Picking a trifecta is difficult, at best. Identifying the first three winners of a horse race, in order, is called a trifecta. The 2019 Kentucky Derby had 19 finishers, so you had to choose from 5,814 potential combinations! If you were correct, the $2 trifecta paid $22,950.

During my career in financial planning, I’ve found three things to be true: individuals aren’t aware of the type of investments they own, how much risk they’re taking, or what level of fees they’re paying.

After meeting with someone, I’ll review their investments to give them an idea of their financial situation. Often, they’re surprised how they’re allocated, their risk level, and the fees they’ve paid. I’ll then compare the results to their financial plan to make sure all three (allocation, risk, and fees) are in sync. The goal is to achieve a financial balance.

Let’s look at the three components.

Asset allocation. Your asset allocation determines most of your returns and your risk level. You might be able to improve your results by investing when the market is low; However, the odds of picking a bottom are extremely rare.

For the past 45 years, a portfolio of 100% stocks generated an average annual return of 12.9%. A portfolio consisting of 100% bonds produced an average annual return of 6%. A balanced portfolio of 60% stocks, 40% bonds made an average annual return of 10.4%.[1]

The returns varied depending on the market conditions. The 100% bond strategy never lost money from 1973 to 2018. The returns have dropped dramatically since 1999; the average annual return has been less than 3% for the past 20 years.

The 100% equity portfolio has produced the best returns, but with the highest risk. From 1973 to 1974, it dropped 41.5%. In 2008 it fell 41.8%. Last year it was down 11.8%. To achieve double-digit returns, you need to take some risk.

The balanced portfolio had considerably less downside than the all-equity portfolio. From 1973 to 1974, it dropped 20.8%. In 2008 it fell 24.8%. Last year it was down by 6.2%. The losses have been about half those of the all-equity portfolio.

Risk level. Risk has several definitions. Losing money is a risk. Volatility is a risk. Longevity is a risk. Inflation is a risk. Liquidity is a risk. Investing all your money in a fixed income portfolio will expose you to inflation and longevity risk. Investing everything in the stock market exposes you to volatility and principal risk. It’s hard to identify your risk level, especially after a 10-year bull market. One test is to review your trading during the 2008 Great Recession. When stocks fell 50%, what did you do? Did you sell your shares? Did you buy stocks? Did you buy bonds? Did you do anything?

Using a service like RiskAlyze or Finametrica can help you determine your risk tolerance. If you’re curious, you can take a quiz on my website by clicking on the “free-portfolio risk analysis” tab located on the upper right-hand corner of my website. Here’s the address: www.parrottwealth.com.

Fees. The fees you pay for your investments matter. Of course, the lower your costs, the higher your return (all things being equal). If you and your brother-in-law own the same fund, but your advisor charges you 2% per year, and his advisor charges .5%, he’ll have better returns. Fees vary, so be aware. Your advisor may bill you by the hour, charge a flat fee, assess a percentage of your assets, or take a commission. Regardless, a fee is a fee. Also, your investments may include other charges if you own mutual funds, exchange-traded funds, or insurance products. If your investment is sold with a prospectus, you’re paying a fee.

If you’re not sure about your investments, then hire a Certified Financial Planner® to help you figure it out. But, before you do, ask your planner how they get compensated and what type of investments they recommend.

Last, completing a financial plan will help you organize and quantify your goals, so they’re in sync with your asset allocation, risk level, and fee structure – a trifecta!

A horse gallops with his lungs perseveres with his heart and wins with his character. ~ Federico Tesio

August 13, 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. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level.

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. Options involve risk and aren’t suitable for every investor.

[1] 2019-Dimensional Matrix Book returns from 1973 – 2018.