The following is our Practical Top 10 Financial Planning Checklist. Use this as part of your financial planning process.
1) Learn About Investing
You really cannot learn very much about investing by watching CNBC all day. One bullish analyst appears after another touting their choice of company stock picks. Why? Because the stocks they are hyping are great stocks? Well, they may be great, but do not assume they are just because an analyst says so. These analysts are cheerleaders for these stocks. These, of course, are not real cheerleaders like the ones that represented their high school with the mascot of the Donkeys on their uniforms in Average Joes. These cheerleaders promote these companies, in part, so their employer can obtain future business from the company they are currently plugging. Let us hope any conflict of interest was disclosed.
These folks are traders, fund managers and analysts. They are hyper focused on the short-term. The reason for this, frankly, is that is how they are compensated. If you do not produce, you are shown the door. Quickly.
Hopefully, your time horizon is long-term. Exceptionally long-term.
On the contrary, you can learn a tremendous amount about investing by reading books by or about Peter Lynch, Warren Buffett, Jeremy Siegel, and Peter Bernstein. There is a huge difference between information and knowledge.
A staggering amount of information is available to investors. Television, radio, newspapers, magazines and, or course, the internet all bombard investors everyday with the latest news. This news is like salt, we can all use a little less.
Knowledge, on the other hand, comes from understanding what you are trying to accomplish.
Therefore, learning about investing, rather than simply knowing the latest stock quote on Yahoo Finance, will ultimately pay far more dividends—both economic and educational. In fact, by gaining insight into the principles behind investing, you are better equipped to make informed decisions that yield long-term benefits.
2) Save Money Every Month
You have heard the adage, “pay yourself first.” There is nothing new here, just the truth. Invest the money you save every month.
After you have made good progress with your cash reserve fund, accumulating money in a checking or saving account will not help you achieve your financial goals. Put your hard-earned dollars to work for you by way of a disciplined plan of investing in stocks, bonds, and cash. Maximize your contributions to tax deferred accounts like your 401(k) plan and IRA’s. Additionally, if you are eligible, take an extremely hard look at both Roth IRA’s and Health Savings Accounts (HSA’s).
3) Calculate and Protect Your Net Worth
Dr. Thomas Stanley attempted to quantify what your expected net worth should be in his book, The Millionaire Next Door. His formula takes your age, multiplies it by ten (10%) percent, then multiplies again by your pretax annual household gross income. Gross income here does not include any investment income.
For example, a 55-year-old earning $100,000 annually would calculate a net worth of about $550,000 (age 55 x 10% x $100,000 = $550,000).
With the passage of time, the formula is now more regarded more as a rule of thumb. The book was written some time ago, and our old ‘friend’ inflation has kicked back in again. In spades.
Once you have calculated your actual net worth, you need to take steps to protect it. Make an appointment with your estate-planning attorney to update your will, power of attorney, health care proxy and any trusts. Review and update these documents every three years. Why? Everything changes. If you do not like paying income taxes, as they say, “you ain’t seen nothing yet.” The federal estate tax starts at 18% and goes up to 40%.
You also need to protect yourself. Like it or not, we live in a litigious society. Take all reasonable steps to protect yourself. Protect your property with auto, homeowners, and an umbrella policy. Protect your family with life insurance and your income with disability insurance.
4) Do not Own Too Many Mutual Funds or Individual Stocks
Investors that hold individual stocks will need at least 25-30 different stocks across different industries to be diversified. Mutual fund investors would be fine with 7-10 funds. Anything over this starts to become overkill.
One of the goals here is to not become a ‘collector’ of stocks and mutual funds.
The fewer investments you have, the easier it is to understand what you own. Peter Lynch, the former manager of the Fidelity Magellan Fund, said you should be able to explain in one minute why you own a particular stock. If you cannot do this, do not own it. Simple.
5) Avoid Margin Accounts, Options, Specific Stock Risk and Too Much Trading
A margin account is when you borrow funds in your brokerage account to buy securities. Borrowing to invest is also known as leverage. You can borrow up to 50% of the value of your account, although individual custodians may have a lower percentage. The interest rates vary from custodian to custodian, with ranges currently from 6%-12%. As you can see, this money is expensive.
The big caution flag here is if the value of your securities goes down. Borrowing, or leverage, cuts both ways. It is nice when the market is on the way up. It can be incredibly challenging when the market declines.
If your account drops too much, you may have to put cash into the account to stay within the 50% mentioned above. Having to put cash into the account is called a margin call due to insufficient equity. If you fail to put in enough cash to get the equity back to the 50%, your custodian has the right to sell securities in the account to generate the cash to get the equity back to where it needs to be. You do not want to be in a position where you are getting a margin call.
