Archive for the ‘Financial Well-being’ Category

Why do we invest?

Friday, November 16th, 2018

Why do we invest? A cursory review of popular financial media and financial industry marketing materials would lead one to believe that we invest because we want to “beat the market”. Whether it’s an index fund or other “passive” strategy claiming that the market can’t be beat (if you can’t beat ‘em, join ‘em), or an actively managed fund or strategy claiming the ability to “beat the market”, this concept of competition against ‘the market’ has become the foundational basis for the investment management industry. It’s a constant debate among professional and non-professional investors alike.

But is that why YOU invest?

We’re willing to bet dollars to donuts that you invest because you have goals in life that require financial resources. Retiring from full time work. Traveling. Sending your children to college. Buying a vacation home. The goals each of us have, and the idiosyncrasies of each of them, are as unique as our finger prints. In other words, 1 in 8 billion. Literally, one of a kind.

So if we have goals, how do we achieve them? If our goal is to get from our current location to another location, and we’re driving, what do we do? Pull up Google Maps of course. The app helps us navigate to our destination, with options because there are multiple ways to get to the destination. Avoid highways? No problem. Avoid tolls? No problem. Shortest distance? No problem. Shortest travel time? No problem. Want to stop by a pizza parlor on the way? No problem. When it comes to our financial goals, a financial plan is our Google Maps. We all have Google Maps (or Waze), so it stands to reason we all need to have a financial plan. But that’s not enough.

Our financial plan must produce a clear and actionable investment strategy, which is the route by which we reach our destination. And just as there are going to be (most likely) multiple cars on the road as we navigate to our destination, nonetheless, the exact route we take from point to point is unique. The same applies to your financial plan. While the financial plan you establish to get from where you are today to where you want to be tomorrow is unique, your plan will share certain elements with many other people. But not everyone. Which is why, just as your financial plan is unique, so too must your investment strategy be unique, specifically tailored to you and your goals and their inherent idiosyncrasies.

So what’s the point?

If your investment strategy is not custom-tailored to, and specifically a product of, your financial goals and your financial plan, you WILL face a higher degree of emotional stress during periods of market turbulence. Why?

Because, with the onslaught of financial media and marketing materials focused on “beating the market”, you’ll inevitably get sucked into that fallacious trap comparing your portfolio against the market. Not growing as fast as the market when things are good? “I’m not beating the market, my investment portfolio is failing. I need to change something”. Suffering a larger decline with the market’s swoon? “I’m not beating the market, my investment portfolio is failing. I need to change something”.

But if you have a solid financial plan, one that allows for market fluctuations, and an investment strategy that directly corresponds to your plan, then you can largely ignore the fluctuations in the financial markets, and more importantly, you can ignore whether your portfolio is doing better or worse than the financial markets. Whether you are “beating the market” or the market is beating you becomes irrelevant, because your goal is not to beat the market. Your goal is to get to a certain destination at a certain time.

So a good financial plan, coupled with a solid investment strategy that corresponds to your financial plan, will help you focus on how your portfolio is performing against your goals. It’s a reality check. It’s a sanity check. Are you making the progress you expected? Are you still on track to reach your destination on time?

Because there are ebbs and flows within your investment portfolio, there will be times when your portfolio is making rapid progress, and times when it’s not making rapid progress. But the times of rapid progress make the times of less-than-rapid progress much easier to process emotionally, because when the various ebbs and flows are evaluated together, it’s likely that you’re still making the progress you need to be making. Which helps you sleep well at night, even when your portfolio is making less than rapid progress. It’s like being stuck in traffic, but still having the confidence that you’ll get to your destination on time. Does it suck? Absolutely. Does it rob us of peace of mind? Perhaps for those who are just cantankerous by nature and inherently subject to road rage. But if the end result is still easily achievable, a slowdown or detour along the way shouldn’t derail our emotional peace.

The combination of the two, the nexus between the two, the necessity of both, offer peace of mind along the financial journey. And while everyone’s financial journey is unique, everyone shares one element – peace of mind along the way. It’s so easily within grasp, but so often overlooked in our current culture of financial competition.

Ignore the financial media and the investment industry’s marketing materials. Whether you do it by yourself or hire someone to help you, set your own goals, develop a personalized financial plan and investment strategy, and execute it. Drive to your destination along the route that makes the most sense for you.

How much is too much?

Thursday, October 18th, 2018

If you leave a financial inheritance to your children, what is the last thing you’d want them to do with it?

