3 Things You Can Control to Maximize Your Financial Plan (and returns)
Updated: Jun 20, 2022
"If you focus on avoiding unforced errors, you won't need to rely on cute market phrases that sound really great but only provide a false sense of security." - Michael Batnick, Big Mistakes: The Best Investors and Their Worst Investments
We often talk to our clients about the things they can do to maximize their financial strategy. After all, what would be the point to hire us if we didn't help them achieve their goals in the most efficient way possible? Most people agree that they cannot "time" the market. No one can predict the exact date and time that a correction will occur or for how long it will occur. However, I've broken down three things that investors have control of that will at least defend their portfolios against adverse market conditions and making unforced errors.
1. Costs You Were Going to Pay Anyway
One of the first questions we ask prospective clients is, "What are you paying?". This is quickly followed up with, "What do you get for it?" (the answer to the second one is normally something like, "What do you mean?" or "I don't know, nothing..."
I'll preface this topic by saying that the cheapest advisor or investment isn't always the best. Since we like to think of ourselves as financial health professionals, we tend to make medical analogies. If someone needed a specific heart surgery that required precision, I don't think they would ask for the cheapest surgeon. Price is only an objection in the absence of value.
However, it's important to make sure you get what you pay for. For example, there are index funds out there that charge 1.2%+ (high cost index funds) and there are index funds that charge 0.04%. If they're holding the same basket of securities tied to the same index, why would a client pay an extra 1% over the course of their investing lifetime?
Over a 20 year investment time horizon, comparing two portfolios growing at 6% and each starting with $100,000 - one paying 1% more in fees than the other, equates to a difference of over $57,000. These are the little things that are important to talk to your financial professional about.
2. What Accounts You're Saving In (tax efficiency)
With most accounts being taxed differently, it's important to make sure our clients are saving in the correct places based on their tax situation. There is more to financial planning than saving into a 401(k) plan through your employer. It's important to think about the characteristics that one wants in an account to meet their goals. Do they want the money in the account to be accessible before 59-and-a-half? Do they want a current tax deduction on contributions or do they want to withdraw money tax free later? What accounts are even out there with which to save? Are there differences between a Roth IRA and a Roth 401(k)? What's the difference between restricted stock units and non-qualified deferred stock options from a tax standpoint? What are the rules when employer stock is held in the 401(k)? - Are we in the weeds yet?!
Questions like these are important, and can have detrimental consequences to one's financial plan if they aren't planned for. Working with a fee-based financial planner can help with questions that you've never thought would have an impact. Simply put, there is more to financial planning than, "Am I saving enough?"
We help clients save into different places with different account attributes so that no matter where the tax environment stands when they need their money, they're able to take it out efficiently.
3. Behavior and Market Timing (most important)
I will write future blog posts on investor behavior that explain it more thoroughly, but for now let's keep it as simple as possible. There is no evidence that anyone has ever been able to consistently predict when a market will go up and/or go down. If you think about it, making market predictions is low risk for the person making them. For example, let's say that someone predicts a 20% downturn in the market in any given year. If they're wrong, no one remembers. If they're right, they're a hero. That's why it's a lot easier to make bearish predictions when really no one knows exactly what will happen. If investors hear or think that a correction is coming (which, by the way, is normal and healthy), and they move their money to cash, they could potentially miss out on gains if there is no correction.
What we do know, is that over the long term, markets have gone up over time. It's so crucial to keep a long term perspective on your portfolio and not try to time the market. If you have short term goals, maybe the market isn't the place to be with all of your dollars. In Thinking, Fast and Slow, Daniel Kahneman explains the psychology of the human brain and mentions that people are 2-3 times more sensitive to losses than they are excited about gains. Simply put, losses have a greater impact in one's mind than gains.
For the hard numbers, there are numerous studies done on missing the best days in the market by trying to time it. Over the past 15 years, if someone missed only the 10 best days of the S&P 500 index, their returns were nearly cut in half. Working with a planner that keep you on track from a behavioral standpoint is a major key to financial success.
"The most important thing successful investors have in common is worrying about what they can control. They don't waste time worrying about which way the market will go or what the Federal Reserve will do or what inflation or interest rates will be next year. They stay in their circle of competence, however narrow that may be." - Michael Batnick, Big Mistakes: The Best Investors and Their Worst Investments
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