Kristen and I were invited to hang out with my Bay Area buddies at their Truckee rental house.
Kristen and I were invited to hang out with my Bay Area buddies at their Truckee rental house.
At some point, anybody with an investment portfolio such as an IRA or 401K has seen a pie chart showing how much equity, fixed income, cash, and maybe alternative investments they have in their portfolio. Depending on how much of each of these investments a person has in their portfolio they are considered aggressive, moderate, or conservative. What does that mean though? Lets break each part down.
Equity represents ownership of something. A person has equity in their house if the house is thought to be worth more than what they owe on it. If a person owns part or all of a business they are said to have an equity share. A share of stock is a small sliver of ownership in a large company. Generally speaking, equity investments have been the greatest creator of wealth for investors. Of course, greater upside means greater downside. If the rental market is sluggish, or GDP growth is not what is expected, the value of equity is going to drop. Because of the risks that investors take by investing in equity, the more equity in a portfolio the more aggressive it is.
The other large portion of the pie chart is usually fixed income. Fixed income is a little deceiving I believe. Debt is a more appropriate name for this portion of the portfolio, because fixed income portfolios primarily invest in bonds, which are a form of debt. Essentially what that means is that the investor is lending somebody money. When someone lends money to someone they have recourse if things go belly up. Having recourse and being guaranteed a stream of income makes bonds and other “Fixed Income” generally thought to be safer than equities. By safer, I mean that the returns are often less than equities in the long run, but they tend not to change in value as much in short-term.
Alternative investments. I have seen The Big Short where they talk about synthetic this and derivatives of that… It didn’t end to well… While those are considered alternative investments, alternative investments are anything that doesn’t fall into the bucket of equity or debt. The point of an alternative investment usually is to have exposure to something the will move in contrast to equities and debt, so when the rest of the portfolio drops (and it will at some point) at least something else moves up. The most popular alternative investment I have seen is gold. Gold, unlike equity or debt does not produce any cash flow. All gold does is sit there and look pretty, but that is kind of the point. If the housing market crashes, if the US is delinquent on its debt, gold will still be pretty.
In my previous post 5 Reasons for financial planning in your 50s, I discussed why it is important to have a financial plan. I have found that most people that I speak to are not entirely aware of what a financial plan is and why they need one. What a financial plan is is not exactly fully agreed upon between financial professionals so it is not surprising that most consumers are not entirely clear on it either. Wendell Fuller of Fuller Wealth Advisors in Richmond, Va. explains, “I see that more than anything — not having a true sense of what will be the true costs of retirement goals and dreams, or thinking of them in today’s dollars, and in 10 or 15 years, with inflation, could cost more than you think.” I am currently working for my 3rd financial company and with each company we have taken a little different approach based on the company’s policy and how I have grown to look at financial planning. I have found through my years in the financial industry that what makes a good financial plan is that it is realistic, comprehendible, and actionable.
At my first firm we were encouraged to create a detailed plan for every client regardless of their situation. What we would end up with is an extremely comprehensive spiral bound notebook projecting future returns, contributions, withdrawal rates, major purchases, etc… What I found with my first firm however was that I would put hours of data input and tweaking into these plans and when I presented them people would kinda nod in agreement and go on with their life as they normally had.
As I moved to my second firm, we followed a similar approach of creating large comprehensive financial plans for the majority of our clients. A large difference though was that a lot of the clients I was working with at my second firm had been clients for a long time with some in excess of 20 years. We reviewed and updated the plans annually with new projected expenses, assets, and goals. Although many of these clients had been through the financial planning process more times than they could count, I noticed that many of them did not fully comprehend the concepts and ideas we tried to portray through the plan.
About a year into working with my second firm we transitioned to a new approach that moved away from the 40 page bound notebook with detailed projections to an approach where we completed the process interactively in the meeting through a simple program. By the end the client left with an 8 page printout listing goals, action steps, and current projections for them to achieve their goals. This approach made the financial plans easier to comprehend and gave clients greater ownership of the plan.
