March Personal Finance Newsletter
March 14, 2011 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
The March personal financial planning newsletter is now available. It includes an update on the investment market, tips on cutting discretionary spending to build your cash reserve, planned charitable giving, and social security survivors benefit. There’s also a special guest column from attorney Rania Combs on the complexities of dying intestate (without a will) for individuals in blended families in Texas. Click here to read the newsletter.
February Personal Finance Newsletter
February 14, 2011 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
The February personal finance newsletter is now available. In addition to the investing market update, the topics are:
- Extension of tax-free charitable contribution option from IRAs for those over 70 1/2
- New cost basis reporting rules (important for those with taxable investment accounts)
- Summary of the health care law provisions going into effect this year
Click here to read the newsletter.
January 2011 Personal Finance Newsletter
January 14, 2011 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
The January newsletter is now available with a 2010 investment market recap, a humorous look at investing resolutions for the new year, and details on the estate tax changes enacted in December. It also includes an announcement of topics for the Keller Public Library personal finance workshop series for January – June. Click here to read the newsletter.
December Personal Finance Newsletter
December 16, 2010 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
The December 2010 personal finance newsletter is now available. It includes an important update on social security rules, 2011 IRS mileage rates, considerations in rolling your traditional 401(k) to a Roth IRA, and changes to the adoption assistance program. As always, there’s also an investment market update. Please click here to view the newsletter.
October Personal Finance Newsletter
October 15, 2010 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
The October 2010 personal finance newsletter is now available. It includes information on social security, medicare open enrollment season, year-end investment planning, and the new small business jobs act provisions. In addition, an investment market update and information on free financial workshops in Keller (TX) are always covered. To view the newsletter, click here.
Portfolio Diversification Pitfalls
October 12, 2010 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
Common Investment Diversification Problems and How to Avoid Them
You’re diversified, right? You own all kinds of investments – individual stocks, traditional mutual funds, and those new-fangled exchange-traded funds (ETFs) – and have multiple accounts at different financial institutions. That’s enough, isn’t it?
Well, maybe not.
Many investors believe their portfolio is more diversified than it really is. Here’s a sample portfolio that on the surface might appear diversified:
- Fidelity Blue Chip Growth Fund
- Schwab Dividend Equity Fund
- T. Rowe Price US Large Cap Core Fund
- Yacktman Fund
- Rydex S&P Equal Weight ETF
- iShares 400 Social Index ETF
- Procter & Gamble
- Pepsico
- ExxonMobil
- Microsoft
Dig a bit into this collection of six funds and four stocks, and you’ll see that this portfolio is not well diversified at all. It’s invested almost exclusively in large-cap U.S. stocks. There’s almost no exposure to small-cap or international stocks, and there’s no bond exposure. A big chunk of your overall portfolio is in the top 25 U.S. companies, and the individual stocks you own are among the largest holdings in several of your mutual fund holdings. Your risk level is comparable to just owning a single S&P 500 Index fund.
This portfolio illustrates some false signs of diversification:
1) Large quantity of mutual funds or ETFs from different fund companies
2) Accounts with different institutions
3) Several different large-company stocks
A truly diversified portfolio includes many different kinds of assets, as well as many different companies or governments within each asset class.
The most basic division of asset classes is between stocks and bonds. Both stocks and bonds can be further divided by geography. Stocks can be categorized based on company size or by whether they are value or growth stocks, while bonds can be categorized based on credit rating quality and whether they are short, intermediate, or long-term bonds. You may also add real estate and commodities for additional diversification.
To build a well-balanced diversified portfolio, follow these steps:
1) Assess how your current portfolio is allocated.
If you have multiple investment accounts, including employer retirement plans, IRAs, and individual accounts, you need to get an aggregate view of your asset allocation. If you’re a Quicken user, you can access its asset allocation report. Many brokerages and banks offer aggregation services that will provide some level of detail on your total holdings.
2) Select what percentage of your portfolio you want to invest in each asset class.
This decision is a function of your risk tolerance, time horizon, and goals. For those with a moderate risk tolerance, I recommend using these general ranges as a starting point:
- Just starting out (20s and 30s): 60% to 70% stock
- Peak Accumulation Years (40s and 50s): 50% to 60% stock
- Nearing / In Retirement (60s+): 40% to 50% stock
You may wish to exclude some asset classes completely if you their risk level is inconsistent with your goals. Make this decision with caution, however, because even an asset that doesn’t seem to fit with your objectives may play an important diversification role in your portfolio.