Margin accounts may be fine for so-called “professional traders.” For all other investors it is great way to lose your money quickly.
If you have stock options through your employer at work, that is fine. Otherwise, avoid options like you would with margin accounts. About 30% of options expire worthless. You can lose your money even faster! 1)
Specific stock is having too much money invested into one stock. As a rule of thumb, you do not want to have more that 4% invested into one stock. Said differently, you will need at least 25 stocks across various industries to have a diversified portfolio.
Trading too much is a common problem. Why is this? Well, back in the day, there were commissions to buy and sell securities. This made investors pause before having too many trades. Now, most large custodians have platforms where you can trade and not pay a commission.
So, the convenience when working from home of logging onto your home computer and trading, is, well, tempting. This activity accelerated during the COVID-19 pandemic. You could not head out to the local casino to gamble. Instead, you went online and bought and sold stocks. At the time, many bought meme stocks like GameStop (GME) or AMC (AMC).
Active buying and selling decreases your odds of success. First, you must be right on the stock to buy. Second, then right again when selling it. Finally, paying the income taxes on your capital gains. If you have any. Then doing it all over again.
Wash.
Rinse.
Repeat.
What are the odds of you doing this successfully over an extended period? Low. Extremely low.
A measurement of this buying and selling is called portfolio turnover. This measures the lesser of the number of buys and sells in a year divided by the average value of the portfolio. You want to target low turnover. This is up to about 30%.
6) Do not “Pick Your Flowers and Water Your Weeds.”
Too many investors sell their stocks that are winners (picking their flowers) to “lock in the gain.” These same investors will hold stocks that are down (watering their weeds) thinking they will come back again soon and sell once they are even.
Hello!
Sure, if you own a quality blue chip company that is down in the dumps, for whatever reason, you may want to continue to hold this position. Do you want to continue to hold those Special Purpose Acquisition Companies (SPAC’s), that generated a SPAC ATTACK, many of which are off over 50%? In most cases, the answer is no. The key here is to know the fundamentals of the company. Water your flowers and pick your weeds!
7) Play on the “home field” when investing in individual stocks.
Many investors should use mutual funds and or Exchange Traded Funds (ETF’s) as the cornerstone of their investment portfolio. Other investors cannot resist and want to own individual stocks. That is fine.
However, why is it that some investors who work in the technology field invest exclusively in gold mining stocks? Or investors that work in the pharmaceutical industry “specialize” in technology stocks? And what about those bank executives that invest in biotechnology shares? Does this make any sense to you? It does not to me either, but this seems to happen frequently.
Use every (legal) unfair advantage you have when investing. If you work technology, why not invest something into the technology sector. You probably know more about the strengths and weaknesses of Amazon (AMZN) and Apple (AAPL) than most of the Wall Street analysts.
This is not to suggest that someone working in the technology space should avoid all other industries and just invest in technology stocks. Far from it. It is just to say that if you are going to invest in individual stocks, play on the “home field” and focus on areas where you should have an inherent advantage.
8) Do Not Follow the Herd
Investors have tendency to follow the herd. One of the more recent examples of this was with meme stocks. Now it is anything, and everything related to artificial intelligence (AI).
If you want to read an excellent book about many past crazes, check out Extraordinary Madness and Popular Delusions by John Mackay. One interesting event depicts the Tulip Mania in Holland in the early 1600’s. The story indicates that many times, physical bulbs did not change hands. Often, there were contracts issued for future delivery. The mania reached its apex when some bulbs were worth more than a house.
Repeat, some bulbs were worth more than a house.
Talk about irrational exuberance! As you would expect, it did not end well.
Do not follow the herd. Find your own grass to graze on.
9) Get Help
Time is very stretched to the limit in today’s fast paced society. Career, family, and community involvement can rapidly fill up our day (and night). Unfortunately, this leaves truly little time to create and monitor your financial plan. Seek out experienced professionals that you feel comfortable working with and trust.
10) Be Patient
This easily could have been the first item on this checklist. The returns from the stock market decade plus have been intoxicating to say the least. According to reversion to the mean, the returns going forward will be more subdued. That is OK.
Patience is a virtue with investing. This is difficult to practice in our instant gratification society. Often the best course of action is to do nothing. Just sit tight.
Action Item
If you need help with The Practical Top 10 Financial Planning Checklist, call Thomas F. Scanlon, CFP®, CPA at (860) 645-1515 or E-Mail Thomas.scanlon@raymondjames.com.
This is original content written by Manchester, CT Financial Advisor, Thomas F. Scanlon, CFP, CPA.
The post has been updated from its original published date of July 6, 2023.
1) Quantifiedstrategies.com – July 12, 2024
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