Feeds:
Posts
Comments

Posts Tagged ‘investment’

I watched a bit a marathon of “Say Yes To The Dress” from TLC last week.

As a financial planner, my first reaction to the show was wanting to scream “DON’T WATCH THE SHOW!” as it will skew your perception of how much a wedding dress should cost.  I don’t think I saw a budget less than $3000!  And all for what?  One day of make believe and grand delusions?  Ask yourself, do you remember what dress the brides wore at a wedding you have attended 2 years ago?

To be fair, the whole show is not completely without merit.  After a few episodes I started to see how the process of choosing ‘the right’ dress can be a metaphor for making any emotionally charged financial decision.  I see many of the same pitfalls arise every day as a financial planner.  There were :

  • those who want everything but aren’t willing to pay the price
  • those who are looking for the ‘perfect’ dress and so afraid that they will regret their decision that they don’t make any decisions at all
  • those who love everything and can’t decide

The show is set in Klinefield’s, a ‘mass affluent’ bridal store in New York.  In one episode Randy, the fashion consultant, told us his cardinal rules about wedding dress shopping which I think are rules we can follow anytime we are making other large dollar, emotionally charged financial planning decisions in our life:

1. Don’t try on a dress outside of your budget, it will only lead to tears – isn’t that so true?  Our wants will always outpace our needs.  Even in the dream factory that is Klinefield’s the first rule is not to temp yourself.  Life would always be easier if you had more money, but if you don’t have it then why tempt yourself? This is where understanding how much money you have and can spend will keep you grounded.  As I’ve said before, you need to be realistic…and Think Poor. Live in the bliss of ignorance.

2. Don’t keep secrets from your consultant –  Yes, they want to sell you something, but they also want you to be happy, even if for no other reason that you will come back they can sell you something else.  Just remember the advice you get is only as good as the information you provide.  If you tell me you have no debt and want to retire at 65, my advice to you will be very different than if you have lots of debt and you want to retire at 55.  So don’t waste your time and the time of your advisor if you are not going to help them to be successful in helping you.

3. Leave the entourage at home – Don’t be surprised if everyone has a different opinion of how to achieve financial success; too much advice is not necessarily a good thing.  Reading all of the financial blogs and books isn’t necessarily going to help you (except this one of course). It may sound cheesy, but a better way to spend your time is to get to know yourself and what your goals are.  There is always a financial solution out there to get to your goals…just as there is always a dress out there for you. The trick is finding the dress or the financial plan that you can afford and that you can live with.

4. Stop shopping once you found the dress – The fundamentals of financial planning are actually pretty simple and universal.  You will need a tailored plan to suit your needs, but once you have plan, stick with it.  Stop trying to find the ‘better’ plan.  Changing course and second guessing yourself won’t help you and will only cost you more money if you make rash corrections to your plan over the short term.

5. Always wear underwear – Well that goes without saying… you never want to be naked at Klinefield’s or in your finances.  Make sure you always have a rainy day fund that is separate from your other accounts.

I would add one more cardinal rule:

6. Keep some perspective on what is really important – In many ways the rush and excitement of the wedding dress purchase is like the initial stages of your financial planning. Wrapped up in each stock purchase or mutual fund selection are all the hopes and dreams of your whole life, career, family and retirement. The wedding dress encapsulates everything brides dream about their marriage. But the dress itself is for just one moment in time.  It’s a lot of work and done right it can be the foundation of something wonderful but it isn’t the marriage. Try to think of your financial planning as if you are buying that wedding dress and planning for the entire marriage that comes after it. Just like in marriage,  the real return on your investment comes from years of hard work, communication and self-reflection.

So say yes to the dress or to your financial plan, but remember these rules to keep your head out of the clouds.

Advertisements

Read Full Post »

As a financial planner I am often bemused by the thousands of financial self help books.  Like most self-help books, they simplify complex problems and provide an easy sounding and tempting solution which never quite works.  If any one of the books actually were able to help most people to save more and invest wisely then I hardly think that there will be so many books crowding the financial planning  section of the book store. But while they don’t actually provide the cure that they promise, most are harmless. So as I was recently flipping through “The Total Money Makeover: A Proven Plan” by Dave Ramsey, a few things caught my eye which I really felt I had to comment on. In the section “what this book is not” the author responds to previous challenges to his approach. In fact, if you search for  “Dave Ramsey bad advice” on Google you’ll get over 100,000 hits, so what I have to say may be treading some old ground. In a subsection entitled “This book is NOT going to mislead you on investment returns” he says:

“People seem to think that making a 12% return on your money in a long-term investment is impossible. And that if I state that there is a 12% return available then I have lied to you or misled you. I recommend good growth stock type mutual funds in this book as a long-term investment and dare to state that you should make 12% on your money over time.”

He then goes on to explain how the S&P 500 has averaged 11.67% in the last 80 years and how this indicates that you should therefore be able to get the same returns. Now, you can search for  funds that have averaged 10 year returns over 12% on Morningstar (I found 19).

