incorporate in Canada is mostly tax-related. If you think about other reasons that other business owners might incorporate, there’s some other – I guess, the high-level reasons you might do that, like liability protection. But I think you’ve talked about raising capital for a business.

Generally speaking, with few exceptions, that’s not too relevant for physicians. The primary driver behind incorporation or tax reasons, okay. I think there’s a misconception out there that it depends on how much you earn, but it’s really about how much you can save and retain in your medical practice. So high-level overview on corporations. Your corporation is a separate legal entity. So your medical professional corporation or MPC is a separate legal entity. Each province, the College of Physicians in each province actually has their own bylaws that dictate who’s allowed to be a shareholder of a medical corporation.

So in Ontario, where you guys are, only a physician, or a physician spouse, I believe can be a shareholder. But in BC, the spouse can be a shareholder if they’re not a physician. So different rules there. In Ontario, they’re not allowed. A holding company is not allowed to own shares of a medical professional corporation. In BC they are allowed, for example. So for every province, you have to be aware of the college bylaws that dictate the structure. If you’re going through the incorporation process, you would work with lawyers, and professionals, and they would know these rules anyway. So as a physician, it’s not something you necessarily need to be on top of if you’re working with professionals, but just keep that in mind, as listeners across the country. Every province is different.

Now, why might you want to corporate? Again, it’s a separate legal entity. When you practice medicine through a medical corporation, it’s the corporation that earns that income, right? So if we just think about a high-level example, let’s say your physician earning, say $300,000. If you are not incorporated, you’re basically a sole proprietor. I’m talking about fee for service for a concessional work. Some physicians are salaried, they’re employed by the hospital, for example, and they actually have a salary. In those cases, they can’t really incorporate and run their salary through the corporation. This is more for hourly work, and sessional work, and fee for service work. But if you’re not incorporated, you as an individual earn that $300,000 in this example, and you pay tax at your own personal effective tax rates through the different tax brackets. On a $300,000 of income, you’re going to pay – I know you might know the number, but call it 35%, 40%, something like that. But if you’re incorporated, it’s your company, it’s your corporation that earns that $300,000.

In every province, the tax rate on the first 500,000 – I think Saskatchewan is an exception there. But the first 500,000 Generally speaking, you will pay a very low tax rate on business income, and medical practice income when you’re incorporated is business income. So in our example, $300,000 goes through the corporation as income. And in BC, it’s taxed at 11%. In Ontario, that would be taxed at I think 12.2%. If you compare that to earning that $300,000 personally, huge difference in tax there, right?

Now, if the company earns that money, and you don’t need the whole $300,000. Let’s say your lifestyle expenses, and everything else costs you, I don’t know, call it $100,000. Isn’t it a shame when you’re not incorporated, that you have to pay tax on the whole $300,000 when you only need 100. And to the medical corporation, the corporation earns 300,000, it pays you a salary or dividends of say $100,000, and it retains the difference inside the company. That difference, the retained earnings of the company have only been taxed at a very low tax rate, at 11%, 12%. So it’s a tax deferral. So you keep it in the company, and you can invest that money in a corporate investment portfolio.

Yes, there’s a whole bunch of nuance around taxation of corporate investment portfolios that we won’t get into today. But it’s a huge tax deferral because that money can be invested, it can grow over years and years. Ideally, when you’re in a much lower tax bracket, let’s say, retirement or when you actually need the money, and you’re not practicing medicine anymore. Now, you can pay out the corporate portfolio as dividends to yourself in retirement. So you’re deferring tax like an RSP, in many ways. You’re deferring tax from today, and hopefully long into the future. That’s the primary benefit for physicians. Things like liability protection that other business owners would incorporate for generally aren’t relevant because for – and this is not just for physicians, but for all professionals.