A lot of the time now, especially with clients new to financially planning process, I start with pen and paper. It is odd being a millennial discussing in my blog about using pen and paper instead of some fancy app or algorithm, but it is true. At this point I have enough experience discussing finances with people and preparing financial plans that I can get a rough idea of whether someone’s current goals are feasible or whether changes need to be made. What pen and paper does is makes it interactive with the client so that they can see exactly how each number is arrived at. I will use outside tools to explain why some numbers are used and help make projections, but for the most part I am using high school algebra. Pen and paper also allows us complete flexibility. As we go through the process it is easy to make changes to assumptions throughout the process without trying to manipulate an advanced program on the fly and possible messing up other assumptions in the process.
No one process is correct and different processes are better for different people in different situations. Many people just need a couple of simple helpful tips to get their finances on track. For other people, they would prefer to see a chart detailing every projected financial transaction for the next 30 years. The important thing is that however someone creates a financial plan whether it is with a professional or on their own is that it is realistic, comprehendible, and actionable.
A person in there 50s is in a unique situation when it comes to planning for retirement. A person in their 50s most likely has established their career as well as their lifestyle, yet they still have 10-20 years before retirement. Having a relatively stable lifestyle with retirement in the not too distant future makes financial planning both important and fruitful for most people in their 50s for 5 reasons.
In a person’s 50s they have been likely working in their current career for multiple decades. Additional promotions can often happened, but they are more predictable and annual raises are probably expected. With income being predictable, savings rates can also be predicted with some accuracy such as contributions to retirement accounts (401K, IRA, etc…), figuring out if/when they can pay off their mortgage, and when they will eliminate any other debts. By using some sort of projection of asset growth a person in their 50s can accurately estimate what their assets will look like in retirement.
I have seen two schools of though when it comes to projecting retirement expenses. The first school of thought is to actually list all of a person’s current and expected expenses and adjust for inflation accordingly. The second school of thought (and my preferred method) is to start with current income, back out savings, and adjust for lifestyle changes and inflation from there. I like the second method, because I have found people are very good at underestimating what they spend. Either way, both these methods can work as accurate predictors for retirement.
Once a person knows what they will have as far assets and expenses in retirement it takes a little bit of algebra to figure out their withdrawal rate. Subtract any fixed income in retirement like social security or pension income from expenses. Divide this number by the total investible assets and you have the withdrawal rate. Walter Updegrave explains what a reasonable withdrawal rate is in his article for CNN Money when he says, “That’s a judgment call, but I’d say 3% to 4% is a decent place to start if you want your savings to be able to support you 30 or more years.” As explained in my previous post 4 Ways to Plan for Retirement in your 40s, a person in their 50s can look at a number of ways to alter their plan.
If insurance products like life insurance, long term care, annuities, etc… make sense in retirement it is worth it to start looking before retirement. Insurance starts getting expensive quickly into a person’s 60s for obvious reasons. I don’t suggest anybody just start going out and buying any or all of the above types of insurance in their 50s, but it is worth seeing if some insurance options make sense with an advisor. Many annuities in particular can be much more beneficial if purchased up to 10 years ahead of when a person needs the money. I could write a whole thesis on annuities, and I will most likely dedicate at least one whole blog post to annuities.
At some point everyone will hit the big one. When some one is in their 50s I would hope that they have accumulated enough assets that it is worth while to take a hard look at estate planning. For most people estate planning includes a health care directive, power of attorney, and adding beneficiaries to accounts. As the estate becomes more complex and real-estate and other larger assets become involved, a trust can make a lot of sense. Estate planning may not be the most fun discussion some one can have with their family, but by the time someone is in their 50s mortality starts becoming more of a reality and is important to plan for.
Jeremy and I went ghost hunting in an abandoned pipe factory in Hunters Point San Francisco California.
We had to climb into a hole in the wall in-order to enter the building.
We had to walk across this catwalk to get to the second taller building and go to the roof.
In the basement we found the blueprints to the building.
For our holiday party at Bank of America we went to a Paint and Sip in South Lake Tahoe California.
The progression of my painting