by Derrick Handwerk MBA CWPP, CAPP
Every year when I sit down to write my annual New Year’s Resolutions for the affluent investor, my goal is to suggest behaviors for the affluent. I define affluent as people with less than $10 million in investable assets. Your home, vacation home, and the value of your business are excluded.
If one of your goals for 2011 is to be more financially secure with more peace of mind, then I believe this article will be helpful.
From my experience as an investment and wealth advisor, I will share with you the top five most pervasive behaviors that need to be considered.
The first three items on the list relate to investing and the last two relate to planning.
Investment behaviors to be addressed
1. Trying to beat the stock market — This is a myth. When you look at net returns, the majority of the managers and investment advisors cannot beat the market over a 20-year period unless they take on excess risk. While history should speak for itself, modern studies confirm this “terrible truth.” In the book, “Stocks for the Long Run,” Professor Jeremy Siegel reports that there were only three years in which many investments beat the market index (as measured by the S&P 500) in the past 20 years.
Solution: Don’t pick an advisor based on the promise of beating an index or giving you guaranteed returns. Aside from the primary market trend, investing in stocks is a sum zero net gain. For every person that beats the market, someone else has to underperform.
2. Investing only in stocks, bonds, and cash — They say variety is the spice of life. This axiom also may apply to investments. Depending on definition, there are 10 asset classes. The goal is to find noncorrelated assets that may give you a more steady return and not be tied to the volatility of the stock market.
Solution: Look at other asset classes that are suitable for your age and risk tolerance. If appropriate, commodities, real estate, and alternative investments may be a consideration for your portfolio. How would you feel if you were five years from retirement and the stock market cratered 30% and you had the bulk of your assets in stocks?
3. Not matching risk tolerance to return — Everyone would like to earn a 20% return. But with potentially high returns comes high risk. Just look back to the 1999-2001 Internet craze. People were making 20%, 30%, or 40% a year in the stock market. Most didn’t realize that with abnormal returns comes the possibility of abnormal losses. Return on a stock portfolio is commonly based on “Beta.” Beta refers to the change in a stock or portfolio in relation to the overall stock market.
Solution: Depending on your age, risk tolerance, liquidity, and goals, set your expected return target. Ask your advisors to show you a five- and 10-year historical average return for the asset allocation they recommend. This information may give you some sense of what you can expect.
Wealth-planning behaviors to be addressed
4. Only investing and not planning — I am amazed with how the terms “investment advisor” and “financial planner” are used interchangeably. The confusion may stem from financial institutions giving financial planning advice, which is incidental to the selling of investments. I see very few financial plans. What I do see a lot of are cash flow analysis. This “plan” shows cash projections at various rates of return on your nest egg. The moment the investment advisor hands the book to you, it is in the process of becoming obsolete.
Solution: If you’re net worth is above a million dollars, there may be many wealth preservation tactics and strategies for potentially increasing and preserving your wealth. If you are only investing and not doing financial planning, I would suggest you are missing potential opportunities. Also, as most people with a high-net worth will tell you, constant oversight and updating of strategies is imperative.
I assert that good planning at the margin can be more important than good investing. The problem is many investors haven’t seen good financial planning. If you work or have worked 50 to 80 hours per week to amass your wealth, doesn’t it make sense to have a plan in place which is constantly updated to set the direction for your financial life?
And last, but certainly not least …
5. Failing to save enough money for retirement — Most people I talk with underestimate their life span and the amount of money they will need in retirement. From my experience, less than 10% of millionaires have enough money to retire on and keep their present standard of living. I’d suggest that if you are affluent, educated, exercise, and have good genes, the chance of reaching the age of 90 increases significantly.
Having one spouse living to age 90 means your assets must support your lifestyle for 25 years or possibly longer. This realization may not occur until age 74 and the money is gone. Can you think of many things worse than being 74 and out of money? Instead of having a grand life, you now may have to accept Medicaid and see your lifestyle dramatically change.
Solution: Save, save, save, and if you think you are close to reaching that magic number, run some cash flow illustrations with various inflation levels, investment returns and “end points” until you feel comfortable that you should be “OK.” Remember, it is better to have too much money in retirement vs. too little!
These five behaviors come from over 25 years of investing and working with affluent clients.
I hope that 2011 is a prosperous year for you and your loved ones. I wish you health, wealth, and happiness.
Editor’s Note: The information presented is general in nature and should not be considered legal or tax advice. The reader should consult their legal or tax advisor for information concerning their own specific tax situation.
Derrick Handwerk received his MBA from Lehigh University and is a Rauch Business Scholar. He received his certification in wealth preservation and asset protection from the Wealth Preservation Institute. After college, he spent three years in the pharmaceutical industry, and then went on to run and own several businesses, including Handwerk Wealth Advisory. Handwerk Wealth Advisory works with accredited investors and small business owners. He also specializes in working with medical and dental practitioners. Visit his Web site at www.handwerkwealthadvisory.com.