Asset Archives - The Free Financial Advisor

What It Take To Be A Successful Investor

July 31, 2019 by Jacob Sensiba

What makes a successful investor? Is it your ability to beat the market or to beat your competition?

In my opinion, being a successful investor doesn’t have to do with out-earning your peers or leaving the S&P in the dust. No, my definition is very simple.

Develop an investment plan using a variety of factors, and be able to execute and follow that plan indefinitely.

Suitability

This is step 1. You need to figure out what your “suitability” is. Your suitability will lay a very good foundation upon which you build your investment plan. Suitability involves three things:

Risk tolerance – This is your ability to handle drawdowns in your portfolio. If you crumble with fear every time you lose 5 percent, then you’ll probably want a fairly conservative portfolio*. On the other hand, if you have no problem seeing your portfolio drop 50 percent, then you’re ready for a more aggressive allocation.
Time horizon – Probably the most important factor of the three. Your time horizon is basically when you’ll need the money. A long time horizon allows an investor to take on more risk because there’s more time for them to recover from drawdowns. The inverse is true for short time horizons. You’ll want to be conservative because you have little time to earn back what’d you lost.
- Long time horizon – 10+ years
- Medium time horizon – 2-5 years
- Short time horizon – Less than 2 years
Goals – What’s your plan? Is this savings going to be used as a down payment for a house? If so, there’s probably a minimum dollar amount you have in mind and you’ll want to tip the odds in your favor that you don’t go below that. Similarly, if this is for retirement and you have 30 years to invest, you have the green light for risk assets.

Keep in mind that all three of these things, plus one other, need to be used together when determining your asset allocation. If you are tolerant of risk, but need the money in 5 years, somewhere in the middle between aggressive and conservative is probably better. That one other thing is your behavior as an investor.

Investor behavior

The finance/investment world is coming around to this, but your psychology is a HUGE factor as an investor.

Obtaining a high return on assets is one of your goals, but it should not be the primary goal. When you create an investment plan you have to make sure it’s something you can actually stick with.

I wrote about it previously, here.

You could be tolerant to risk and you could have a long time horizon, but if you lay awake at night every time the market drops, then you need to rethink your approach.

That kind of fear and anxiety hinders your ability to follow your plan. What normally happens, is someone sets an unrealistic investment plan, one where they take on too much risk.

Thereafter, volatility picks up. They check their portfolio and it’s declined 15 percent. They wait a day and check the next.

Another 2 percent drop. Then the thought of 2008 creeps into their heads and the panic sell.

You can set up a great investment plan, but your behavior will ultimately make the decisions. Keep that in mind.

Asset allocation

Using your suitability and behavior, you can then determine your asset allocation. The types of assets you use in your allocation can vary. If you wanted to invest a small percentage of your portfolio in gold, for instance.

The three most common assets are stocks, bonds, and cash. With risks ranging from high risk to virtually (there’s always some risk) no risk.

Speaking very generally, people with long time horizons and are more tolerant of risk, have a more aggressive portfolio. The inverse is true for people with short time horizons and a low-risk tolerance.

That said, the ultimate goal is to develop a plan that meets your goals in the smoothest fashion possible.

Ignore the noise

Throughout your investment “career” you’ll run into people, friends, family, or even random people on the street that will tell you the sky is falling or that the newest IPO will go gang-busters and you need to get in now!

Put your blinders on. There are two things that hurt investors. Their own behavior and their ability, or lack thereof, to tune out what’s happening around them.

This is extremely difficult because we, as humans, have evolved to use our peers to compare or judge, our standing in society.

Stay in your lane and focus on your goals.

Never stop learning

Every single experience in your life is a learning opportunity, especially the bad one. I recommend journaling daily, recount your day, and dig little nuggets of knowledge from your experiences.

Additionally, take in some form of content every day that improves your understanding in your line of work, or in an industry that you’re interested in.

With regard to your finances, give our Toolkit page a look. There you’ll find a number of books and resources to enhance your financial know-how.

Please be advised: Everything written in this article is for informational purposes only and should not be taken as investment advice. Opinions are my own and do not reflect the opinions of this publisher or my employer.

Expected Family Contribution: Digging For (and Finding!) Financial Aid

January 14, 2013 by Average Joe 19 Comments

As you’re waiting for that perfect college to give you the nod, “Expected Family Contribution,” or EFC, is a key term you need to understand BEFORE filling out the FAFSA form (…and you should be filling out the FAFSA form NOW).

Expected Family Contribution is the amount you’ll be expected to pay out of pocket toward your education. Here’s the simple formula:

Cost of college – your need = Expected Family Contribution

Sometimes it’s easier to understand what’s being asked by seeing the equation drawn out. Not to be completely obvious, but that equation makes three points clear:

– You can lower your bill by attending a less expensive institution
– You could attend a more expensive school and not pay a dime more if your need covers the difference between the cheaper school and more expensive school.
– You can lower your Expected Family Contribution by attending a less expensive school, increasing your need, or a combination of both.

Like I said, pretty obvious, huh?

If it was SO obvious, though, why do so many people overpay for college? Not my readers, though, right? We’re so lucky we hang out together!

EFC is about Income and Assets:

An overall note about assets: Assets are excluded for most people with adjusted gross income below $50,000.

Child Money – The FAFSA treats dependent student money as MORE IMPORTANT than parent money in the EFC equation.

Rational? While parents may have other priorities, the child has one: graduate.

Therefore: 20% of dependent and independent student assets count against them when calculating EFC. Little Jimmy’s got $10 in his savings? That’s $2 less financial aid school will give him.

The EFC calculation includes an “asset protection allowance” for parents and independent students with children before ANY money counts against their EFC calculation. How much is the allowance? While the amount varies depending on age and marital status, the average family receives a $45,000 allowance. After that, only 12% of assets are used toward the family EFC calculation.

So, to summarize:

– Parents and Independent Students with Children receive an asset protection allowance of around $45,000
– 20% of dependent student assets are used for the EFC calculation
– 12% of parent assets are used
– 7% of independent students with children assets

Got it? Awesome.

What’s the rational for these numbers? Parents and students with children have to make ends meet at home first, and then can focus some of their money on college. Students in college should spend a higher percentage of assets on education.

I hope you’re starting to see that WHERE you save is an important factor when deciding how to save for college. Clearly, keeping money in a parent’s hands vs. saving in junior’s name can be a good idea in many circumstances.

Big Point: It’s illegal for parents (or anyone other than the child) to remove money from junior’s name to avoid horrible EFC consequences (or for another other reason). However, junior can purchase items beyond food, clothing and shelter with his own money. You can also choose to save more money (or an equal amount) into the parent’s name for college.

Also notice – 529 plans….they’re in a parent’s name.

…and that money in life insurance policies? It doesn’t count against you at all. As far as EFC calculations go, it doesn’t exist.

Want more on the best places to save for college? Check out: College Savings Simplified, The Best Places to Save for Education

Income

Forget full time work for dependent students. It weighs heavily against EFC!

Yeah, I know, you want junior to have a job in college. Guess what? Every dollar junior earns (after a small allowance) counts more severely against his need than income a parent earns. Once again, there’s good rationale for this: junior should be focused on graduating, so if he works, then he should pay every dollar he makes toward school.

As with assets, there is an income protection formula:

– Dependent students receive an income protection amount of $6,000. After that, between 22 and 47% of the amount junior earns is used for EFC calculations. (It’s a sliding scale with percentages rising as the income level rises.
– Independent students with children and parents receive a much more generous allowance. For parents, the number ranges from $16,000 to $55,000 depending on the number of dependents in school and overall family size.

As you can see, parent income counts against need, but once again, parents only have a smaller percentage of their income that counts against EFC.

Rationale? Parents have many priorities besides a dependent student’s education, while dependent students need to save. The EFC allows for a small part time job to learn skills, but punishes students who work full time. Work on graduation!

Good news for me: during the EFC calculation, because I’ll have two in college at the same time, my total parent contribution is divided by two.

Retirement

How do retirement accounts factor into EFC? Money saved into retirement accounts DOES COUNT against EFC. Rationale? You should expect to sacrifice for a short time to help junior through college. If you’re the one headed to school, graduation quickly is your number one priority.

Strategies

If you’re reading this with young children (or just a glimmer in your eye), realize these calculations can change. However, I’ve been teaching clients about EFC since my children were born, and things are roughly the same as they were then. So:

– Save money into the parent name instead of a child’s name.
– Save aggressively into 401k plans BEFORE college years start because you may have to lower your contributions during college years.
– If you’re fairly certain you’ll be a financial aid candidate, cash value life insurance may be an option (although I generally shy away from these products)
– Forget about junior working full time during college. You’ll just elongate the process for him and you.
– Use Junior’s money to buy assets he’ll use during college and for expenses that don’t include food, clothing and shelter. If you’d like, use the money YOU save by NOT covering these non-essentials into a plan in the parent’s name.

Fun, huh? Financial aid programs actually make a ton of sense to me AND it becomes much clearer HOW to save when you know the keys to the FAFSA and EFC.

What parts of financial aid are most confusing to you? Leave them in the comment section and we’ll try and tackle those next.

This is only one piece of an overall college financial plan. Check out: 5 Steps to a Successful College Financial Plan.

Photos: College student w laptop: Ed Yourdon;

In Defense of Financial Advisor Fees

May 22, 2012 by Average Joe 20 Comments

I was a fee hater.

Like a younger, more handsome John Bogle, I would rail on fees. I’d stand on every rooftop screaming about avoiding fees at all cost.

For this reason, when I was a financial advisor, I provided what I thought was top-notch service and undercharged for it every day.

How much did I charge? My minimum fee was $500 per year.

Undercharged? There is no such thing, Joe! Less fees = better. Duh! You should have charged $300!

Think so, do you? Sit close, young padewan, while Uncle Joe tells you a story:

My Experience With Fees

Early in my career I lucked into the opportunity to give speeches on behalf of one of the top advisors in the country. I’d fly wherever he wished and spoke to rooms full of people about good planning. In exchange, he allowed me to move my offices into his suite.

Awesome! What a break for a new advisor; I’d get to see the inner workings of a well-honed operation and maybe glean some tips.

At first I was disappointed. All I saw was what looked like a cookie-cutter assembly line of advice and deliverables. Many clients received offshoots of similar advice. The firm never stuck their neck out. They avoided complex situations at all cost.

That lead me to believe that he was among the best in the country only because he could “sell” people on ways he’d jack up their fees.

…and jack he did. I rarely saw him charge less than $2,500 for planning, then garner asset management fees on top of that. He was a fee-based selling machine.

One day the operations manager and I were talking. I asked a polite question about how redundant their process management workflow seemed. To give you an idea of what I thought about this guy: I’m sure the term “cocky smartass” wouldn’t be far off the mark.

He said, “Have you noticed that we charge five times what you charge?”

I smiled. “Yes.” What a loser. I could never charge what they did! They were just leeches, skimming off of their client’s blood.

He said, “We charge five times more because we’re five times better than you.”

I took it personally.

I shouldn’t have.

Three months later, we were in agreement:

he was five times better than me.

Why He Was Better

This planner was so good, I’d worked right under his nose and hadn’t noticed his skill. The systems were sublime. Where I’d seen cookie-cutter assembly lines before, now I saw a brilliant asset allocation arrangement. Where I’d believed he was charging excess dollars to put boring plans in place, he was dotting every “I” and crossing every “T” for clients…mostly doing the boring stuff that usually was swept under the rug.

In short, he had a proven system of asset management and plan building. If you wanted that service, he covered his costs with his fees. If you didn’t want it, you should probably look elsewhere.

He didn’t try to be everything to everyone.

What You Can Learn

You don’t have to pay $2,500 or more to some advisor if you’re willing to perform the critical tasks that this advisor captained for his clients:

1) Design a plan that covers the six areas of financial planning and rigorously maintain the plan according to a set schedule. Make sure everyone involved is up-to-speed with the details.

2) Build a system to check and maintain your assets against your plan. He had systems in place to notify him when assets deviated too much from the plan. Build your own set of alarms.

3) Carefully guard against taxes and excess fees. This seems like an oxymoron, because this advisor charged a ton of money, but his fees were largely performance based. To increase his fees (and his client’s net worth) he had to ensure the plan was a lean-mean-return-gathering-machine. The only way to do that was to develop a comprehensive tax strategy (example: tax efficient investments outside of IRAs while tax-eaters inside shelters) and low-cost investments.

4) Scour insurances for opportunities. This advisor would review all of his client’s insurances regularly (every two years) to find wasted money. He’d also use insurances wisely to plug holes. One place he nearly always recommended: disability coverage.

5) Build legacies. He was the adamant that everyone either had a family or charitable organization they’d want to have flourish if they couldn’t use their own money. He’d make sure that the estate plan was air-tight and (as with insurance) review these plans every two years.

6) Set communication systems. Clients received a newsletter every six weeks. There was a conference call scheduled for two quarters of the year, along with two face to face meetings. Generally, the face to face meetings were comprehensive and the phone calls were “just checking up.” While he “allowed” only one member of a marriage to take part in phone calls, he was adamant that both spouses attend meetings. He’d become especially irate if one didn’t understand finances and didn’t want to participate. His thinking: if the knowledgeable spouse passed away, the other was screwed.

He also wasn’t afraid to call every client when markets imploded. During the 2002 and 2008 crisis, his whole team was on the phone non-stop, sharing information and passing along strategies. Usually, he wasn’t changing course, because his asset allocation model was already designed to weather downturns. However, clients loved hearing from him.

Was some of this overkill? Maybe. Often insurance and estate planning needs didn’t change. However, when something did, the advisor was on top of it fairly quickly.

It’s a Choice

During my 16 years as an advisor, there were many clients who refused to pay fees even though they would have been far better off had they paid this advisor. It’s fine to accomplish your financial goals without an advisor (in fact, if you’re willing to complete the six steps above, I’d recommend it). But if you decide not to, make sure you’ve designed systems for success and aren’t just being cheap.

Financial planning is just one example. Are there areas of your life where you’d be better off paying a fee and you just can’t do it? Are you cheap?

(Photo credit: Hands Clenching Dollars, Muffett, Flickr; Couple and Advisor, Jerry Bunkers, Flickr)

High Yield vs. Other Investing Categories in Pretty Pictures

May 16, 2012 by Average Joe 14 Comments

When words don’t work, I’ll emulate my buddy PK at the DQYDJ blog and resort to graphics when explaining your investing options. Since I can’t personally be bothered to create any type of creative chart, I’ll instead use a graph that I received from a friend.

Before we peruse this particular investing chart, I should introduce it, like a big star explains the movie clip:

People worry often about risk when investing. You should. It doesn’t make sense to risk your portfolio without knowing what type of return you’ll receive.

As an example, one of the riskiest investment classes is art. I know and you know that your dogs-playing-poker is probably a timeless classic, but beauty is definitely in the eye of the beholder on that one. Unfortunately, if you paid $10k for your Velvet-Elvis-and-the-Eagle rug, that’s probably considered a capital loss.

Here is the risk/reward profile of high yield vs. other asset classes:

People are generally shocked when they see the risk/reward profile of high yield bonds. Is it true that JUNK BONDS are significantly less volatile than large-cap stocks?

Yup.

High yield bonds aren’t much more volatile than 10-year treasuries (which, ironically, have been more volatile than investment-grade bonds)?

Yup again. I knew people who came to this website are flippin’ brilliant.

Maybe now is a good time to review my posts last week on the topic of high yield bonds:

Off topic: Check out German stocks. Lots of volatility, plus those people wear black socks with sandals. I don’t know what those two points put together says, but it sure feels awkward.

How about you? Does this chart surprise you? Can you see my love affair with high yield? Make you laugh? Improve your outlook on life?