Some things in life really matter-a lot. Financial resources for food and housing matter much more than your choice of socks or lunch today. Adequate retirement resources are critical to ensure that you don’t need to work on your last day on earth. (The joke is that you don’t want to have to cut your cash flows so closely that the last check that you write bounces.) The reality is that people experience far too many mismatches between spending and portfolio income, and the retirement years are not so “golden.”
Whether the 1%, middle income or lower income, good decisions and implementation are critical. Like everyone, you have investment and financial planning needs and you probably wonder about the best course to meet these needs. If you don’t have any adviser, then should you get one? If you have an adviser, then is this person meeting your needs? After all, your role as the proverbial Walmart greeter should be because you like getting out and meeting people, not because you are short of cash. On a more serious note, you want the financial flexibility to fund college (whether for yourself, your kids or your grand-kids) and you also want flexibility related to healthcare choices and other living expenses.
Finding answers can be overwhelming for some, and pure drudgery for others. A typical response for many is to simply procrastinate. But the needs don’t go away and the adverse consequences of procrastination compound exponentially over time. Nevertheless, it seems some would rather have a root canal than have to deal with these matters.
CORNERSTONE Criteria and Guidelines-A Roadmap:
The objective of this Cornerstone blog is to provide some basic criteria and guidelines. The blog gives both a high-level overview with general information, and also links to provide much greater detail. People and circumstances are unique so there is no simple cookie cutter answer, but the intent is to provide objective content to help meet your needs. The information should help determine the type of professional counsel that you may need. It may also help evaluate costs and benefits of any current advisers. Hopefully the content is worthwhile so that you don’t have to fall back on your brother-in-law (who sold used cars before getting into investments.)
At a basic level, you need a strategy and tactics so that your savings can be invested in a way to meet your needs. This involves a determination of your Investment Objectives and Risk Profile. See Investment Objectives . It also involves an Asset allocation Plan to help meet your objectives. See the Cornerstone Asset Allocation example . This plan should utilize primarily mutual funds and Exchange Traded Funds-ETFs rather than stocks of individual companies. The Asset Allocation Plan provides diversification and rebalancing, and it involves the appropriate mix of:
- a) equity and fixed income,
- b) domestic and foreign,
- c) large and small capitalization,
- d) Other assets. There are many other asset classes that can comprise your Asset Allocation Plan as the portfolio size increases.
Major Investment Options: Although the development of Investment Objectives and Asset Allocation Plans may seem daunting, the good news is that there are many potential strategies and options. Moreover, technology has made investing easier and less expensive, and online websites are excellent.
Investment options are as follows:
- a) Do It Yourself (DIY).
- b) Robo-Advisers.
- c) Outside Advisers-Registered Investment Advisors.
- d) Outside Advisers-Brokerage/Commission.
Do It Yourself: For many individuals, the default is the DIY model. DIY is common because most people aren’t interested in investments, they don’t know where to go, they don’t know who they can trust and consequently they simply take whatever comes their way. The DIY approach typically produces mediocre outcomes and it is not recommended unless you commit to a disciplined approach. If you follow a disciplined approach, however, the results can be excellent. A major DIY risk is an over-concentration in risky assets in bull markets and then fear-driven selling during bear markets. This is called Buy High and Sell Low. See Do It Yourself .
Robo Advisors: A better strategy for most is a modified DIY that utilizes Robo Advisers. “Robo Advisor” is a generic term for an investment platform that offers investment advice based on computer algorithms. These algorithms are designed to assess your overall investment risk/return profile and then recommend an investment portfolio. These Robo Advisors then monitor your portfolio over time and make adjustments to rebalance the portfolio to stay aligned with your strategic allocation as the market changes over time. These programs are capable of producing a disciplined investment approach, and they are typically a very low-cost approach. A major issue regards the lack of human contact and counsel in the event of a large market decline. For example, would you feel comfortable trusting a computer algorithm in another severe market downturn like we saw in 2008/early 2009? Robo Advisors are also impersonal and lack the intuition and personal touch of an experienced adviser. To address these concerns, some Robo services are incorporating supplemental services that include contact with a live person. See Robo Advisers. Cornerstone strongly believes that these Robo Advisor platforms are an excellent choice for individuals who are comfortable with technology and who do not need face-to-face interaction.
Registered Investment Advisers: For many individuals, a RIA is the best solution. These advisers typically provide both investment advice and financial planning services. RIAs can provide advice that is tailored to an individual’s unique needs and circumstances. A fee-only RIA offers fiduciary advice (See Fiduciary below), and compensation is based on a fee that is typically 1% of Assets Under Management-AUM for a $1 million portfolio. Fees vary based on portfolio size and are lower for larger portfolios due to economies of scale. Some advisers may charge both an AUM fee and a planning fee. Some RIAs charge a flat fee and some charge based on an hourly fee. Hourly rates for financial planners often range from $150 to $300. There are many considerations in selecting and working with an RIA. See Outside Advisers . RIAs use both Passive and Active investment styles, and Cornerstone recommends RIAs that utilize the passive/index investment approach Passive/Active Investments .
Note: the RIA description above is generalized. While many RIAs are fee-only and they handle both client investment portfolios and financial planning services, there are also pure financial planners who are fee-only, but they do not handle investments. There are also RIAs that call themselves “Wealth Management” firms. Some Wealth Managers have the capabilities to handle high-net-worth clients with complex needs, but many other so-called wealth managers are less skilled and they use the wealth management term as a marketing ploy. Finally, there are dually-registered RIAs who receive both fees and commissions and are best described as fee-based. See Outside Advisers .
Brokers: Brokers constitute another major category for outside investment services. Traditional stock brokers, insurance agents and commission-based advisers have business models where they are compensated for commissions on trades. Some of these individuals offer both investment services and financial planning services. Some of these businesses may also offer investment advice for a fee instead of commissions. There are some highly skilled individuals offering excellent advice for a commission, but there are also many who do not. Whenever a commission is involved, there is a potential embedded conflict of interest. There is always a question about whether the trade benefits your portfolio or whether it is more beneficial to the broker. There can also be questions related to doing more trades to generate more commissions. Brokers also tend to use more higher-cost actively managed products that tend to underperform. It needs to be said that commissions may be an economic choice for very small portfolios. Outside Advisers
Key Investment Considerations:
Fiduciary Standards are a key consideration if you choose an outside adviser. Fiduciary Standards require that an adviser act in the best interest of the clients. Stated simply, a fiduciary places your interests above their interests. Cornerstone is generally cautious about the brokerage business model because brokers are not fiduciaries and current laws and regulations hold brokers to a lower standard than RIAs. Whereas RIAs need to act as a fiduciary in the best interest of the client, brokers must only provide investments that are “suitable”. As a result, brokers and may use products with high commissions rather than an alternative with lower costs. RIAs with dual registrations may have the same potential conflict of interest because they can offer commission-based products. Historically, partnerships and Variable Annuities are other examples of investment products that have high commissions and lower investment returns. The Department of Labor has proposed rules that require brokers to have a fiduciary standard similar to RIAs for retirement accounts but courts have struck down this provision. At this time it is difficult to know what fiduciary standards may develop from the various regulatory agencies and the courts.
Passive/Active Investments. Another key consideration involves Passive versus Active investment management. Your Investment Objectives and your Asset Allocation Plan can be structured, implemented and managed in a number of ways. When considering your options, it is important to understand the distinction between Passive and Active investments. Passive investments use low-cost index funds, whereas Active investments utilize a higher-cost strategy to find investments that “beat the market.” Research shows that Passive Index investments typically outperform Active investment managers. At its worst, active management pitches hot products like Bitcoin at its peak. See Passive/Active Investments .
