Learning the jargon of financial investment can be daunting, but it can also provide you with a better way to understand the status of your investments. Here is a brief primer on some common financial terms you should know, and things you should consider when evaluating your portfolio and investment returns.
“Two roads diverged in a wood, and I—
I took the one less traveled by,
And that has made all the difference.”
--Robert Frost, excerpt from the Road Not Taken
In a recent article from Financial Advisor Magazine that identified the regrets many people have for not taking more risks in life. “Among the top regrets were: not following their dreams, not taking risks with their careers, not taking risks with their lives in general, and not being gutsy enough in the choices they made.”
What was reassuring about these findings is that many people vowed to fix these regrets by taking more risks with the time they have left. There is an optimism there that is unique to our time. People are living longer, way longer than we were even a few decades ago and with that comes opportunities to evolve and edit things about our lives that don’t make sense or don’t satisfy us regardless of our age or stage in life.
Gambling is speculation. One cannot assume any expectations based on the amount of risk one takes. You could win $50 million from a $5 lottery ticket or you could bet $50,000 and win nothing. Investing is quite different. Investing in capital markets has a positive expected return for risk taken.
Stock markets worldwide have reliably rewarded long-term investors. For example, over the past eighty years, investors who held the S&P 500 (including dividends) for at least 12 years would always have had positive returns.
Commodities, like many things that come out of Wall Street are easy to sell and hard to trust. Though the Commodities market is sometimes in vogue, they are too volatile to be held for the long-term. According to a Goldman Sachs Group Inc. study from 2016, a portfolio of stocks, bonds and commodities showed a worse return in the period from 1987 to 2015 than a portfolio of just equities and debt. They also may not be a good hedge during stock market declines: Commodities fell more than U.S. equities during the recent stock market declines in 2008, 2010, 2011 and 2015.
The reliability of investment outcomes and the relationship to performance in a diversified portfolio
The benefits of diversification is something we discuss at great length with our clients. In addition to the commonly discussed benefits of diversification: increased returns and volatility reduction; the other lost leader is the positive impact that diversification has on delivering reliable outcomes.
In a research paper by Wei Dai, PhD of Dimensional Fund Advisors, Dai identified that the most reliable drivers of expected returns, or what they call dimensions, are the premiums associated with company size, relative price and profitability. But that isn’t the end of making sound investment decisions when choosing what companies to include in a fund or which equities to include in a portfolio.
If you are nearing retirement and a pension is part of your retirement income, then you are likely considering how you might like to take that distribution. How you choose to receive your pension is a big decision, not only because it can have a big impact on your potential income, but it can impact your spouse and your family as well. If you have options when it comes to how you receive your pension, it is critical that you carefully weigh the pros and cons of taking a lump sum versus the annuity distribution option before you make a permanent and irreversible decision.
It is in our behavioral nature to assess risk based on identifiable examples, not only can that mindset skew decision making, it can leave us vulnerable to risks we are not as familiar with and closed off from opportunities we may believe to be too risky. These things coupled together do not make for clarity of thought when making investment choices.
Availability Bias or Availability Heuristic is “a mental shortcut that relies on immediate examples that come to a given person’s mind when evaluating a specific topic, concept, method or decision.”
As we live in the aftermath of the Great Recession, though the strides that the markets have taken between then and now have been impressive, investors maintain an availability bias that “safe is good” and “risky is bad.” Unfortunately, that leaves investors with quite a dilemma.
For many wealthy investors finding new avenues to increase the amount of assets they can leave to their loved ones is important to the goals that they have set in a wealth transfer plan. An interesting strategy for facilitating this is referred to as a “stretch IRA”. The method designates beneficiaries with the longest life expectancy so that that the Required Minimum Distribution (RMD) is lower. In implementing this strategy the base asset is larger for a longer period of time, which will help it grow more quickly.
Factors to Consider
It is imperative to consider vital components before settling on this sort of choice:
- If you need to withdraw more than the RMD amount, review how much the projected remainder of your IRA will be in the future.
- If you are married, you may still wish to implement this strategy, but list your spouse as the primary beneficiary and then, those in later generations as secondary beneficiaries.
Retirement can spark both stress and disagreement in an otherwise contented marriage. After years of happy, healthy wedded bliss, sometimes one or both spouses are surprised to find themselves unhappy once retirement comes.
Negotiation and compromise are key elements in a successful marriage—long-time spouses already know this and practice both well. Entering retirement doesn’t change this. It’s hard for two spouses to enjoy their later years if each wants to sail in their own direction.
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