These days, Americans are living longer, healthier and more productive lives. Thanks primarily to advances in medicine, healthcare, and overall quality of life, average life expectancy has risen steadily and dramatically over the past 50 years. Forty percent of retirement-age men will live to be at least 85, and fifty-three percent of women that age will live to be at least 88. Overall, the average life expectancy in the United States is now 78.6 years, up from 69.7 years in 1960. Retirees and seniors living longer, healthier lives would appear to be a good thing for everyone involved, right? Not so fast, my friends. Without planning properly for it, living long into your “golden years” could quickly go from something you’ve dreamed about to a complete nightmare…particularly if your money dies before you do!
As we’ve discussed in previous articles, planning for your family’s financial security is a multi-faceted endeavor. From investments to insurance, the probability that you (and your spouse and children) are going to live longer adds a few new wrinkles to that planning process. Below are some suggestions for maximizing your financial security for a longer life expectancy.
Re-think “retirement”: It should seem fairly obvious that the longer you live in retirement, the more money you’ll need to…live in retirement! If you’re approaching traditional retirement age, you may want (or need!) to consider ways of forestalling living off of your retirement savings. For example, can you re-career or work in a more limited capacity for several years beyond traditional retirement age to supplement your income? Can you adjust your investment strategy or portfolio to maximize those additional years spent in the workforce? If you’re a younger investor, can you adjust the scope of your investment strategy, or your career arc, or both, to take into account working longer into your “retirement” years?
Plan for the long, long haul: With the help of a certified financial planner, map out a plan for a retirement period that lasts well into your 80s, and perhaps even into your 90s. Strive to understand the implications of long life expectancy on the principal balance of your nest egg; your goal should be to formulate a plan which allows you to live off a reasonable income stream for as long as you can before spending down the principal balance of your investments. Remember that time, in this instance, works just as easily against the value of your portfolio as it does in favor. Although we don’t mean it negatively in this sense…plan for the “worst-case scenario!”
Consider “longevity insurance”: Like a private pension - longevity insurance is another option for retirees seeking to turn their savings into a steady income stream throughout retirement. Unlike other strategies, annuities can offer a guaranteed income stream that will last as long as you and your spouse live if set up properly. With an immediate fixed annuity, you “buy it, set it and forget it.” As long as the insurance company remains solvent, annuity owners generally get a check for the same amount every month – they can even set up payments to last as long as they live, so that the longer they live, the more valuable the annuity becomes. They can also be set up to continue to pay to the surviving spouse in the event of death. Consider diversifying your investment strategy to include fixed-income annuities as part of your “worst-case scenario” planning.
Once you understand where you are financially (see my last two articles on Net Worth and Cash Flow), you should consider protecting your family. Purchasing life insurance is a solid financial decision. However, because every family’s circumstances are different, choosing the best policy requires some planning and research. There are some basic questions you can answer that will help get the process started: Why purchase it? How much do you need? Which type best fits your needs? Which companies offer the best policies? Let’s take a look at each of these questions below.
The most common use of life insurance is to ensure family stability after the insured has died. Life insurance policies can also be used to pay for funeral expenses, estate taxes, charity or the transfer of a business. There are many uses for life insurance; think about how you want your life insurance policy to work for your specific situation to determine how much and what type to use.
When purchasing life insurance to protect the family, carefully consider the projected annual living expenses of the survivors. If you have children at home, factor in the amount of lost income needed to sustain the household. For example, survivors usually need immediate help paying off the big bills such as the mortgage, expected college costs and other family expenses. Adding up these costs will give you the amount of insurance the family needs. These calculations should be done for each spouse to ensure that both have a death benefit sufficient to protect the survivor and family. Quick financial recovery from the stress of the death of a spouse leaves the survivor debt free and able to make an easier transition into the new life circumstances. Of course, a large number of variables will come into play here. Look holistically at your circumstances to best determine how much coverage you should purchase.
