Wednesday, February 8, 2012

Investing for Good Times & Bad

Your investment strategy is about way more than not putting all your eggs in one basket. But how do most financial advisors create your investment strategy? They have you fill out a questionnaire that somehow magically determines your risk tolerance. That questionnaire is supposed to tell them if you’re Aggressive, Balanced, or Conservative etc. And if you came out balanced for example your money should be invested in 60% stocks and 40% bonds. They use big words like efficient frontier, beta, and standard deviation which more than likely they don’t even understand. But it makes them seem smart. You say OK, and now you a false sense of security believing that you are following some sort of sophisticated investment strategy.

If it were that easy, why not just train a monkey to do that and we could save everyone from paying these guys commissions and fees. That’s because it’s not that simple. And if your Advisor is handling your investments this way, now you know why you may not be getting the results you desire, especially in tough times. Anyone can make money in good times. Do you really believe that by answering 10-15 questions someone can create a viable investment strategy? I hope not.

Don’t feel bad. They are a lot of people out there that listen to the other financial talk radio show based out of Nashville, TN and believe that by only investing in 4 types of mutual funds with a 10 year track record is the end all be all. Simply Ridiculous!

So how do you create a viable investment strategy? We all basically face the same risks when it comes to investing: Deflation, Inflation, Taxes, and Market Volatility or Risk

If our strategy is going to worth anything, we must address each risk as much as possible. To do that we need to understand that there are 4 main types of asset classes to do this: Interest Earning, Real Estate, Commodities, and Equities. Each asset class serves a unique purpose or function to protect us from potential risks. Miss an asset class and you don’t cover a potential risk you will most likely face.

Can anyone tell you what income taxes will be next year, in 5 years? No. Can anyone tell you for sure where the market is headed? No. Lots of talk right now about inflation and deflation. Does anyone know which we will have or how much it will be? No

We have no control over any of those things. What do we have control over? Only 2 things: How much we save and where we put it. I used to say we could control how long we save, but we can’t. Anyone of us can drop dead tomorrow. What else do we know? How much time do we have before we want to reach our goal assuming we are around? Is college 10-15 years away for our children? Do we want to be financially independent in 10-15-20 years?

What else should we know? Our financial personality. Or your tendencies, thoughts, and fears about money. We covered that in the “Foundation” article, so I won’t go into to it here

Once we understand ourselves and our goals. We need to create a strategy that gives us the best chance to get from point A to point B. Then we start covering all the risks we could potentially face: Again: Deflation, Inflation, Taxes, and Market Volatility or Risk

And to do that you need to own 4 types of asset classes. Each type of asset or asset class inside your investment portfolio serves a very different function.

Assets should be divided into four main categories:

1.      Interest-Earning
2.      Real Estate
3.      Commodities
4.      Equities
Most advisers never even discuss commodities or real estate. I believe that all portfolios should contain all four categories. How much you should own of each category will depend on your unique situation. All four categories are important and serve totally different purposes.

Purposes:

1.   Interest-earning assets such as cash and bonds give you access to capital on a short-term basis. If you need access to liquidity, bonds and cash are the first place you should look. Bonds are also hedge against deflation.
2.   Real Estate is one of the best ways to protect you from inflation. It is one of the most inflation sensitive assets you can own. Inflation decreases your purchasing power as the prices of goods and services increase, and it is a major risk to your long term financial goals. Usually owning your primary residence is enough to have at least a third of your assets in real estate. However, if you have built up a bit more wealth, you might need to purchase real estate beyond your home in order to keep your portfolio balanced.
3.   Commodities are actual physical goods like corn, soybeans, gold, crude oil, etc. In years past, using this asset class was done only by professionals. But since the addition of commodity based mutual funds and exchange traded funds, this is no longer the case. Recently we have all been hit by rising prices at gas stations and grocery stores. By adding commodities to your mix, it provides a hedge against rising prices of goods.
4.   Equity Investments should be held long term, and typically outperform all other asset classes during periods of economic growth. Equities are broken down into large cap, small cap, international stocks, and emerging markets. Each area of equities also serves a different purpose and amount of ownership should be based on you and your goals.
As I mentioned earlier, most Financial Advisors do NOT understand functional asset allocation. Understanding the function of each type of asset is critical to tailoring your investment strategy to your specific needs, rather than using a one- size-fits-all approach. If you need a second opinion on your investments from someone who understands risk and asset functionality, call me at 615-878-2134 or click www.jasonwqualls.com.

No comments: