Investing Control

When it comes to investing, it seems that many people think one of two things:

  1. “Since the S&P has returned nearly 10% per year over the last 30 years, I can simply invest in it and expect to do the same going forward.  I am in complete control.”
  2. “Whatever I earn on my investments is left to the whims of the markets and Wall Street.  I guess I have to cross my fingers and hope for the best.  I have no control over it.”

In actuality, I believe neither of these are actually true.

Statement A is false.  To use the language of investment advisors, “past performance is no guarantee of future returns.”  Put simply: Just because investment AAA returns XXX% in the past, there is no guarantee it will do so in the future.  To build your portfolio by looking in the rear view mirror to see what did well in the past is foolish.  All too often last years winners are this years losers.

Statement B is false as well.  Some things that influence the markets are surely beyond our control or influence.  Wars, famine, fraudulent companies (like Enron), political upheaval at home or abroad all affect the markets (at least in the short run).  But that doesn’t mean we have no control over how our investments perform.

 

What You Can Control

As a “retail” investor (that’s you and me!), I believe there are three things we can control (or at least strongly influence):

1. Risk – We can influence the risk level of our investments.  A 100% stock portfolio will be much more risky and volatile than a 100% bond portfolio.  Of course, with that risk comes a higher expected return.  Were that not the case, why would you take on the additional risk?

An investor needs to find the appropriate level of risk to provide an expected rate of return necessary for them to meet their financial goals…..while making sure the risk level taken does not exceed their personal risk tolerance.  Let me explain what I mean….

While the math may indicate, for example, that you’d need the returns expected with an 80% stock/20% bond portfolio, your personal risk tolerance may be limited to the volatility you’d expect to find in a 60%/40% allocation.  In this case, go with the 60%/40% allocation.  Determine other ways to meet your financial objectives, like save more, retire later or lower your expenses.

My advice: let your risk tolerance set the maximum cap on your equity allocation – not your return needs.  If you stretch your risk profile simply to try and capture a higher return, you are much more likely to bail out of the stock market when the periodic correction occurs.

2. Taxes – Taxes can be controlled by investing in tax preferred accounts (401(k)’s, 403(b)’s, Thrift Savings Plan, traditional IRA’s, Roth IRA’s, etc.).  In some cases the taxes are deferred (tIRA, 401(k)).  In other cases the earnings are potentially tax free (Roth IRA, HSA).  Of course, these accounts have a lot of rules to follow – Thanks, Congress – but, if handled correctly, you can save on your tax bill.

If you also invest in a taxable brokerage account, you can reduce your current tax bill by placing investments with lower taxable distributions in the brokerage account.  Leave higher yielding investments in your tax preferred accounts, like 401k’s and IRA’s.  For example, a large-cap index fund is a great brokerage account investment because it doesn’t spin off a lot of dividends and capital gains that would increase your tax bill.  Taxable bonds, REIT’s and other high yielding stock funds are better suited (for tax purposes) to be held in tax preferred accounts.

My advice: look at your portfolio as a whole first, and then decide which of your available account types would be best to hold each asset class.

3. Costs/Fees – This is a big one!  Investing expenses such as mutual fund management fees, trading costs and fees charged by asset managers can greatly reduce your net returns, especially over the decades your funds will be invested.  The compound effect of seemingly small costs suddenly makes them extremely material.  Vanguard has an on-line tool that clearly shows the long-term impact of higher costs.  If you’re interested, play around with the tool.  You’ll be shocked at the impact over several decades!

I have personally chosen to manage my own investments, but I understand why others may chose to use professional management.  Be sure to ask them to clearly explain how they are paid and the amount they charge.  Only work with an advisor willing to openly disclose this information!

My advice: make sure you understand all of the costs within your portfolio.  If you hire a professional manager, make sure you understand the increased returns and services that should be expected to make up for the additional costs they will add.

You’re Not Powerless

You’re not helpless when it comes to influencing how your portfolio will perform over time. Exercise investing control where you can!  Addressing these issues now will lead to a more successful investing experience!

Feel free to contact me for a no-cost / no-obligation conversation about this (or any!) important personal financial issue.  My singular goal is to educate others on their road to financial empowerment!

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