Adviser/Broker Compensation: If you are considering an outside adviser, or you already have an adviser, then you need a clear understanding of their compensation and all the costs and expenses included in your portfolo’s investments. Unfortunately, most individuals do not understand the compensation and costs/expense structure in their working relationship with their adviser. Many advisers and brokers do not provide the necessary transparency, and they may make you feel like you don’t trust them when you inquire. It’s your money and it’s their job to provide full disclosure regarding these costs. When advisers are vague, or when they say investment costs are not something that they can control, then simply move on. Life is too short and the consequences may be too large.
FINANCIAL PLANNING SERVICES:
Financial Planning services provide practical guidance and tactics to meet a wide range of individual financial needs. Financial planning needs are generally very basic for people just getting started with jobs and careers. Your needs may be as simple as a monthly budget and a payroll deposit into an investment account. Over time, however, life gets more complex and there is an increasing need for financial planning services. Financial planning services may involve complex tax and estate planning strategies for a corporate executive. Although the DIY approach for financial planning works, there is often a point where professional help is essential. Cornerstone has links that cover basic topics, but cost-effective financial planning services are available through many Robo Advisor programs, and more comprehensive services are available through RIA firms. Good financial planners have the experience and judgment to be able to provide good objective advice. For example, telling clients they are spending too much, or investing too little, or taking too much risk.
Financial planning examples include:
Cash flow budgeting to provide guidance for monthly income and spending. Mint is a free personal finance tool to create a budget and Quicken is another excellent product. Finally, a simple Excel spreadsheet can handle simple budgets. See Cash Flow Budgeting.
Managing debt is critically important and includes items like consolidating credit cards, paying off student debt, securing a mortgage and establishing flexibility for refinancing a mortgage.
Retirement Investments are a major financial planning service. This involves assessing the amount of money to invest for an expected lifestyle.
This involves determining:
a) guidelines for financial planning life stages, contribution rates and withdrawal rates.
Financial Planning Life Stages and Link.Life Stages
b) Assessing progress towards achieving retirement goals. It is good to examine several models to get a more robust perspective on achieving your retirement goals. Cornerstone includes models from Fidelity, JP Morgan and T. Rowe Price. Cornerstone has also developed a sophisticated model that allows you to input your own data and generate your own scenarios.
See Asset Accumulation/Retirement Mileposts Link. Asset Accumulation/Retirement Mileposts
College costs and funding are increasingly expensive, and strategies are essential to prepare for this high cost/high reward expenditure. See Investment Products link. College Funding
Tax preparation, planning and strategy is another key financial planning service. Cornerstone maintains basic tax considerations in the Taxes Link. Turbo Tax offers easy-to-use software for tax preparation for easy and moderately complex tax returns. Some RIAs incorporate tax preparation in their planning services, and this is beneficial because it integrates tax loss harvesting and tax planning into the investment process. CPA services are also available for moderate to complex returns. See Tax Link.Tax
Insurance coverage is another consideration to meet various potential adverse risks. Once again, online services provide easy, cost-effective comparisons and Geico and Progressive are two good online examples for auto and homeowner coverage. Online services are also available for term life insurance. Finally, health care insurance is critical, but this is complex and requires specialists in this field.
Estate Planning becomes increasingly important as individuals become older and as they have a wide range of assets and larger portfolios. It is ironic, but there is a large need for people to get good advice to transfer and divest the assets that they accumulated during their lifetime. This involves wills, trusts and other complex strategies and Cornerstone recommends specialized legal advice. It should be noted that some RIAs incorporate estate planning into their overall financial planning advice.
This summary was designed to educate and to provide an objective overview of typical needs based on my career observations. It is certainly not all-encompassing and it definitely benefits from feedback. Feel free to Reply with all comments, recommendations and corrections. jjohnson@CornerstoneInvestmentsLLC.com.
June 22, 2018