A corporation does not absolve you of professional liability. So you would need separate insurance or in the case of physicians, they’re members of the CMPA. It’s not exactly insurance, it’s like a big fund that they contribute to that helps them in malpractice cases and that type of thing. So that’s why you might incorporated primarily tax deferral. There are certain instances where you can income split with family members as well through corporation. So if you have family members that work for the practice.

I was just speaking with the client of mine this morning, she’s a physician, her husband’s not, but he does a lot of administrative work, and bookkeeping, and accounting for the medical practice. So she’s able to pay him a salary for that work. There’s an income-splitting mechanism there. Also post 65, you can also pay dividends to a spouse, shareholder. You used to be able to do that prior to 65 until they introduced new tax laws in 2017, I want to say. We call them TOSI for short. It’s probably a whole other episode we can do on TOSI. But generally, you can’t usually split dividends prior to 65, except for in very certain circumstances. But after 65, you can. So that’s a huge benefit as well.

There’s other fringe benefits, like in an estate planning. You can do things like an estate freeze with the corporation. So if you’ve built up so much wealth in the company, that you’re likely not going to spend it, and you want to pass on some of that wealth to, say, children or future generations. You can freeze the value of the company for tax purposes, and then growth on the investment portfolio, or on the value of the company from that point forward can accrue to the next generation. So there’s some other benefits there. It does add complexity, and it does add costs. So to incorporate the practice, you need to go talk to lawyers, need to pay lawyers. You also need to apply to your college. Once you’ve created this company and found a name for it and worked with lawyers, you have to apply to your provincial college and get the authorization from them to practice through the corporation.

And on an ongoing basis, you’re going to have to file separate tax returns for the company, and that is a pretty steep increase from a personal tax return. It varies according to the accountants, but it could go from, say, a thousand dollars for personal returns to $3,000 to $5,000 for corporate returns. So it does add some complexity for sure.

Cameron Passmore: Give a sense of how much someone should be retaining inside the corporation to make it worthwhile.

Mark McGrath: Great question. It depends, like every question in financial planning, the answer is always, it depends. There’s a bunch of rules of thumb that I’ve heard varying from 15,000 to 50,000. You probably know me well enough to know I don’t like rules of thumb and every case should be looked at on an individual basis. Because it really depends on the delta between what your personal tax rate might be, versus the corporate tax rate once you also factor in the additional expenses, and complexity of incorporating the business. I’ll give you an example though. There’s a client of mine that I’ve worked with for many years. She works mostly part-time, not full-time. She’s done very well for herself. She’s well on the road to early retirement. Prior to me working with her, she was working with another advisor. But because her income was, I say only, her income was about $100,000, which is typically low for physicians, because of her part-time hours. They told her, “Don’t incorporate. You don’t make enough money.”

What they didn’t realize is, her lifestyle expenses are like $30,000 a year. So she could have retained tens and tens of thousands of dollars each year in the company, and defer that into the future. But by the time that we started working together, she was close enough to that early retirement phase that it probably didn’t make sense to incorporate at that time. That goes back to that misconception I was talking about earlier. It’s not really about how much you earn. It’s about how much you think you can keep in the company and defer.

Ben Felix: It’s how much you’re saving. It’s also – you got to think about the full lifecycle because the deferral is most valuable if your future tax rate is lower. You go and look at the financial plan for someone thinking about incorporating if you just look at the differential and current tax rates I can tell the whole story, you got to think about how valuable is that deferral of personal income tax, because you’re going to have the money invested in the corporation, you’re then eventually going to pay personal tax to get it out in the future. It depends like to the max.

Cameron Passmore: So you could be upside down.

Mark McGrath: You could be, and future tax rates are uncertain. I think if you have a spouse involved, that helps, again, because you can generally income split in retirement. So you can take advantage of household lower tax rates. That’s a big benefit. I’ve had clients that earned over a million dollars a year that never incorporated because they just didn’t want the complexity. It was that simple. They just said, “You know what, I’ll pay my taxes, I have no problem with it, I’m going to do just fine for myself, and I just don’t want the added burden of going through the corporate process.” Totally fine, reasonable answer. Mathematically, maybe not the best, but you know what, emotionally, and psychologically, fine. It makes sense, right?

