Hundley: Investment Risk, Fees, & Diversification
Question: I want to start investing but I don’t know how to take the first step?
Believe it or not the first step to investing is not finding an investment itself but the path to the investment. What type of investment account should you open? Let’s walk through the different investment accounts available and their different purposes.
Account Type: Traditional IRA, SEP IRA, Traditional 401k, 403b, 457 Plans.
These accounts typically will provide the investor a present day tax deduction. This can help an individual or family reduce their tax liability in the year the funds were placed in the account. Some of these accounts may allow contributions up until April 15th of the following tax year to help offset the tax year being prepared.
These accounts are best for high income individuals with a long term investment horizon. The purpose of the funds are for retirement purposes.You may be charged with taxes and penalties if you use these funds prior to age 59 and a half.
Account Type: Roth IRA, Roth 401k
Tax free growth. Let’s do that again only go to your window open it up, stick your head out and scream “TAX FREE GROWTH”. That feels good right. The downside is no current day benefit to you.
Roths are best served for those with lower incomes with hopes of being in a higher income tax bracket in the future. The funds, like the IRAs discussed above are intended for retirement purposes and should be held for extended periods of time. Penalties may be incurred for distributions prior to age 59 and a half.
Account Type: Non-qualified or Brokerage
Liquidity. These funds are readily accessible for investors at any point. This type of investment can be converted to cash at any point. The downside is taxes are owed each year for any capital gains, dividends, or other possible transactions.
These types of accounts are for those with intermediate to shorter investment timelines or may need access to capital.
Before you go looking for the perfect investment, you need to find the best account path to help maximize return. If you are unsure what type of account you should open ask yourself or your advisor these simple questions:
- Will I need access to this money?
- What is my goal for this investment?
These things should help you determine the best course of action. More information on various account types and benefits can be located here https://www.valuepenguin.com/investing/investment-account-types.
Make it a healthy, happy, profitable day.
When I begin working with a new client, I get asked many common questions by the client. What’s my investment style? How do I decide an investment is a worthwhile investment? And what should they expect from my firm?
I could spend an inodorimate amount of time answering each one of these questions, but I will not bore you with such details. However, the succinct answer to these questions is explaining the investment strategy for which I subscribe to which is the Nobel Prize winning, and time-tested, Modern Portfolio Theory.
What’s Is Modern Portfolio Theory?
Modern Portfolio Theory (MPT) is an investment philosophy developed by renown economist, Harry Markowitz. Markowitz’s theory operates under the assumption that investors are risk averse; however, an investor can optimize their return by investing in asset classes with varying degrees of correlation, and in-turn, reduce risk.
Why I choose to follow Modern Portfolio Theory?
Over my long career in financial services, I have had the privilege to hear from thousands of investors. What I have learned is that the overwhelming majority of investors want a portfolio that meets their goal, while simultaneously keeping the volatility of their portfolio in check. And this makes perfect sense, as it is how we are wired as human beings. It’s some respects it is akin to traveling on an airplane. We expect the pilot of the plane to use his professional expertise to map a route that will take us from Point A to Point B in the shortest amount of time and with the least amount of turbulence. Many of these same principles apply to investing and how I approach a client. My goal is to bring my clients to their desired destination, but I try and avoid turbulence and make the ride as smooth as possible by taking on only enough risk required to achieve my clients goal. And this is exactly what Modern Portfolio Theory does for an investor – it optimizes the route based on historical volatility of asset classes, thereby making a client’s retirement journey much more comfortable.
Hear more about Modern Portfolio Theory from the Nobel Prize winner himself by watching this video.
When assessing investment portfolios, we often discuss the economy and its impact on your investments. Questions typically arise about the stages or phases of the economy and how to assess where the economy is sitting. The stock market has been on a record run since the great recession of 2008 with the S&P 500 bottoming out on March 7th, 2009. The economy itself works in 4 stages, often called phases.
- Early recession: this is when things go bad for the economy. Generally this is when consumer expectations are poor, industrial production is falling, and yield curves flat line and sometimes even go inverted.
- Full recession: this is when GDP has retracted in two successive quarters. This is a particularly hard time for the unemployed, corporations, and 401k balances. By this point, consumer expectations have bottomed out and the Fed typically tinkers with the yield curve with the hopes of injecting life into the economy.
- Early Recovery: Industrial production is picking up, the yield curve is steep and interest rates are beginning to rise. Consumer expectations are rebounding at this point.
- Late recovery: Consumer expectations are beginning to decline, along with flattening industrial output. Interest rates typically rise quickly during this phase.
How can we tell where we are at besides just eyeballing it? Economists use economic indicators to help determine phases and where the economy is currently resting. While investors may pay attention to both leading and lagging economic indicators. Insight to the difference of both leading and lagging economic indicators can be found here https://www.moneycrashers.com/leading-lagging-economic-indicators/.
Timing these phases of the economic cycle are almost impossible. In fact, even the most well-respected investors find it almost near impossible to time these cycles. That’s why I stress to my clients that these phases should never impact their investment decision making. Your investments should be built in a manner to help accomplish your short, intermediate, and long-term goals in all kinds of market environments.
As a financial advisor I thought I would share with you my personal favorite 8 tips I believe all individuals, couples or families should be practicing.
- There are no get rich quick schemes. Embrace this mindset. Once you realize the path to prosperity is through a slow methodical plan of attack the better off you will be.
- Build your emergency fund. You should be thinking along these lines: If a storm damaged your roof, could you comfortably replace it? If your car suddenly dies, could you comfortably replace it?
