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It seems as if I have been involved in finance and money all my life. For 25 years I was an institutional trader and now for the last 15 years I have been focusing on helping everyday people to understand and cope with everyday financial issues. I have my own small Registered Investment Advisor firm in Connecticut focusing on discretionary money management .
The last several years have been difficult for many people as they have seen portfolios shrink or not grow. While not losing money can be viewed as a positive the loss of time in the accumulation phase will have consequences. Simply put, if you created a financial plan in 2000 and it projected a certain level of assets in 2010 and you are at the same level now that you were in 2000, you may be in trouble. While ten years of growth may have been lost it can be made up in a variety of ways.
When I sit down with a person to review their financial situation I employ a three prong approach.
The first step is to examine how much money is needed on a yearly basis taking into account the payment of income taxes. Next we calculate the income from “guaranteed sources” such as Social Security, pensions or part-time work. The difference is how much is needed from the portfolio. This exercise serves multiple purposes. It allows the client to examine expenses and look for an area that may be trimmed and it reframes the role of the portfolio. Often it is not the primary source of money and once people recognize that they often feel a bit better or reassured.
We then look at the portfolio in terms of construction versus the client’s goals and risk tolerance. They may notice that their portfolio has a certain amount of cash or stable short term investments to provide for the next 12-24 months worth of draw downs. It is important to have a portion of your portfolio available to use either for expenses or an emergency without having to liquidate other assets. One way of replenishing the cash is to have dividends and capital gains paid out as cash each year as opposed to reinvesting. The tax consequences are the same.
Next we look at allocation to fixed income and equities. Fixed income has been among the best asset classes over the last 10 years because interest rates have fallen and, when that happens, the underlying security price rises. It would be a mistake to think that fixed income will do as well in the coming decade but it is not an asset class that should be abandoned. Keep in mind that interest rate increases should be gradual and it is not likely that the rates will rocket upwards. Instead, when rates do rise it should be gradual and the higher interest rates should mitigate some of declines in asset values that will occur. Fixed income areas that should do better in a rising rate environment should include high quality Ginnie Mae securities, BBB/BB grade securities and bank loan funds. It is conceivable that US Treasury securities may perform worse than those mentioned.
Despite a rather flat decade for many of the equity averages, theory says that we need equities for growth and possibly income. There has been an increase in the number of mutual funds/ETFs that are focused on stocks that pay dividends or have a history or increasing dividends. Companies that pay dividends tend to be in the larger, to be a bit more mature and established.
REITs, or Real Estate Investment Trusts, are also entities that pay good dividends. By law 95% of a REIT’s profit must be distributed to shareholders.
Overseas markets cannot be ignored. Europe and Asia are well developed economies that are producers and consumers. China, Latin America and India are among areas that are both producers and have rapidly rising consumer profiles that are indicative of equity growth and a portion of a portfolio has to be devoted to those segments.
It is important that a portfolio contain exposure to cash, fixed income and equities in an appropriate mix to help you meet your goal. It is also important to recognize that all investing entails some risk and that needs to be balanced against your goals.