If you answered “Buy a car”, you’re part of the overwhelming majority of parents in the country.

How long do you think, on average, a financial inheritance recipient waits to buy a car?

According to the New Car Dealer Association: 19 days.

Which is why, when we’re asked “How much is too much?”, we always answer that question with another question: “What’s the least amount of money your heirs would need to buy a car?”

Just kidding. We don’t give that estate planning advice because we’re not estate planning attorneys (nor do we play them on T.V.), and even if we were, it wouldn’t be practical.

But we do facilitate our clients’ exploration of that question when they ask it by attempting to help them see that money, in and of itself, has no power for evil or good, and that the widely-regarded belief that wealth above a certain threshold will negatively influence character is a myth.

The truth is, money is intrinsically inanimate. Therefore, money doesn’t create or influence character, it simply reveals character. Money is a tool that allows us to express our values, whatever they are. Rather than limiting the amount of wealth heirs will receive out of fear or pessimistic expectations, we encourage clients to focus their energy on preparing their heirs to be good stewards of their financial inheritance, regardless of the amount.

So how do parents prepare their children to be good stewards? By providing opportunities to adopt healthy values. We’re particularly fond of two strategies. First, philanthropic / charitable inclusion. Philanthropic experiences are second-to-none when it comes to expanding someone’s world view and opening their hearts and minds to others. When we look beyond ourselves, beyond our own needs and wants, and recognize the dignified humanity in those around us, the concept of resource stewardship becomes easy to understand and desirable to embrace. It can be as simple as having a child place your money in the church offertory, the Salvation Army bucket, or any other spontaneous opportunity to give a small sum to a non-profit organization. It can be as complex as asking them to research and make recommendations for non-profit organizations for your family’s foundation or donor advised fund. It can incorporate money or time. And it can be your money when they’re very young, and theirs when they’re a bit older. Whatever the tactic, build strong, selfless values such as prudent stewardship of resources through some form of philanthropic or charitable experiences.

The second strategy is not so easy. Let your children fail. Failure is the greatest teacher, but as parents, we’re hard-wired to protect our children from painful experiences. Nevertheless, if we let our children fail, in safe ways, they will learn exponentially more than we ourselves can ever teach them directly. Let them make poor purchase decisions. Let them spend all of their savings on insignificant items. Let them choose to perform a job poorly and then pay them based on the quality of the work. Let them fail a test or turn in a poor paper and get a poor grade. But afterwards, follow up with them, talk with them about their experience, help them reflect on it, learn from it, and grow from it. When it comes to failure as a teacher, the second part is just as important as the first.

How much is too much? The question implies a monetary topic, but the essential subject is not money-related. It’s a different kind of inheritance. An inheritance of values and character, which is always more precious than money.

How much is too much? The answer depends on the values and character of the recipient. For those who are self-centered and unprepared, the answer is “anything is too much”. For those who are self-less and well-prepared, the answer is “nothing is too much”.

We want to ask you: “What are you going to start doing today?” so that tomorrow, you can answer the “How much is too much?” question by confidently stating “Nothing is too much for my children.”

Rising Interest Rates – Is a Bond Bear Market Such a Bad Thing For Investors?

Friday, September 21st, 2018

In the last few days, bonds have experienced a sharp upward movement in yields across all maturities, but especially so in what traders call “the belly of the curve”, maturities between 2 years and 10 years. And since bond yields and bond prices move inversely to each other, as bond yields have risen, bond prices have fallen, creating a drag on the performance of portfolios that hold a diversified basket of stocks and bonds. The decline in bond prices and the resulting drag on portfolio performance prompts two questions. 1) “Is the bond bear market, which pundits have been forecasting for years, finally here?” and 2) “If bond yields continue to rise, and bond prices continue to fall, should an investor maintain an allocation to fixed income in their portfolio at all?”.

While the first question makes for good cocktail conversation, we think it’s too early to forecast with any certainty whether bonds have entered into a prolonged, multi-year bear market. Only time can answer the first question.

The second question, however, is an important one. In order to answer it, we have to look at the key risks that bond investors face when allocating a portion of their portfolio to fixed income, and we have to look at what vehicles investors use to satisfy that allocation.

First, bond investors face a number of risks, most of which are peculiar to the specific bond they are considering purchasing, and therefore, can be eliminated simply by avoiding particular types of bonds (high yield bonds, for example carry greater default risk, whereas U.S. Treasuries carry virtually no default risk). For the purposes of our discussion, there are only two risks we need to consider: interest rate risk, whereby bond prices fall when interest rates rise, and reinvestment risk, whereby bond payments received (interest and maturity) are reinvested at lower interest rates.

Since bond prices fall when interest rates rise, allocating a portion of a portfolio to fixed income necessarily incorporates interest rate risk, BUT ONLY WHEN CERTAIN TYPES OF FIXED INCOME VEHICLES ARE — USED. As we discuss in a moment, investors can effectively mitigate the interest rate risk by avoiding certain types of fixed income investments.

Reinvestment risk, on the other hand, is a bond investor’s friend when interest rates are rising. When a fixed income investor receives interest payments, and especially when a bond matures, those cash flows can be invested at higher interest rates at that moment in time, which increases the investors’ overall rate of return, all else equal. So in a rising interest rate environment, reinvestment risk IS ACTUALLY BENEFICIAL to fixed income investors, and therefore, argues in favor of an allocation to fixed income when interest rates are rising.

But not all fixed income vehicles are created equal. In fact, there is a wide disparity between the effectiveness and therefore usefulness of various fixed income vehicles. On one end of the spectrum are individual bonds, which, when used properly, are effective at mitigating interest rate risk, leaving only the positive impact of reinvestment risk. On the other end of the spectrum are bond funds, whether they be exchange traded funds, actively managed mutual funds, or passively managed index funds. In truth, these funds have more in common with stocks than they do with bonds.

Let’s start with individual bonds. An individual bond’s ability to mitigate interest rate risk is solely the result of its nature as a contract, which specifies a defined maturity date and maturity price. Excluding the possibility of default (breach of contract), an investor can be assured of their rate of return when they purchase the bond, because they know exactly what price they paid for the bond, what their cash receipts will be, and when they will receive them. This assurance is what gives bonds their “anchor to windward” characteristics, and why they are considered to be, in general, a risk-averse, defensive, less volatile asset class than stocks. Granted, between the time an investor purchases a bond and the time it matures, the price of the bond will fall if interest rates rise, but the bond’s price decline IS ONLY TEMPORARY. Once the maturity date of the bond draws closer, the bond price will approach the maturity price, such that upon maturity, the investor will receive exactly what they expected to receive. In this way, an investor can ignore the negative impact of rising interest rates on an individual bond, with the confidence that the price will recover, and that ultimately they will earn the rate of return they expected when they purchased the bond.

On the other end of the spectrum are bond funds, which are fully exposed to interest rate risk. Unlike individual bonds, bond funds lack the contractual mechanism (stated maturity date and maturity price) that offsets interest rate risk. There is no mechanism that returns a bond fund’s price to a pre-determined level at a pre-determined time. Moreover, the absence of a stated maturity date and maturity price robs an investor of the certainty and confidence that an individual bond would otherwise provide. Because a bond fund investor does not, and cannot, know the price at which they will sell the fund, their ultimate rate of return when buying a bond fund is not only unknown but unknowable. For this reason, a bond fund is more akin to a stock, which has the exact same characteristics, than an individual bond.

In most cases, the interest rate risk is larger than the potential gain an investor would receive from reinvestment risk when interest rates are rising. Therefore, it’s entirely feasible for a bond fund investor to LOSE money during a rising interest rate environment, while an investor using individual bonds would MAKE money during a rising interest rate environment, AND be in a more attractive position since they can now reinvest their cash receipts at even higher interest rates.

As with all things, there are a few caveats. First, an investor who buys an individual bond and sells it prior to maturity would take on interest rate risk, in exactly the same way a bond fund investor does. Offsetting interest rate risk requires an investor to hold the bond to maturity. Second, there are bond funds that have stated maturities, and while they have stated maturity dates (roughly, within a few days), they do not have a stated maturity price, and therefore, the ultimate rate of return is still uncertain, just like it is for a bond fund.

So, back to our question – “If bond yields continue to rise, and bond prices continue to fall, should an investor maintain an allocation to fixed income in their portfolio at all?” The answer is “Yes, as long as they use individual bonds for their fixed income allocation.” In fact, we’d even go one step further; an allocation to Fixed Income using individual bonds is especially important when interest rates are rising because rising interest rates often mark the final phase of an economic expansion, before economic activity declines and stock prices decline with it. But we’ll save that topic for our next entry.

In the meantime, if you have questions or comments about this piece, or own bond funds and have already experienced losses in them, or concerned you will in the future, shoot us a note. You can use the “Contact us” form at the bottom of this page, or simply email us directly.