Life insurance policies are available as permanent or term. Permanent life policies typically pay a fixed amount upon death, and normally contain an investment vehicle that allows the cash value to grow, tax-deferred, over the life of the policy. You pay a fixed premium for the policy for as long as you own it. Term life policies don’t include an investment vehicle; they simply offer varying levels of coverage based on age, health, and desired monthly premium. With term life, you’re paying purely for protection.
Simply put, permanent life insurance is expensive and term life insurance is cheap. There are many other investments to choose from, so it’s not necessary to buy life insurance that does both. The goal is to provide indemnification (protection) in the event of a death. For family protection term policies provide the most protection for the least cost.
There is no shortage of companies selling life insurance. Fortunately, there are agencies which rate those companies on things like financial strength and willingness to pay claims. Stick with companies which get top ratings from Standard & Poor’s and A.M. Best.
Answering these basic questions should give you enough of a head start to have an informed conversation with an agent or financial professional about your exact needs, and the types of life insurance products available to match them.
You’re probably familiar with the term “rightsizing” from its common use in corporate America, where it usually describes a situation in which an organization makes changes to the corporate structure, such as reductions in workforce or reorganization of management, with the goal of restructuring the business so it performs optimally. (This process used to be called “downsizing,” a term which has taken on an almost universally negative connotation, and has thus been replaced by the far-friendlier term we’re using here.) What you may not be familiar with is the concept of rightsizing your investment portfolio so that it provides both a vehicle for achieving your financial goals AND giving you security and peace of mind. Rightsizing a portfolio is especially important for DIY investors; if you’re managing your investment strategy without the help of a professional advisor, it really does pay off in the long run to understand how issues like liquidity, asset allocation, and diversification can impact your money, and your security, in both the short run and over time. Below, we discuss several of these topics, and offer practical advice for effectively rightsizing your investment portfolio.
The guiding principle for rightsizing your portfolio should sound familiar if you’ve read any of our other blog posts about the “4 Rs” of DIY investing: careful, judicious, and realistic planning is the cornerstone of putting together a rightsized portfolio. There are many unfortunate stories of DIY investors chasing unrealistic performance benchmarks, putting their money at risk by “getting in over their heads” and over-leveraging their liquidity, or not effectively planning for the fact that different asset classes generally perform differently (i.e., stocks and bonds usually don’t move in the same direction!). We hope that you don’t become one of these unfortunate stories, and we offer the following tips for effectively rightsizing your investment strategy. These are drawn directly from our experience managing our clients’ portfolios, and generally summarize our professional approach to making sure that our clients get the returns AND security they want and need.
Leverage your liquidity wisely
This piece of advice might seem self-evident: invest only what you can afford to invest, given your current life circumstances. Alas, we regularly see and hear of scenarios in which DIY investors over-commit themselves, usually in an attempt at “out-performance,” and run into serious financial issues when their investments underperform (sometimes dramatically) or market conditions fluctuate unexpectedly. Risk tolerance is a focal point of rightsizing a portfolio. Apply a realistic, even conservative, risk tolerance metric to your current liquidity scenario and review and revise it often. As we’ve mentioned before, your investment strategy should be formulated according to your long-term goals, but must be realistically linked to your current station in life. A truly rightsized portfolio begins with knowing that you can afford to fund it without compromising your family’s short-term financial security.
Asset allocation is critical
Generally put, the concept of asset allocation is simply a strategy for deciding which investment products represent the best options for reaching your financial goals and adhering to your risk tolerance threshold. Common asset classes include stocks, bonds, cash, and U.S. Treasury securities. More specific products, like lifecycle funds, bond funds and good old stock mutual funds also exist within these broader categories. Specialized asset classes like private equity funds, real estate, and commodities like gold and other precious metals are also available, but less likely to be a large part of the average DIY investor’s portfolio. Realistic asset allocation is a critical factor in the success of any investment strategy. As the old saying goes, putting all of your eggs in one basket rarely works well; if you lose the basket, you lose all of your eggs! Historically, bonds, cash, and stocks have been the bedrock foundation for most asset allocation strategies, as the relative fluctuations of these asset classes tend to balance each other out quite effectively in both short- and long-term scenarios. Specialized assets can be added to or removed from a portfolio as goals, and markets, change. At ACM, we practice asset allocation stridently, offering our clients diversification across the five major market categories. We can’t overemphasize the importance of understanding asset allocation, and realistically selecting asset categories that match your goals, means, and appetite for risk.
