The S&P 500 rose 13% in the first quarter. Are you satisfied or frustrated if your investment portfolio “only” made 12%?
During the quarterly review season investors want to know how well their accounts performed. Did they make money? Did they outperform the market? Will the trend continue? These are common, and logical, questions investors ask their advisors – but are they the right ones to ask?
Of course, returns matter. However, rather than focusing solely on your investment returns, you should review your financial goals and savings target. Are you saving money? Are you investing for a purpose? Do you have written financial goals? If you aren’t saving any money, your returns won’t matter. Nor will they matter if you’re not investing for a purpose like buying a new home, saving for retirement, or funding an education.
Identifying your investment goals is paramount to determining if you’re on the right track. For example, if your goal is to retire with $1 million and your current account balance is $1.2 million, you don’t need to take aggressive risks with your money. A conservative mix of investments will help you grow and preserve your wealth. On the other hand, if your balance is $250,000, you’ll need to own a growth-oriented portfolio loaded with quality stocks.
Time is also a factor. A 25-year old who saves $500 per month needs to earn 6% per year to reach $1 million in assets by age 65. A 50-year old needs to earn 25% – an unrealistic rate of return.
Investment goals and time frames are linked. Will you need your money in one year or less? If so, invest in short-term investments like U.S. T-Bills, money market funds, or CDs. These low-yielding investments will underperform stocks over time, but your goal is not to generate the highest return because you’ll need the money in the near term.
Saving for college is also time dependent – 18 years or less. If you recently had a baby, then an all-stock portfolio makes sense. As your child approaches age 18, move the assets to safer investments. When my daughter was born her account was filled with individual stocks. When she entered college, I moved half her assets to U.S. T-Bills so I could pay for her tuition, rent and food. She’s graduating from college in December and this strategy worked well.
Retirement is a primary goal for most. Saving as much as possible for your retirement is recommended. You’re allowed to contribute $19,000 per year to your 401(k). If you’re 50 or older, you can add another $6,000. You can also contribute $6,000 to an IRA. You can contribute another $1,000 if you’re 50 or older
During your next quarterly review, focus on your goals rather than your returns. Here are a few suggestions to help you transition from returns to goals.
- Establish goals. If you don’t have a target, you can’t measure your progress. Once you document your financial goals, you’ll know if you’re on track – or not. Set up a system to monitor your progress. You can create a savings thermometer like you see at fund raising events! If you’re on track, stay the course. If not, make the necessary adjustments.
- Increase your savings. You can’t control the stock market and returns are fleeting, but you can control how much money you save. In 2017 the S&P 500 rose 21.8%. It fell 4.4% last year. Let’s return to our 25-year old investor. She needs to earn 6% per year to reach $1 million at age 65 if she saves $500 per month. If she increases her monthly savings to $1,000, she only needs to earn 3.32%.
- Control your spending. To retire, you need to cover your expenses. The lower your expenses, the less money you’ll need to save for retirement. For example, if your annual expenses are $100,000, you’ll need at least $2.5 million to pay for your expenses. If you can lower them to $75,000, then the amount you’ll need to save is $1.875 million. Do you track your expenses? Creating a spending goal or budget plan will help you establish your asset target. Multiply your expenses by 25 to figure out how much money you’ll need for retirement. Are you on track?
- Adjust your asset allocation. An allocation to 100% stocks will give you the best opportunity to create long-term wealth, but it will be a bumpy ride. In 2008 the S&P 500 fell 37%. A portfolio consisting of 50% stocks and 50% bonds fell 20%. Adding bonds to an all equity portfolio will reduce your risk. What is your appropriate asset allocation? It depends on your tolerance for risk, financial goals, and time horizon. You can click on this link to identify your risk tolerance: https://clients.riskalyze.com/risk-questionnaire/questionnaire-intro
- Big wins. The largest investment in your account will have the biggest impact on your returns. My parents best performing stock has been Starbuck’s, it’s also their smallest position. It has little impact on their account. Denmark’s stock market has outperformed the U.S. market by 4% per year for the past 20 years. Denmark accounts for 1% of the global market capitalization while the U.S. accounts for 54%. When U.S. stocks move it makes an impact, not so much with Denmark.
It’s important to generate positive long-term returns, but it’s more important to have financial goals. Take some time to identify your goals so at your next quarterly review meeting you can focus on your progress.
Risk comes from not knowing what you’re doing. ~ Warren Buffett
May 9, 2019
Bill Parrott, CFP®, CKA® is the President and CEO of Parrott Wealth Management located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose.
Note: Investments are not guaranteed and do involve risk. Your returns may differ than those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation.
 Dimensional 2019 Matrix Book