Morningstar search result where mutual fund's 10 year average return is > 12%

But none of the above funds had the tenure that Ramsey had indicated in the book where he’s citing data from the 1930’s. Ramsey did give return data but slyly did not tell you what funds he’s invested in, rather referring to you to speak to one of the “approved” advisors (I would assume that they pay a fee to be approved by Mr Ramsey who must share his secrets with them).

So a little more digging led me to this list which does seem to be the funds that Mr. Ramsey is talking about in his book.

Hey if there are magical funds out there that are giving you S&P returns over the long term then sign me up (keep in mind this means they have to be beating the returns of the S&P since there are fees involved).  But why aren’t any of the funds that’s recommended by him on my morning star list?

So I dig a little deeper.

I looked at American Funds Invmt Co of America fund. The fund was created on March 31, 1934 just as the country was coming out of The Depression.  Up to Dec 31, 2011 it had an average return of approximately 11.79% annually. Even accounting for inflation which was 3.37% over that time, the returns are still above 8% annually.  So Mr. Ramsey seems to be telling the truth.

But again I ask, why isn’t on my morning star list? It didn’t make it on to my little search list because it’s return for the last 10 years is only 4.42% although it has been out performing S&P by 0.42%.

And that’s the problem that Mr. Ramsey’s critics and myself included have with his assumption of 12% return.  Just because a fund has returned on average 12%,  doesn’t mean that your return will be 12%.  When you invest matters a lot.  If you were smart and got into these funds 3 years ago at the depth of the current downturn, your return on this fund would be over 20% annually.  However if you started to invest 5 years ago (at the top of the market) your return would only be 1% annually.

Mr. Ramsey will of course say that for you to gain the average return, you need to invest in the long term.  As you can see, the 10 year results aren’t 12% but what if we look at 20 years?  The answer is 5.99%.  Only when you go back 30 years – a very long investment horizon for most people – do your numbers start to look better at 11.88%.  The question is will you able to hold the investment for 30 years and ride through all of the 50+% corrections? What if that correction came as you are just about to retire?  These are the questions that many who are nearing retirement are grappling with.

So what’s the solution?

Well I don’t really have one.  I’m no better at driving forward on an unmarked road while looking in the rearview mirror than you.  But I have a general approach that you can try to help you to get to your goals:

  • Work out what kind of returns you need to retire – be reasonable in your assumptions about your life style and government program’s availability. Likely the return won’t need to be 12%.
  • Create a portfolio that can give you a good shot at that return.  If you only need 5% to retire, then a more conservative portfolio will work.  If you need 6-7% a 60/40 portfolio will work.
  • Make your portfolio more conservative over time so that corrections have less impact on you as you near your goals, but keep your return assumptions the same.
  • Track where your investment funds should be annually/every 5 years and see if your portfolio (including money you may still be adding to to it) is meeting your objective.
  • If it isn’t, then you need to put away a bit more to guarantee the returns.
This way by the time you retire, hopefully you will guarantee you have the amount of funds you will need through both investment returns and putting enough away.

Read Full Post »

I just read another article about returns.  I don’t understand why everyone out there is constantly summarizing  different ways to calculate returns when there is only one way that matters to you as an investor.  While it is important to understand how other returns are calculated the average investor really only cares about their own returns.

To summarize, there are basically 3 ways to calculate returns:

  1. Regular rates of return – this should be used for quick summaries usually. It is computed as (End Value – Total Contributions) / Total Contributions.  Can be annualized to calculate actual returns if no additional contribution is made after the initial contribution.
  2. Time Weighted Returns – Used by mutual fund companies to remove the effects of  individual investors moving their money in and out.  Calculates the ‘pure’ performance benefit that advisors bring.
  3. Dollar Weighted Returns (you should use this one!) – Internal rate of return (IRR)  calculates returns taking out the effect of when contributions were made.

This info sheet (pdf) has the clearest explanation I have found  of how these calculations can provide very different results. And it doesn’t require wading through overwhelming math like most explanations.

Because IRR is the only way to take out the effect of when funds arrive in the account, it is the preferred way to calculate your individual returns. This is especially true for those of us who use dollar cost average.  Since the only way to compute the IRR is to track when you put the money in, you will need a spreadsheet to help you and you will need to input numbers often.  I’m not too concerned about getting the returns down to the day so I use my quarterly statements to calculate how much I contributed for the quarter and annualize that value (note in Excel you need to calculate -IRR not IRR or you will be getting the negative of your return).

Since I’m tracking my returns quarterly, I also use it to tell me how much my portfolio should be worth if I were getting the return I want on my portfolio  (you just do compounding on the contribution and add them up) this way I can see in one shot if I’m meeting my expected return or not and if not, how far am I off.  I use this to adjust how much I need to top up my contribution to my investments.

In the end it is the final dollar figure that I really care about.  All of the talk about math is inconsequential.

Comment if anyone is really interested in how the excel spreadsheet works.

Read Full Post »

%d bloggers like this: