This article is original content written by Manchester, CT Financial Advisor Thomas Scanlon, CFP®, CPA
When reviewing their investment portfolios, investors frequently focus on the wrong item—the rate of return. Where should you start? You should center your attention on the areas that are under your control.
The Amount of Money Saved
The amount of money you save forms the basis from which you will accumulate your future net worth. Without savings there is really nothing else to talk about. There are many books, websites and software to help you out with a budget. If any of those tools are not for you, try using my favorite—the good old-fashioned #2 pencil and paper. The purpose of your budget is to find a way to pay yourself first. Many of us have the opportunity to do this by contributing to a retirement plan at work. You can save a fixed dollar amount or a percentage of your gross pay every month. The primary benefit of investing every month is to take advantage of dollar cost averaging. When you dollar cost average, you are investing a fixed amount of money every month irrespective of how the market is performing. Investors are reminded that dollar cost averaging does not assure a profit and does not protect against loss in declining markets. Since it does involve continuous investments in securities regardless of fluctuating markets, investors should consider their willingness to continue purchases during market downturns. By doing so, you are buying more shares when the market is down and fewer shares when the market is up. The amount you save has become even more critical in the current market environment. We can no longer count on getting a 10% (positive!) return every year. You always need to be ready for A Bear, A Bear, A Bear. When the stock market declines, people are constantly asking us for advice as to what to do. One answer to this question is quite simple—save more. Remember, Only The Thrifty Survive.
The Time Your Assets Are Invested
It’s an old saw, but the early bird really does catch the worm. We can’t turn back the clock, so we need to start now. Trying to “save up” to invest does not work for most investors. You are better off saving and investing on a monthly basis. This is where it pays to have the long view. Like Diet and Exercise, this may not be easy but it is necessary.
Your Asset Allocation
Other than the amount you save and the time these funds are invested, asset allocation is the next major contribution to expanding your net worth. The Brinson, Hood and Beebower study found that 94% of the returns you achieve are related to the asset allocation model you select.¹ That sure is a big percent! What’s the big deal? Well—just about everything. Your allocation needs to be monitored and rebalanced so you can stay on course. Unfortunately, many investors found out the hard way that their portfolio should not be
The primary driver of your asset allocation will be the issue of when you need the money. A portion of the money that is not needed for more than ten years should likely be invested in the equity markets. Keep in mind—when calculating your asset allocation, you should combine all of the accounts that you have and treat all of your investable assets as one portfolio. Many married couples may have many different accounts.
Each spouse may have a 401(k), an IRA, personal investment accounts, and 529 College Savings Accounts set up for their children’s education. All of these accounts should be considered when monitoring your allocation.
Taxes and Investment Expenses
Taxes and investment expenses can eat into the wealth you are trying to create. Taxes can be increased by short-term trading and not by maximizing the tax-deferred and tax-free investment vehicles that are available to you. It helps to know How to Use The Tax Code to Retire In Style.
What’s an investor to do? First, trade less. This is helpful in reducing the income taxes. Of course tax efficiency is not an issue with funds in tax-deferred vehicles such as 401(k) s and IRA’s. Second, monitor your investment expenses.
Out of Control?
What is out of your control as an investor? The one thing people worry about most—the rate of return. Is the rate of return really out of your control? Not entirely, but much more than you think. Most importantly, monitor your asset allocation (see above). Beyond that—the market will give and the market will take away.
Keep in mind that when the market opens for trading, some days will be up and some will be down. The long-term (think 50 years here) trend, however, has been up. This means you need to block out all of the “noise” that occurs in the market. The amount of data that the market generates is unbelievable. You need to develop a system that filters out most of this “information” that is put out by Wall Street on a daily basis. Is some of this data useful? You bet. It just happens to be a very small percent of the total. Unfortunately, monitoring and reviewing the rate of return is the area where many investors will spend most of their time and emotional energy. You should understand Why The Affluent (Mostly) Ignore The News.
Far too much time and energy is expended on an investor’s portfolio that is not productive. You will enhance your portfolio by focusing on the items that you can control. Identify your goals and objectives. Start a savings and investment plan early. Take advantage of dollar cost averaging and monitor your asset allocation. If you take all the time spent thinking about and monitoring the rate of return and put it toward the four controllable factors, you will be much better off.
If you would like help controlling your destiny, give us a call at (860) 646-1515 or e-mail Thomas.firstname.lastname@example.org
¹Gary P. Brinson, L. Randolph Hood, and Gilbert L. Beebower, “Determinants of Portfolio Performance”, Financial Analysts Journal, July-August 1986