Diversify, diversify, diversify
Most reasonably-educated DIY investors recognize intuitively that portfolio diversification is a “no-brainer.” What many investors don’t realize is that effective diversification takes place at multiple levels. A solid portfolio is diverse at both the macro and micro levels. For example, it’s just as important to diversify within an asset category (i.e., funding both individual equities AND equity funds) as it is to diversify across asset categories (i.e., funding stocks AND bonds). Furthermore, it’s possible to diversify even further within asset classes by focusing on specific markets, industries, and verticals. If your risk threshold permits, you may want to add some specialized assets to the mix. (If this makes sense to you, you’ve probably already realized that this process involves a lot of research. Diversification at both the macro and micro levels helps greatly to buffer your portfolio against the inevitable market fluctuations that come with long-term investing. If you don’t have the time or wherewithal to “deep dive” into diversification, some firms offer products known as lifecycle funds, which target specific investment goals like retirement or college planning and “automatically” adjust diversification strategies over the term of the fund. Lifecycle funds can be effective diversification tools for some DIY investors, but we’ll point out again that adopting a lifecycle fund makes sense only if it’s not an “eggs in one basket” strategy.
Whether you’re just starting out or have been managing your own money for years, it’s never a bad idea, nor is it ever too late, to apply the principle of rightsizing to your DIY investment strategy. If you’d like to learn more about our strategies for rightsizing our clients’ portfolios, we encourage you to contact us to schedule a free consultation today.
If you’ve spent any time searching for financial advice online, you’re surely aware that the Internet is replete with Squawkers, talkers, gawkers, and hawkers. From big-company websites to late-night infomercials, there is no shortage of available advice, opinion, and research. Giant financial services firms use it to sell their (highest-margin!) products and services, “unbiased” advice websites use it to drive clicks and sell advertising (usually for the giant financial services companies), content aggregators package and feed it through various social media outlets, and talking heads use it to make themselves look smart on TV. Some of this information is solid and valuable; some of it is not. Some of it is shockingly bad. Most of it is free; some of it is parked behind paywalls. On the whole, the widespread availability of financial research is a good thing for DIY investors, but the mind-boggling number of outlets and options can make even the most stalwart consumers scratch their heads in bemusement (and/or bang them on whatever hard surface happens to be nearby).
The value of personally researching financial instruments for your portfolio is (or should be) self-evident. After all, it’s your money, and if you’ve chosen the path of managing it yourself, it’s wise and prudent to understand as much as you can about how various instruments and markets perform. Markets change, strategies change, economic fortunes change, and risk is everywhere. Outside of partnering with a certified financial planner like Atlantic Capital Management, the willingness and ability to get down in the weeds and research your investments is probably the smartest move you can make if you’re going to manage your own money.
At ACM, we use high-level aggregate analysis of the five major market sectors (domestic and international equities, fixed income, real estate, currency, and commodity and cash equivalents) as the cornerstone of our research methodology, and we incorporate that analysis into all of our client interaction, individualized for every portfolio. (If you’d like to learn more about our investment methodology, you can do so here.) DIY investors sometimes partake in high-level analysis, but our experience shows that most DIY investors tend to focus more on the practical, tactile issues surrounding things like ratings, performance benchmarks, and sector trend analysis. With that in mind, we’ve prepared some useful tips for getting the most out of your research, which you’ll find below.