Ben Felix: It’s a significant additional layer of complexity. Even stuff like, should you use your TFSA? Should you pay an additional dividend or salary to max out your TFSA this year? If you’re earning a salary, that decisions already made, the income’s personal, and you probably will max out your TFSA. If it’s in a corporation, it probably still makes sense, especially if you’ve a long-time horizon, but it’s much less obvious. Should you pay down your personal mortgage by paying a dividend for your corporation? Much more complicated than if it’s just at the personal level.

Mark McGrath: Those topics that you just mentioned are at the heart of the decision of whether to incorporate or not, right? Let’s say, you’ve just finished residency, you’re new to practice, you’ve got a bunch of student loans, you’re really debt adverse, and you just don’t want the loans, and you’re going to spend every single dollar of income paying down those loans. The corporation is not going to benefit you because in theory, if you insert a corporation between you, then you’re going to still take all the money out of the corporation to go pay down those loans. So there’s no tax deferral there, because you’re not leaving money in the company.

Another example, clients I’ve been working with for years. They took on a $2 million mortgage. Spouse is both physicians, but very high-income earners. They’re in their mid-40s now, and they haven’t really started saving and investing their money, simply because of this mortgage has been their primary focus. So they’re spending every single dollar paying down this mortgage. So it doesn’t make sense to incorporate it yet, because they won’t be deferring any tax. To your point, Ben, RSPs, and TFSAs is. If you’re maxing those out, and wait until on top of that, there’s additional funds that you can retain in the company before you make that decision.

Ben Felix: Yeah, that’s another great point.

Mark McGrath: And then, yeah, the complexity from an estate planning standpoint, it adds a whole bunch of complexity, even though it does add some opportunities. It certainly makes things more complex.

Ben Felix: Yes. More room for error too. Cool. That was great. We do talk about a lot of this stuff in the Money Scope podcast, so I’ll plug it again.

Mark McGrath: I assumed you would, but I thought, you know, it’s a good topic at the top of mine, and I was reading something about it recently. And so I thought, given today’s topic, it was relevant.

Ben Felix: Great topic. We don’t get into this until – I don’t know, much later episodes anyway. The first, I think we have 15 episodes done, and then this is in the later ones. So it’ll be many weeks before we get to it.

Mark McGrath: Nice. Can I get a sneak peek? Can you send me that specific episode before it’s launched?

Ben Felix: You can have all the episodes before it launches.

Mark McGrath: Awesome. That’s great.

Cameron Passmore: Thanks, Mark. This is our last Mark to Market for this year. So have a great holiday.

Mark McGrath: Yes. Thanks, guys. Likewise. See you soon.

Ben Felix: All right, Mark. Thanks.

Cameron Passmore: All right. That was another awesome Mark to Market from Mark. So let’s jump now to our quick look back at what is one of my favourite episodes are Episode 198 with Gerard O’Reilly. So let’s go with a quick recap of that. In Episode 198, we welcome the co-CEO and CIO of Dimensional Fund Advisors, Gerard O’Reilly. This is, honestly, the episode that I’ve listened to the most often, as Gerard is one of the sharpest communicators in this world of equilibrium-based investing.

The reason why I think this episode is a must-listen is simply his ability to take very complicated questions, then step back and build a very solid foundation in his responses, and all with incredible clarity and precision. For example, he dove into question around assessing risk based on ICAPM, which is not exactly the lightest of topics. Gerard also explained how Dimensional decides what criteria, any new variables need to be met in order to be considered dimensions of expected returns, how they decide to underweight or exclude securities, how they view intangible assets, such as Goodwill. And investment strategy was another topic that he covered off beautifully.

