Financial Optimism: Are You Better Off Than Last Year?

The emergence of real investment diversification empowers our clients

By Herb Daroff, JD, CFP

Let’s not start with investment performance. Instead, let’s look at what are the obstacles and hurdles to a successful financial future.

Cost of health care/custodial care for you, your spouse, children, and grandchildren

Regardless of your investments, your financial future can suffer if you or a family member incurs expensive medical treatments or needs assistance performing the activities of daily living. As Congress attempts to reform how we pay for health care, we have not yet really examined how we go about keeping ourselves healthy and how health care is provided.

Supporting your children (unemployment and underemployment)

After my children graduated from college, step one was making sure they were employed. Step two was making sure they had health insurance. The issue for many is that IF the kids find employment, does the job provide sufficient income to cover their costs of living? Will part of the parents (or grandparents) retirement income be needed to help financially support other family members?

Educating your children and/or grandchildren

Once educated, there are still the outstanding loans to pay. Funds set aside for helping to education children (and grandchildren) reduce the dollars set aside for retirement or come from funds that were earmarked for retirement.

The future of Social Security

Will Social Security become an add-on income only for those who have not otherwise saved for retirement? Will we, in essence, be punished for having successfully set aside dollars for our own retirement income? These and other discussions are taking place to help cover the costs of providing income for an ever increasing number of those no longer working.

Inflation

We haven’t talked a lot about inflation as interest rates continue in low single digits. However, many costs that we incur are not included in the inflation calculation, including the cost of energy to heat and cool our homes, the cost of educating our children, the cost of health care, etc.

Living too long

Do I have enough money set aside for my retirement? Depends on how long you will be alive and need to tap into those resources.

So much for the doom and gloom. Now, why should we optimistic?

Access to worldwide investment choices and information (real diversification)

We live in an amazing time where information is readily available. The problem is how to decipher the overwhelming amounts of data that cross our eyes every day.

• When do we invest?
  Dollar cost averaging (putting away approximately the same amount on a regular basis into the same asset classes) has been institutionalized with 401(k) plans. This is a proven strategy for accumulating retirement assets. Each period you buy a differing amount of each asset class since the price of the investment changes. You buy some when prices are high, others when they are low. You don’t try to time the market. Most investors end up buying high (when greed sets in after hearing about how much money others are making) and then selling low (out of fear when they hear about how badly things are going). Of course, all of us would like to buy low and sell high. But, most do not. It’s common nature not to buy a generator during the summer and instead waiting until after a big storm, when prices are sky high. We have to overcome that conventional “wisdom?”.

• In what do we invest?
  Many American investors think that 5% to 20% is more than enough international holdings (companies and governments outside of the U.S.). Many non-American investors rarely hold more than about 40% to 50% of U.S. holdings. So, in essence, they are investing 50% to 60% (not 5% to 20%) international. Some non-American financial advisors use contribution to world GNP in order to select in what countries asset to invest.

Asset allocation re-visited

• Old Asset Allocation = stocks/bond (correlated to S&P500)

All too often, investment portfolios are not really all that diversified. Increases and decreases in value of most holdings are correlated with the performance of specific indices.

• New Asset Allocation = stocks/bonds/alternatives (along with financial hedges)

– options
– stop losses, and
– variable annuity lifetime benefits

Adding other asset classes (real estate, currencies, commodities, etc.) to the investment mix helps to more fully diversify into asset classes that are not all correlated to one index.
Key is chasing net return — not chasing lower fees — first, re-balancing

Re-Balancing

For example: Your risk tolerance directs you to invest your $30,000 equally into asset classes A, B, and C. After some period of time, your $30,000 is now worth $33,000 with A increasing by 50%, B decreasing by 20% and C staying level. Disciplined re-balancing dictates that you re-align your portfolio back to the equal thirds. However, human nature says, “you want me to SELL 4 of my winner in order to BUY 3 of the loser and 1 of the asset that went nowhere?” The advisor says, “that’s right.” The client says, “no way” and puts all the holdings into A (the big winner, looking into the rear view mirror). What happens next? A had its day. After the next period of time, the total portfolio has dropped to 13.
Second, what truly is your risk tolerance or risk capacity? I like to ask this simple question?

•  Suppose you BOUGHT a stock for $10 and then SOLD it at $12.
•  Then that stock, had you kept it, GREW to $15.
•  In your mind, did you MAKE $2 or LOSE $3?
•  The Conservative risk takers (1,2,3) tend to answer, MADE $2.
•  More aggressive risk takers (7,8,9) answer, LOST $3
•  Those who can’t really decide are the moderates (4,5,6)

Risk Tolerance

• If you BOUGHT a stock for $10

• and then SOLD it for $12, but

• after that the stock went to $15,

• did you MAKE $2 or LOSE $3?

Then, you need to recognize that it takes more “work” to keep a portfolio UP than to raise it after it has fallen DOWN.

•  $100,000 dropping by 20% to $80,000,
•  needs 25% growth ($20,000 on $80,000) to return to $100,000

So, in addition to disciplined re-balancing that is consistent with real risk tolerance, we need asset LOCATION