(As a caveat, we’ll take a moment here to mention that in general, we don’t subscribe to an investment strategy which is focused on “out-performance.” In our view, simply benchmarking against performance indicators doesn’t provide enough context for the management of a truly individualized portfolio. As we’ve said before, focusing solely on “out-performance” gets a lot of people in trouble, because the drive to artificially adhere to an arbitrary performance standard wreaks havoc with a risk tolerance strategy. In a lot of ways, an investment strategy focused on “out-performance” is a lot like stereotypically trying to “keep up with the Joneses.” Most of the time, your own grass is plenty green enough.)
Cross-check opinions and advice from various sources
Treat your research as due diligence. Invest the time necessary to cross-reference advice and opinions relevant to your risk tolerance, asset allocation, and performance strategies. You’ll find that a lot of investment advice, even from reputable firms, has a certain “flavor of the month” aspect to it. If a particular strategy catches your eye, and fits into your various profiles, double-check it for a consensus (or non-consensus) opinion. Try to find practical examples that line up with your approach and expectations. Where possible, directly solicit opinions from others.
Consider the source
Marketing is a necessary evil of the financial services industry. Unfortunately, so is hype. The industry is so crowded with players, big and small, that the penchant for trying to “stand out in the crowd” is prevalent even for the most conservative firms. The “big guys” have a relentless drive to churn out more new products and services every day. The “little guys” often follow along in an attempt to look bigger and more influential. The pundits and talking heads are tasked with capturing clicks, eyeballs, and viewers. Truly objective research is hard to come by. Our advice is to rely as often as possible on the “neutral” information sources like FINRA (Financial Industry Regulatory Agency). That’s not to say that good advice can’t be gleaned from the Charles Schwabs, Fidelitys, and INGs of the world, nor is it to say that the “boutique” investment firms aren’t providing good information, either. You may genuinely be able to gather some good advice from those sources. But remember, that research is designed to sell products and services, not necessarily to inform you on how to best manage your family’s nest egg. Be critical.
Consider paying for it
If you’ve chosen to bypass the services of an investment firm like ACM in favor of doing it on your own, you may want to consider paying for access to high-quality, less-biased (notice we didn’t say “non-biased’) research. Services like Morningstar Premium provide a plethora of “independent” research for a fairly low subscription fee (although you’ll still see plenty of ads for the big financial firms even behind the paywall).
Don’t rely solely on ratings
This is particularly true for equities. Ratings and “stock screener” tools are great for aggregating snapshot research into an easily-digestible format. But ratings and stock screeners are essentially a “one-size-fits-all” proposition. Use them to supplement honest, detailed, and relevant research and advice. Avoid the tendency to over-rely on dashboards and other simplistic widgets. Always make sure that what you’re seeing corresponds to your risk tolerance and overall investment strategies.
Doing your own portfolio research can be an interesting and engaging pursuit, albeit with some pitfalls and things to watch out for. Be wide-ranging, be critical, be diverse, and make sure you’re always benchmarking your research against your goals, strategies, and risk profile.
“Only a very brave mouse makes a nest in a cat’s ear.” -- Danish proverb
The concept of risk tolerance, while fairly simple for most folks to grasp, is nonetheless a core foundational concept in DIY (do-it-yourself) investing that really shouldn’t be taken lightly. Many DIY investors give risk tolerance a cursory nod while putting together their portfolio strategies, or spend a little time online taking one of the generic risk tolerance surveys that can be found at various financial research and opinion sites. Younger investors often make the mistake of discounting risk tolerance altogether, rationalizing that large fluctuations in an aggressively risky portfolio can be “smoothed out” over time…after all, they’ve got a lot of years of working and investing ahead of them, right? Older, more established investors sometimes overlook the importance of risk tolerance because their asset mix is better developed; they may not worry too much about the risks inherent in their equity-heavy portfolios because they have other, more stable assets (real estate, for example) on hand. Fundamentally, both of these rationalizations are only partly problematic. Younger investors usually DO have more time to experiment with higher-growth, higher-risk investments. Older investors usually DO have a stronger mix of assets and/or higher income potential, mitigating the possibility of being completely wiped out by an equity-heavy portfolio that performs poorly in bad market conditions. The real issue at hand for DIY investors isn’t really tied to economic circumstances or station in life so much as it is tied to the willingness to withstand the emotional and mental peaks and valleys that come with investing hard-earned money in an industry that’s fundamentally, well…risky.
