You may question if your investments are on track. How do you know?
Mutual fund and hedge fund managers frequently compare their performance to a stock index such as the S&P 500, or perhaps to similar funds. When assessing the growth of your personal finances, we think there is a better way. We believe the best way is to track your progress against your personal plan.
How do you go about putting together a plan?
First, think through what the money will be used for and what the ultimate goal is for the funds. Are the funds for retirement? Or for a house down payment or vacation home? Assign every dollar in your possession a certain name or purpose. Examples would be an emergency fund, new tires fund, wedding fund, retirement, etc.
The next question is when do you need the money? The answer to this question will drive if the funds should be invested and if so, how should those funds be invested. Money for a trip to Hawaii in the next year or two should be managed differently than funds for retirement in twenty years. We often see people nearing or in retirement become too conservatively invested. They feel they “wouldn’t have time to wait out another bad stock market”. Funds needed for the next few years should be in conservative (low risk) investments. But realistically, a retired married couple may have thirty-five year joint life expectancy. For them, rising prices (inflation) are the enemy and conservative investments may not keep up.
Once you have a clear picture of your money’s purpose and when it will be needed, the focus can turn to asset allocation. This is deciding how much you will hold in stocks, bonds and cash. Once that has been decided, select asset classes (for example large companies, small companies, international companies real estate, municipal bonds, U.S. Treasuries, etc.). Once the asset classes have been selected, then you get more granular and pick the investments. You must think through whether to buy stocks, bonds, mutual funds, or exchange-traded funds (ETF’s). You have to choose between investments that follow an index or those with a manager. You must consider the various types of accounts that may used to reach your financial goals. IRA’s, Roth’s, 401(k)’s, 529 accounts, personal taxable accounts, etc. Selecting your asset allocation is a decision that should be taken seriously. Asset allocation has a large impact on your future portfolio performance and volatility. Carefully consider your risk tolerance, time frame, income taxes, savings and withdrawals, and how the asset classes “work together.” Once you’ve selected your asset allocation, you can research and conservatively estimate expected future portfolio returns.
You will want to think through how much you can commit to your goal today. Will you be adding to it monthly? Will your savings increase over time? Will you withdraw it in a lump sum or over many years? Have you considered inflation? If prices go up a modest 2.5% per year, things will cost 25% more in ten years. You definitely want to factor that into the plan.
At this point, you have all the pieces. With a calculator or spreadsheet, use your expected portfolio return and planned cash flows to calculate year by year what this will look like. The plan may not be perfect, but you will quickly have a sense if your plan is workable. What if the plan isn’t working out and doesn’t look feasible? It’s time to reevaluate and look at adjusting the money committed, your monthly savings, your asset allocation, or your planned withdrawal amount or timing. Once the numbers start working out your plan is complete. But you are in no way done with the plan, the real planning is just getting started!
Review the plan regularly, track progress, course correct
Carve out time to check in and compare your account balances to your plan. Don’t “set it and forget it.” You must check in regularly and course correct as needed. Life happens! Your plans will change and the outcome may be better or worse than planned. Your results might be VERY different than expected. That’s when it’s time to reevaluate the plan, recalibrate, and make adjustments. Repeat the process on a regular basis for the rest of your life. Tracking your progress against the plan you built is how performance should be measured.
Does all this seem overwhelming? If you’re not handy with a calculator or aren’t knowledgeable about investing and are looking for help with your plans, contact us. This is what Windward advisors do every day. You have dreams – we’ll make it a plan!
This blog is provided by Windward Private Wealth Management Inc. (“Windward” or the “Firm”) for informational purposes only. Investing involves the risk of loss and investors should be prepared to bear potential losses. No portion of this blog is to be construed as a solicitation to buy or sell a security or the provision of personalized investment, tax or legal advice. Certain information contained in the individual blog posts will be derived from sources that Windward believes to be reliable; however, the Firm does not guarantee the accuracy or timeliness of such information and assumes no liability for any resulting damages.
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