For example, you might be inclined to opt out of risky-sounding assets like emerging markets, commodities, or global real estate completely. But when you add these investments in small doses, they can increase your projected returns with very little effect on the portfolio’s overall risk because of their lower correlations to the U.S. stock market.
3) Determine what “vehicle” you will use to invest in each asset class
This can be a combination of individual stocks, mutual funds, and ETFs, although building a well-diversified portfolio of individual stocks is tough for many investors. Here are the most important factors in picking an investment vehicle:
- Low cost: Cost is one of the biggest determiners of fund performance, so cheaper is generally better. Costs vary for different asset classes, but low-cost index funds usually come in between 0.10% for large-cap U.S. stocks to around 0.30% for emerging markets funds.
- Specific objective: Knowing what investments a fund can buy lets you control your asset allocation, rather than the fund manager drifting among different types of investments.
- Number of securities in the fund: More is better.
If you’re just getting started, you should look for funds that combine asset classes (still with specific percentage objectives) to help meet fund minimums and keep transaction costs down. This can include target retirement date funds, lifestyle funds, or balanced funds.
After you’ve selected funds in each asset class, you should use the same method you used in step 1 to ensure your portfolio achieves your target percentages and diversification goals. Specifically look for overlap issues between funds.
4) Make your investments, and then monitor your portfolio and rebalance periodically (no less than once a year).
Following these steps to real diversification puts you in control of the risk level of your portfolio. It can be tempting to fall for the “false signs of diversification,” but by putting a bit more effort into your allocation, you will be better positioned to withstand market downturns and benefit from upswings.
This blog post was also selected for publication on The Motley Fool.
September Personal Finance Newsletter
September 17, 2010 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
The September 2010 personal finance newsletter is now available. It includes information on opportunities unique to 2010 for year-end tax planning, tips on teaching your college-age child about money, how a stronger dollar affects your portfolio, information on FDIC insurance now that higher limits are permanent, and a market update. Click here to read the newsletter.
Interviewed by Wall Street Journal on keeping investing costs low
June 22, 2010 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
I was recently interviewed for the Wall Street Journal’s website about the importance of keeping investing costs low and how costs affect your long-term investment returns. You can read the article at WSJ.com.
Four Rules for Asset Allocation
May 25, 2010 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
As a special guest blog post, the Motley Fool staff has provided the following article on asset allocation. It’s an excellent summary of some of the most important concepts of investing and asset allocation, and is definitely worth the read. Enjoy!
By The Motley Fool
When it comes to asset allocation, the biggest decisions come down to how much you should have in cash, how much in bonds, and how much in stocks. These four rules for asset allocation will help you slice up your portfolio into these important pieces.
Rule 1: If you need the money in the next year, it should be in cash.
You don’t want the down payment for your vacation home to evaporate in a stock market — or bond market — crash. Keep it in a money market or savings account. And, of course, make sure it’s FDIC-insured.
Rule 2: If you need the money in the next one to five (or even seven) years, choose safe, income-producing investments such as Treasuries, certificates of deposit (CDs), or bonds.
Whether it’s your kid’s college money or the retirement income you’ll need in the not-so-distant future, stay away from stocks.
As with all investments, risk and reward go hand-in-hand when it comes to “safe” assets. So, in order of “safest” to “still safe but technically riskier,” we have Treasury notes and bills, CDs, and corporate bonds. That’s also the order of lowest- to highest-yielding. CDs are still very safe (as long as they’re FDIC insured), can usually be bought commission-free, and you should be able to find some that pay a percentage point above Treasuries. Shop around for the best rates; your local bank may not be the best-yielding option.
As for corporate bonds, the general rule is to choose bond mutual funds if you have less than $25,000 to $50,000 to invest. That’s because buying individual bonds can be tricky. With a stock, you can pull up a quote on your computer and — presto! — you have a good idea of the going price. However, most bonds don’t trade on a centralized exchange. And instead of charging a commission, most brokerages (discount and full-service) embed a “markup” in the price of the bond. This makes it difficult to know what fees you paid.
It is gradually becoming easier (and more cost-effective) to buy individual bonds, so it can be done if you’re willing to put in the effort. The advantage of individual bonds over bond funds is you know exactly how much you’ll get back when the bond matures. However, since bond funds don’t technically “mature,” you don’t know what your investment will be worth when you need the money. In fact, they can lose quite a bit of money, which can be inconvenient if it happens right before you need it.
If you’re going to choose a bond fund, stick with short- to intermediate-term bonds (i.e., bonds that mature in two to five years). And be vigilant about costs — you can find plenty of good funds with expense ratios below 0.50%.
Rule 3: Any money you don’t need for more than five to seven years is a candidate for the stock market.
We Fools are fans of the stock market, and we know our history. According to Ibbotson, large-cap stocks, on average, have returned 10.4% annually from 1926 to 2007, compared to 5.5% for long-term government bonds and 3.7% for short-term Treasury bills.
However, investors in stocks have to keep that “long run” part in mind, since in the short run, no one knows what stocks will do. Make no mistake: Even if you’re in or near retirement, a portion of your money should be invested for the long term. That’s because, according to the Center for Disease Control, a 55-year-old can expect to live another 26 years. A 65-year-old has another two decades. The average 75-year-old lives into her late 80s. A 110-year-old, however, should sell everything and get to Vegas while he still can.
So unless you’re a 95-year-old skydiver who smokes, expect your retirement to last two to three decades. To make sure your portfolio lasts that long, you should …
Rule 4: Always own stocks.
Over the long term, equities are the best vehicles to ensure your portfolio withstands inflation and your retirement spending.
According to Jeremy Siegel’s Stocks for the Long Run, for every rolling five-year investing period from 1802 to 2006 (i.e., 1802-1807, 1803-1808, etc.), stocks outperformed bonds 69% of the time. Stocks beat bonds in 80% of the rolling 10-year periods, and almost 100% of the rolling 30-year periods. For holding periods of 17 years or more, stocks have always beaten inflation, a claim bonds can’t make.
But don’t forget that four-letter word
The bottom line is that when you need your money will partially dictate where you put it. What else determines your asset allocation? Risk.
Most people base their investment strategies on the returns they want, but they have it backward. Instead, focus on managing risk and accept the returns that go along with your tolerance for it. It’d be great if we could get plump returns with no risk at all. But to achieve returns beyond a minimal level, we have to invest in things that involve the possibility that we’ll lose money.
Of course, this isn’t just hypothetical theory for modern investors. The 2000s have brought us two wrenching bear markets, a mere six years apart. (Maybe there was something to all that Y2K hullabaloo after all!). Have you been able to hold on — or did you panic and sell? That’s the true test of an investor’s risk tolerance: the ability to cling to those shares as they become worth less and less, while clinging to the hope (based on history, but nothing more) that they will one day be worth more and more.
So ask yourself: What would you do if your portfolio dropped 10%, 20%, or 40% from its current level? Would it change your lifestyle? If you’re retired, can you rely on other resources such as Social Security or pensions, or would you have to go back to work (and how would you feel about that)? How you answer those questions will lead you to your risk tolerance. The lower your stomach for portfolio ups and downs, the more your portfolio should be in bonds.
As an extra aid in determining your mix of stocks and bonds, consider the following table, from William Bernstein’s The Intelligent Asset Allocator:
|
I can tolerate losing ___% of my portfolio in the course of earning higher returns |
Recommended % of portfolio invested in stocks |
|
35% |
80% |
|
30% |
70% |
|
25% |
60% |
|
20% |
50% |
|
15% |
40% |
|
10% |
30% |
|
5% |
20% |
|
0% |
10% |
So, according to Bernstein, if you can’t stand seeing your portfolio drop 20% in value, then no more than 50% of your money should be in stocks. Sounds like a very good guideline to us.
Copyright © 1995-2010 The Motley Fool. All rights reserved. Used with permission. www.fool.com
May 2010 Newsletter
May 10, 2010 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
The May 2010 newsletter is now available. It includes investing information with perspective on last week’s market plunge and an update on the new reduced fees for trading Vanguard ETFs. For taxes, there’s information on the new 3.8% medicare tax for high income individuals. For cash flow, we cover using a Roth IRA as a back-up emergency fund. For insurance, it includes information on incorporating TX state guarantee association coverage limits and exclusions into your financial planning. Click here to read the newsletter.