Our investment philosophy is first and foremost governed by processes and practices which put an emphasis on effectively managing risk. Beyond advising clients directly about the varying levels of risk tolerance that might be suitable for their purposes, all of our back-end processes are built with risk-managed investment firmly in mind. (You can get a good overview of our investment methodology by clicking here.) We strongly believe that no family, whether they are investing with Atlantic Capital Management, Inc. or striking out on their own, should throw caution (and money!) to the wind when it comes to evaluating the tolerance for risk. Below, we’ve outlined two important things to consider when formulating a risk tolerance strategy for a DIY portfolio.
What am I willing to lose?
Like it or not, this is the fundamental question at the heart of establishing a risk tolerance strategy. Given your current and predicted future income scenario, your lifestyle needs and expectations, and your personal willingness to hold off on pushing the “panic button” when things start to go south with your portfolio (as they inevitably will), what kinds of losses are you willing to bear while you weather the ups and downs? To put some real-life “oomph” behind this question, consider the following research from Wells Fargo: during the precipitous market decline from 2007 through 2009, equity portfolios and equity-focused retirement plans like 401(k)s lost a little more than 50% of their value. While many of those losses have been made up over the ensuing years, it was a long road back for many individual AND institutional investors. All things considered, could you withstand the loss of 50% of your equity positions? 20%? 10%? As food for thought, let’s revisit our “younger vs. older investors” scenario from above.
If you’re in your late 20s or early 30s, making headway in your career, and enjoying the benefits of having a two-income household, you might realistically be able to say that losing 50% of the value of a “high-growth” portfolio is something that you could withstand. (Although we bet you’d say it through clenched teeth!) After all, you’ve got a long road ahead of you, and “a rising tide lifts all boats,” as the financial pundits are wont to say. But what about your non-retirement investment strategy? What if the portion of your portfolio you were setting aside for your child’s education expenses dropped by 50% the year before you needed to access it? That would very likely make a significant impact on your plans to fund at least the first couple of years of college or private school. Under those circumstances, your tolerance for risk, which would normally be fairly high given your station in life, suddenly becomes a significant factor in potentially limiting an important life goal.
In the wake of the economic meltdown outlined in the research above, we heard many stories of people close to retirement age who watched with shock and dismay as the value of their retirement accounts plummeted. As mentioned above, it’s not uncommon for older, more seasoned investors to have a broader mix of assets that can serve as a shelter from the storm in times of crisis. Consider, however, the double-whammy of declining portfolios and free-falling property values, which affected nearly everyone in the wake of the 2007-2008 fiscal crisis. In Massachusetts, for example, average property values have fallen 15.7% since 2007, with many communities north, west and south of the city seeing declines as high as 39%. Suddenly, investors who were counting on weathering the storm by leveraging their low or no-mortgage real estate assets have a much smaller safe harbor than they originally thought they would!
Regardless of where you are in life or in your investment planning process, we can’t overstate the importance of asking yourself, with all of the realism (and maybe even some pessimism) you can muster, what you’re willing to lose as you chart your risk tolerance course.
How do I develop a risk tolerance scenario?
Developing a risk tolerance benchmark for a DIY portfolio can be tricky. Fortunately, there are some fairly good free resources available which can help you do just that. (Alternately, if you’d like personal assistance with creating a risk tolerance profile, we’ll be happy to provide a free consultation at your convenience.) The following tools and services are good places to start putting together your DIY risk strategy.
Risk tolerance surveys
Nearly all of the major financial services companies and opinion websites feature risk tolerance surveys. Some of them are fairly bare-bones, while others are interactive and sophisticated. Most consist of a small number of scale-based questions, and produce results that both categorize your risk tolerance and produce suggested asset allocation charts. We generally recommend the more “neutral” surveys offered by organizations like Morningstar and FINRA (the Financial Industry Regulatory Agency), rather than those connected to the big investment firms.
