Past performance
The Securities and Exchange Commission (SEC) requires a disclaimer “past performance does not guarantee future results” on when mutual performance is advertised. The SEC notes that the long-term investment performance of a fund will depend on factors such as: fund costs (charges, fees and expenses), your tax consequences, the fund’s risk, and operational changes.
Carl Richard equates “Investing based on past performance” with “Driving while looking in the rear view mirror”. Both “cause a lot of accidents”.
“Despite the SEC warning and pretty conclusive evidence that past performance has very little predictive value, most of us still use performance as the predominate factor in choosing our investments.
This is one of those times in investing when our experience in other areas of life works against us. “
“When it comes to mutual funds, however, the past has almost no predictive value. “ “It turns out that fees are the only factor that reliably predicts a fund’s performance. The higher the expense ratio –the cost of owning the fund-the worse the performance for shareholders. This is a case where you actually get what you don’t pay for.”
“Trying to figure out which fund will lead the pack…is a fool’s game. Focus instead on finding a low-cost investment that you can stick with over the long haul.”
The volume of articles and research studies showing that past performance promises nothing about future performance continues to grow. Understanding how an investment fits into your portfolio should be based on other factors, including those noted by the SEC. Understanding the investment’s characteristics and how they relate to the other investments in your portfolio are critical to building wealth.
A financial plan is essential for you to know how to invest your money.
To over simplify, financial planning is how you manage your finances and establish a path to reaching your goals. Investment management is one part of managing your finances. It is the part that determines how your savings will be invested.
Financial planning starts with your goals. The amount and timing are critical. Prioritizing your financial goals is necessary. You can assign a priority of 1 to 10 or categorize your goals by what is needed, what is wanted and what is wished for. This will be essential as you monitor your progress. Life and unanticipated events are not controllable and may require adjustments. Adjustments may result in changes to your goals, the timing of your goals, or your spending.
A reserve fund is needed to absorb unexpected events. Reserves should be held so that they are quickly assessable, that is, liquid. Six months of reserve are generally recommended. As you approach each goal, the reserve fund should be increased. This will avoid the impact of fluctuating investment values when the funds are needed. The amount of liquid assets should be increased as you near retirement. This minimizes the need to sell investments when the market is depressed. Two years of liquid funds are generally recommended for retirees. A portion of the funds for living expenses in retirement might be held in short-term bond funds or bonds.
Investments are purchased with the amount of your savings that exceed your reserves. The amount that is used for investments must be sufficient to reach your goals. Education expenses and health care are two categories of expenses that have exceeded what people anticipated. Many people underestimate the amount they will need in retirement. Because life expectancy has increased and people have retired early, many people will not be able meet their retirement goals.
The planning process needs to consider the above events and your ability to withstand losses.
The above has touched on cash planning, investment planning, education planning, risk assessment and retirement planning. All the planning areas need to fit together. How you manage your investments is dependent on the other areas of your financial plan.
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Do you know how much to save?
This is a question I am asked frequently. I respond with “it depends” followed by a series of questions. There are many rules of thumb used to answer this question. A “rule of thumb” is a rough and easy estimation. It is not based on a specific situation.
Following are some of the questions that should be asked. What is the purpose of the expenditure? How important is the expenditure? Is the expenditure something that is needed, wanted or just a wish? What are the alternatives? Is the cost known? When will the expenditure be made? An estimate can be calculated once the variables are identified.
The savings and the variables need to be monitored. Life is a journey with many twists and turns. There will be many unanticipated expenditures, opportunities and windfalls. You need to identify what you did not plan for so that you can identify when you need to change what you are doing
Financial cycles may impact your ability to meet your expectations. The available rates of returns will vary. If you anticipated too high of a rate of return, you will save less than you planned. If your earnings do not grow as much as you anticipated you will have less than you expected. If your living expenses increase more than your income you will not meet you goals. If the reverse happens you will save more than you planned. That is easier to deal with than not saving enough.
You should monitor your savings and review your goals at least annually. The sooner you adjust to adverse events, the easier it will be modify what you are doing and improve your ability to achieve your goals.
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Most under 45 underestimate their life expectancy.
This was the finding of a survey by the Society of Actuaries, as reported the Financial Advisor Magazine August 1, 2012.
Many people forget that the average represents the middle. That is half will live longer and half will not live that long. The life expectancy for newborn American males increased from 66.6 years to 75.7 years between 1960 and 2010. During the same period the life expectancy for newborn American females increased from 73.1 to 80.8.
A majority say they would be very or somewhat likely to make significant reductions in their living expenses if they thought they would live 5 years longer than they expected. “More than half of per-retirees would also use money they otherwise would have left to heirs or downsize their housing.”
The survey also found many underestimate their planning time-line when making major financial decisions. Retires generally look 5 years into the future and per-retirees look 10 years into the future.
The report concludes this can result in underfunding for retirement. Understanding the increased life expectancy, the current state of the economy and the volatility of the stock market require people to do a better job of managing their finances and planning for retirement.
Insured cash deposits
Many people are moving funds to banks and credit unions as a result of the recent market volatility and increasing questions about money market accounts.
A primary reason is that their deposits are insured by The Federal Deposit Insurance Corporation (FDIC), an independent agency of the U.S. government. Some banks are currently offering interest rate higher than some money market funds.
FDIC insures all deposit accounts, but not other products that are offered and banks. Stocks, bonds, mutual funds, life insurance policies, annuities are examples of financial products that are not covered by the FDIC and are sold at many banks
The standard insurance amount is $250,000 per depositor, per bank, for each account ownership category.
A couple could each have $250,000 in an individual account, and an IRA account (to the extent of deposit accounts in the IRA account). Deposit accounts in revocable trust accounts depend on the number of named beneficiaries. Generally if there are five or fewer beneficiaries, the coverage is $250,000 per owner per beneficiary.
The National Credit Union Administration (NCUA) insures deposit accounts for federal credit unions and qualified state chartered credit unions.
Additional coverage for deposit accounts can be obtained through the Certificate of Deposit Registry Service (CDARS). This service will split a large amount of cash among several banks in its network.
Planning for deposit accounts includes: determining the ownership of the accounts, documentation for retirement and trust accounts, anticipating future interest earned on the accounts, accounting for future deposits and withdrawals, and determining if the financial institution is FDIC or NCUA insured.