We also looked at some of the big changes at Dimensional has made over the years and how they manage portfolios. It was also super interesting to hear him describe the commonalities between aeronautics, which was his initial formal training and asset management. Then at the end, he also explained why he has his own financial advisor and that was Gerard O’Reilly, Episode 198. Such a great episode. I’m sure I’ve listened to it half a dozen times.

Ben Felix: It’s a great one to revisit. He ran circles around the questions that were hard questions and he deconstructed them. Like you said, he built the answer from the ground up, and it was just so incredibly clear. It’s kind of a thing at Dimensional to be like a PhD in aeronautics, or engineering, or whatever, and then arrive at Dimensional, and learn finance from Fama and French. It’s pretty cool.

Cameron Passmore: But to bring your brain to a different problem, which is so interesting, how they analyze the problem, and then just deconstruct it from the ground up. There were some answers that he gave to those complicated questions that you had for him. But I think the answers are five, seven, maybe even longer than that minutes long.

***

Cameron Passmore: Okay, so let’s jump to a book review, which we’ve not done on our own in a while. This is a book I know you will love. It’s called Brave New Work: Are You Ready to Reinvent Your Organization? by Aaron Dignan. This is a book that was recommended to me by a friend of mine, Jeff in LA, who heads a wealth management firm down there. The author is the founder of The Ready, which is a global firm that helps companies adopt what he calls new forms of self-organization and dynamic teaming. So it is a very interesting book and challenges many of the ways that companies that we all work in have been structured over the years. Whether or not you have a role on leadership, this book really makes you think about how organizations might be able to operate. It’s not necessarily like it is in the past.

He gives examples over the past 100 years. So many things have changed, be it houses, cars, fashion, telecommunications, but he says many of the techniques of how companies are built and managed hasn’t changed a bit. Information flows up, decisions flow down. There’s a place for everyone in the org chart, and everyone in their place. Somehow, he argues this way of operating, solving problems, and organizations has simply just stayed consistent for many years.

He gave a great example in the book of a framework to think about, which is the roundabout. So instead of using traffic lights, think of how a roundabout works. So in roundabout cars, enter into this roundabout and share this connection device. It takes whatever, four different directions of traffic, and people just feed into it. They know how they work, they learn to trust one another, they interact with one another, then they keep going on the other side of the roundabout. Dignan suggests that this is a great metaphor for how organizations can operate. For example, you don’t need a traffic cop at a roundabout, people get it. I’m not saying everyone’s perfect at it, I’m not suggesting that. But by and large, people get how roundabouts work.

In the working world, the cop in the traffic lights, or if there was a cop at that roundabout, that’d be the manager in a business. The book suggests that we should think about a world without traffic lights, and those would be, budgets, plans, quarterly results, and said that we should really question how businesses operate, and try to think of them more like a roundabout. Not only is this possible, but he gives a number of examples where this is actually happening in organizations around the world, where they have huge operations, lots of skilled people delivering services with very lean levels of management.

That was pretty cool to look at the examples he gives. It’s interesting because he talks about how people need to be complexity-conscious. Complexity is different than complicated. A car is complicated, software is complicated. But if cars are built right, a software is built right, you know what the outcome is going to be. People are complex, people are adaptive, you never really know how things are going to work out when people are involved. But we try to manage in current organizations, people like software and cars, it doesn’t work as the argument he puts forth.

So he says, stop trying to manage people like software, they’re complex. So his basic premise in there is that, humans, people have an innate desire to fulfill potential and that people are naturally motivated and capable of self-direction, much like people going to a roundabout. They’re worthy of trust and respect. So external control, and the threat of punishment are not the only means to bring people together to accomplish things. This means, eliminating the view that people are like software and cars.

Here’s a quote from the book. “The average human being learns under proper conditions not only to accept, but to seek responsibility. The capacity to exercise a relatively high degree of imagination, ingenuity, and creativity, in the solutions of organizational problems is widely not narrowly distributed in the population. But to accept this, we need to realize that our way of working is completely made up.” This is the big point that differ in the book. “The structures that many organizations are set up as is made up.” He said, “This isn’t the way it has to be.” Another quote that he gives is that, policies are organizational scar tissue. They’re codified overreactions to situations that are unlikely to happen again. Their collective punishment for the misdeeds of an individual in the past. Super interesting stuff. I know you’re all over this. Framework and view of the working world. He then goes on to talk about the difference between job satisfaction and job dissatisfaction.

For example, pay does not lead to satisfaction. However, it does reduce dissatisfaction. Pay is not a motivator, he argues. Satisfaction comes from motivation, and motivators are things such as recognition for achievement, meaningful, interesting work, involvement in decision-making, and advancement of personal growth. You increase satisfaction by improving the nature of the work.

Ben Felix: Sounds like Dan Pink.

Cameron Passmore: Very much. Absolutely. Master, autonomy, purpose framework. Addressing factors such as company policies, job status, and security. Supervisory practices, and salary, and benefits reduce dissatisfaction, but do not increase satisfaction. So this means increasing salaries that are too low can reduce job dissatisfaction. But increasing salaries that are already generous won’t increase satisfaction in any meaningful or lasting way. Compensation is basically a hygiene. Don’t mistake it for a higher purpose. So here’s some things that you can do to make this a little more practical. Enable people to make decisions, give them permission, give them attention, work to step out of people’s way. Let them learn and have a chance to show their drive and creativity in finding solutions.

If you’re leading people, quiet your inner voice. The one that might judge or step in and give direction. Master and control your ego, we’ve talked about that in the past. You do not have all the best answers and people want to help make the world better. Try new things. Ask bigger questions instead of judging. Get out of evaluating all the time and judging. Be the roundabout. People are not cars, nor software. Great book.

***

Cameron Passmore: Okay. Let’s go to the after show. Been quiet on the review and hearing from people in the past couple of weeks. But if you’re enjoying the podcast, we’d love you to go and review it and perhaps give it a rating as many stars as you’re willing to give us, I guess, would be nice, because it does help other people find it. Upcoming guests, we’ve talked about Scott. Scott Cederburg is next week. Then in two weeks, we have the Year End Show, and then to kick off in New Year, very exciting to let you guys know that Academy Award-winning filmmaker, Errol Morris will be here to talk about a pretty cool movie that’s coming. We’ll have more news on that as we get closer to that date.

If you want to get a kickstart on reading some books for next year for the guests that would come up, you might want to check out Morgan Housel’s new book, Same as Ever. Morgan is coming up in January. Also, Scott Rick’s new book called tightwads and spendthrifts. So I’m going to dive into that over at Christmas. I’ve already read Morgan’s book, which is excellent. But Scott’s book is also coming up. Also, in the new year. For those that follow the debate on X or Twitter, we have the retirement income. I think some would say the dream team coming here inspired by little dust-up between Dave Ramsey, and I guess we call it the goobers in the basement. We’re having three incredible goobers here, Dave Blanchett, Wade Pfau, and Michael Finke are joining us, which should be very interesting, Ben.

Ben Felix: I don’t even know what to do to prepare for that conversation. A lot, I guess is probably the answer.

Cameron Passmore: Any one of them on their own is no joke. The three of them, that’s a pretty good lineup.

Ben Felix: It’s the dream team, like you said.

Cameron Passmore: They’re good guys. It’ll be good conversation. Anything you can touch on in the community?

Ben Felix: It’s been pretty active lately with some really good conversations on housing, and also on Scott Cederburg’s research, because I posted the paper in there a while ago. Then, we had our episode on this a couple of weeks ago on that paper, basically. So some really good, deep conversations going on in there, which Scott has participated in. Lots of good questions, lots of good answers. I anticipate more of that when Scott’s episode comes out next week.

Cameron Passmore: Love it, 24 in 24, the reading challenge will continue next year. So Angelica and the team had been working on the badges and the rewards for that, which will be fun. We’re also going to be looking for new merchandise in the store to kick off next year. And make sure everyone looks out for Dan and the Loonie Doctor, Dr. Mark Soth’s new podcast, Money Scope. I guess you can find that wherever you find your podcast currently, ben.

Ben Felix: Yes, it’s dropping tomorrow. It’ll be on podcast platforms. We’re putting it up on Lipson, which is the syndication platform. So it’ll go out to all the podcast platforms. It’ll be on YouTube, we’ll put a link to the YouTube channel in the notes and description for this episode. So you’ll be able to go and check out the YouTube channel and subscribe there. Then, the website is moneyscope.ca. As you heard, Mark and I talked about, we’ve put a lot of effort into making the web pages, really easy-to-use resource to dig through, because it’s a massive amount of information that we’re discussing in the podcast episodes.

But we’ve really tried to make it easy to navigate through the transcripts so you can find if you’re looking for a specific thing that you can go and find that. We wanted to make it easy to access different pieces of information as opposed to having to listen to a full episode to learn one specific thing.

Cameron Passmore: Awesome. Anything else going on?

Ben Felix: The Money Scope podcast, that combined with – I’ve revived my YouTube channel. That’s been going on. People may have noticed that I started making videos again.

Cameron Passmore: see you repackage your dollar cost averaging thread into a video, getting lots of traction this week.

Ben Felix: We talked about that paper on Rational Reminder years ago, probably when we did it, which was 2019. I did a thread on it on Twitter more recently and people loved the thread, so I had been meaning for a while to make it into a video, which I did and people seem to be enjoying that. But I’ve done a bunch of new videos in the last few weeks, so that’s been going on. Between that and Money Scope, Rational Reminder, and my other jobs at PWL, it’s been pretty busy.

Cameron Passmore: The other book I forgot to mention that I just finished, and I suspect you finished as well is The Fund. Rob Copeland’s book about Ray Dalio and Bridgewater.

Ben Felix: That was crazy.

Cameron Passmore: So Rob’s coming on the podcast in the new year. Wow, what a book! What a story!

Ben Felix: I’m biased. I’ve always felt like there was just something not quite right with Dalio. A lot of people look to him as an oracle and a genius. Maybe he is in some ways. It never quite felt right. And there are a couple of academic papers who have taken jabs at him. One paper on gold takes a jab at some of his comments that he’s made on gold in the past, and basically say why he logically can’t be correct. Then, Neil Ferguson, in one of his books that I read, also takes some very critical jabs at Dalio’s. Between my own spidey sense and the things that I’ve read, I always wondered. But this book really deconstructs the whole phenomenon.

Cameron Passmore: That’s putting it mildly. Neil Ferguson goes to visit Bridgewater. The stories in there, and that did not go well, not to steal the thunder from the book.

Ben Felix: That made me realized why that made it into Neil’s book. Why isn’t Neil talking about stuff Ray Dalio said?

Cameron Passmore: Now, it makes sense. It’s an incredible book. It’s incredible story. Just a story of it. It almost seems like fiction. Some of the stuff is so outrageous.

Ben Felix: I listened to it as an audiobook. It was a very enjoyable. Every free moment I had, I was putting my headphones on listening to it.

Cameron Passmore: I have a lot of books backed up just to get ready for these interviews. We have Justin Breans coming up in the new year. So there’s his book. There’s Jim Benson coming up in time management piece, another book. We have a lot going on, so it’s going to be a high energy, lots of great content to kick into the new year. Not only this year ended on a downer, we’ve been unreal guests to finish off 23. So just keeps on rolling.

Ben Felix: Yes, it does.

Cameron Passmore: Thanks, everybody, for listening. We appreciate your support. Have a great week.

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