Researching worst-case scenarios
Analyzing the historical worst-case returns for certain types of assets and securities can give you an eye-opening look at exactly how much upheaval you’ll be comfortable with in the event that your investments take a hard or sustained hit. This data is available from numerous sources, including FINRA, the Securities and Exchange Commission, and the Congressional Budget Office.
Understanding asset allocation
We strongly encourage DIY investors to develop a healthy understanding of the concept of asset allocation, particularly as it relates to multi-asset allocation. (Atlantic Capital Management utilizes a proprietary fundamental and technical strategy to define multi-asset-allocation strategies for our clients.) Most of the recommendations you will get from risk tolerance surveys and other types of research focus very heavily on asset allocation because this is a time tested risk management tool. It imposes discipline to the investor and by the virtue of rebalancing, it provides a buy low sell high benefit. Again, we think you’re better off utilizing the more general research found in this area, rather than that espoused by the big financial players, who often have the performance of their product lines, rather than your individual needs, at heart.
All investments carry risks; developing a risk tolerance strategy for a DIY portfolio doesn’t have to. We wish you success in defining this important aspect of your investment scenario, and encourage you to contact us at Atlantic Capital Management if we can be of assistance.
Last month I talked about assessing your need for life insurance to protect your family. This month I want to examine the basic elements of investing. Despite how the “big guys” of financial services industry might like to otherwise portray it, all forms of investment involve an element of risk. Even with the current availability of huge volumes of free research and opinion, managing risk in an investment portfolio is something that many people who take a “DIY” (do-it-yourself) approach struggle with. Understanding the core strategies for developing a low-risk investment portfolio is critical, and can mean the difference between ensuring your family’s financial future or losing most (or all!) of the money you’ve worked so hard for. We call these strategies the 4 “Rs” of Low-Risk Investing, and we present them for you briefly below.
Risk Tolerance: Perhaps no concept is more important to a low-risk portfolio than that of risk tolerance. Clearly defining and understanding your personal tolerance for the risk involved in the investment products you choose is absolutely crucial to a DIY scenario. Are you comfortable with high-risk products like sector-based equities and index funds, or do you want safer but slower-growth products like Treasury Bills and bonds? Determining the right mix of products that meet your personal risk-management strategy is the very first place you should start.
Research: Once you’ve determined your risk tolerance, it’s time to do the research you’ll need to both quantify and adjust your risk-management strategy. You’ll find no shortage of free research on the Internet, but beware: not all research is good research, and some of it is downright horrible! Cross-check opinions and advice from various sources. Don’t rely solely on ratings, performance snapshots, or benchmarks. In our opinion, focusing heavily on “outperformance” gets a lot of people in trouble! Do your due diligence with your risk-tolerance profile firmly in mind.
Realism: It’s important to be realistic about your investment goals, and to build and manage a portfolio that matches them as closely as possible. For example, if you’re in your 20s or 30s, you might have higher risk tolerance for your retirement portfolio than for the investment strategies you need to put your kids through college. Ask yourself “Realistically, given my current and anticipated future circumstances, what can I expect from my portfolio over the next 5, 10, 20 or more years?” Make decisions about the mix and relative risk of investment products from there.
Right-Sizing: Be judicious about how to fund your portfolio. We’ve all heard the stories about people pouring their money into shaky investments, or day-trading it away. Unfortunately, those stories happen all the time. Take the time to think hard about your present and future liquidity, and how that liquidity can be applied to your investment strategy. Benchmark constantly against your risk tolerance, and make adjustments as circumstances warrant.
William C. Newell, Certified Financial Planner (CFP), is president of Atlantic Capital Management, Inc. a registered investment advisor located in Holliston, Mass. With Wall Street access and main street values Atlantic Capital Management has been providing strategic financial planning and investment management for over 25 years.