- Be aware of your costs and expenses. Many of us turn on automatic payments and deductions and may not take the time to reconcile our monthly expenses. It is a smart exercise to look through and review bank and credit card statements, reviewing receipts, and turning off services you are not using.
- Start investing today. The path to retirement begins the moment you start saving for retirement. Remember tip 1: there is no get rich quick scheme. Don’t wait to start planning ahead, the earlier you start the better off you will be.
- Walk away from that purchase. Take 24 hours from that impulse big expenditure. If you still need it or want it 24 hours later, it will most likely still be there. Do you want money or things?
- Protect your loved ones. If something were to happen where you, or your spouse, lost your ability to earn an income you will want disability and/or life insurance to protect against this loss.
- Basic estate planning. At the very least, you should have a legally binding Will in place to determine where and how assets will be distributed. Do not leave this task up to the government to decide.
- Set goals! Setting goals is important for a few reasons. Setting and meeting goals grants us a feeling of achievement, of a job well done. Setting goals also allows us to hold ourselves or our professionals we hire to a high standard. If your goals are unattainable your financial professional can set you straight. If you are investing for yourself and never making your goals it may be time to seek help.
If you would like to learn more about my thoughts related to personal finance and how easy building blocks can begin a lifetime of wealth please email me at email@example.com or find me on Facebook at Paul Hundley, Lighthouse Capital. You can read more of my blogs at the Lighthouse Capital Blog.
Make it a healthy, happy and profitable day!
Life insurance: this is a topic I avoided for most of my professional career. I always liked to view myself as an “investment” guy. I would rather focus on equity, fixed income, asset allocation, macroeconomics, and how the world around us can affect your investments. However, when I became a father almost a year and a half ago life insurance was a topic I could not continue to ignore. My daughter depends on me for everything, financial support being one of them. It is not fun to think of my mortality at just 37 years of age, but my mother passed at 48 years old and my uncle passed at 32, both due to cancer related complications. Unfortunately, my family history is my reality and it would be irresponsible to not plan defensively, should a day come and I am unable to provide for Cadence.
The most common question I encounter regarding life insurance is determining how much insurance an individual needs, and what kind of insurance coverage they may require. There are a few simple starting points that I take into consideration.
How much are your earnings? How much does your spouse earn?
What are your current liabilities – mortgages, cars, credit cards, student loans etc.?
What are your future projected liabilities- children, college etc.?
The next issue is determining what type of life insurance coverage is needed. Do you need temporary, or more commonly referred to as term insurance? Term insurance covers you for a set number of years. Or is a permanent policy through whole or universal life more appropriate for you and your family? Permanent policies are typically for families with special needs children or possible estate planning needs.
Click Here for an explanation of different types of life insurance.
Planning for the cost of life insurance should not be a burden..There are extremely affordable policies on the marketplace, and we would be happy provide you with a number of different quotes and policy types.
Personally, life insurance is extremely unfun. But I promise you this, if for some unforeseen reason your spouse calls me with tragic news we will not be talking stock. We will be talking about how you did the right thing protecting your family.
I look forward to regularly sharing with you my views relating to personal finance. I would appreciate any feedback that you may have, and if you have a topic that you would like me to cover, please email me at firstname.lastname@example.org or find me on Facebook at Paul Hundley, Lighthouse Capital. Or read more of my blogs at the Lighthouse Capital blog.
Make it a healthy, happy, and profitable day.
Today is a big day, my first blog post for Lighthouse Capital, LLC (I think the lawyers make us include the LLC). When the Managing Director of Lighthouse, Brian Foley, approached me regarding blog posts I thought to myself, “but I’m a financial advisor, not a writer?” Well, I have never turned down a chance to embarrass myself publicly, so here it goes.
To get my feet wet, I thought it would be best to outline the most common issues I encounter when reviewing a prospective client’s investments. These are issues I focus on the most in my practice and I challenge myself daily to best educate my clients on these topics.
- Misconception of risk. I find many people not knowing how much risk they are exposed to within their investments, which can be a major factor in not accomplishing financial goals. Too much risk can lead to significant loss of value in a short amount of time. And too little risk may result in not achieving the rate of return you need to accomplish your long term goals. When determining the appropriate amount of risk for one of my client’s I go through a fact intensive exercise to determine their goals, needs, time horizon, and overall risk tolerance. In other words, each individual and family has their own set of circumstances and the amount of risk one takes with their investments should not be generalized.
- Understanding fees. How much are you paying? Is it a management fee? Transaction fees? Underlying fees or administrative fees? All of the above? I believe it’s important to have a clear understanding of all costs up front. This is why we do a cost analysis right on our account application and send out quarterly fee notices to all our clients. Transparency is key when it comes to cost. Additionally, I strive to provide my client’s with the best value, as the lowest cost investment does not necessarily equate to the best investment.
- Over-concentration in one particular stock, fund, or asset class. Diversification is one of the key pillars to sound long-term investing, and is lacking in many prospective portfolio’s I encounter. At times, diversification can result in investment performance being out of sync with one particular index and/or asset class (i.e. S&P 500, large cap growth category, etc.). But don’t be alarmed if your diversified portfolio underperforms the top performing asset class, as this is exactly what a well diversified portfolio is designed to do. Diversification is designed to mitigate unforeseen risk, and in-turn increase the likelihood of achieving your long term goals.
I look forward to regularly sharing my views relating to personal finance. I would appreciate any feedback that you may have, and if you have a topic that you would like me to cover, please email me at email@example.com or find me on Facebook at Paul Hundley, Lighthouse Capital.
Make it a healthy, happy, and profitable day!