The 10 Things I Got Right in Financial Planning
I wrote an article last month regarding the 10 things I got wrong about financial planning over my 20-year career. As it happens, I also got some things right and was happy when I was asked to write about them. Hopefully, these will benefit your clients.
1. The need versus the willingness to take risk. For most of my clients, I’ve reduced allocations to risky assets such as equities. It wasn’t because I sent them a risk tolerance questionnaire. It was because their need to take risk was low and they didn’t need to risk the consequences of a sustained market plunge.
I tell clients that risk tolerance questionnaires are dangerous for two reasons. The lesser is that everyone’s risk tolerance is not stable and has a high correlation to market performance. The more problematic reason is that they don’t consider one’s need to take risk. As author and advisor William Bernstein puts it, “When you’ve won the game, stop playing.” It turns out that, so far this century, a moderate portfolio that was rebalanced has done as well as an aggressive portfolio. And taking risk off the table made it less hard (still not easy) to rebalance and stick to the plan.
I let clients know that the risk assessment questionnaires I’ve taken tell me I should be between 70% and 140% in stocks. I’m not kidding – one had me with a margin account. I’m sticking with 45% because dying the richest person in the graveyard isn’t the right goal for any of us.
2. Rules over research. There is no shortage of research attempting to show what markets, companies, sectors, styles, interest rates, etc. will do. Many of these forecasts are from academics and economists and present compelling logic – so compelling that they even make me want to abandon my own plan.
But rules work better. For example, I typically advise clients that they can rebalance as often as they want but must stick to a tolerance. A 60% equity portfolio must stay within six percentage points of this target, or they would be in breach of our agreement, which I enforce with guilt. That has worked well in every bear market (so far) but never better than the 33 days between February 19 and March 23, 2020, when stocks lost 35% and then quickly recovered.
3. Dumb beta. Even before the term “smart beta” became popular, it made perfect sense that certain factors such as small cap and value would outperform the boring market-cap indexes since they take on more risk. While I was wrong that they didn’t outperform, I never used factor investing for clients as I knew it wasn’t a free lunch. Rather, I embraced dumb beta especially when the term smart beta become so popular.
It turns out that virtually all the factors underperformed the total-cap-weighted market over the past 10-15 years. And there is a psychological value in knowing a total-stock-market index fund is virtually assured of beating most investors in that asset class. This is true even over shorter periods of time, though some imperfect benchmarks may show otherwise as I investigated earlier this year.
As John Rekenthaler, vice president of research at Morningstar, recently told me, “Owning a low-cost market cap-weighted total index fund is both psychologically and mathematically superior.”
4. Paying off the mortgage. Even before I entered the field of financial planning, I understood that a mortgage was the inverse of a bond and that paying it down or off had no impact on the price the house was ultimately sold for. I told clients that it as a risk-free and often tax-free return (since many clients were getting little or no tax benefit from mortgage interest due to SALT deduction limitations). I stated that liquidity was the only reason to lend money out (bond) at a lower after-tax rate than at which they borrow (mortgage) as long as they had bonds in their taxable account. We should not compare a risk-free decision to stocks, as that’s comparing risk free to very risky.
Even though some mortgage rates may look reasonably good now that Treasury securities are yielding nearly 4%, it was still the right decision. That’s because the higher rates resulted in bonds declining. As of August 31, iShares Core US Aggregate Bond ETF (AGG) lost 10.68% for the year and paying that mortgage avoided that loss.
5. Bond alternatives. I’m not talking about master limited partnerships private REITs or other expensive and risky investments. I’ve often recommended safe and more stable investments. One example I’ve often used is CDs from banks and credit unions (staying below FDIC and NUCA insurance limits) that pay as much as high-quality bonds but have easy early withdrawal penalties. When rates shot up, breaking the CDs resulted in losses of less than 1% and avoided the bond loss noted earlier.
Every client had the CD alternative, but many had even better options to protect against the possibility of rising rates. Federal employees had access to the “G” fund, which gives a Treasury yield with no volatility. Many clients had access to a stable value fund in their 401(k)s and 403(b)s, which paid bond yields. The TIAA traditional annuity also provided attractive yields though each one varied by contract.
All these options offered rates higher than the AGG with less risk.
6. Lowest fees. While it may be true that what you make is more important than how much you pay, fees take from returns. Though one can easily have an awful low-cost portfolio, I’ve never seen a good high-cost portfolio.
I define investing in eight words – “minimizing expenses and emotions; maximizing diversification and discipline.” I tell clients to “get real” as in real inflation-adjusted returns. I expect a real return of three percent on a portfolio of half bonds and half stocks, so they need to give away as little of that as possible.
7. Taxes. While I was wrong in thinking tax rates would go up, taxes still matter greatly. Tax efficiency is key. This means using tax-efficient investments, locating assets in the right tax wrappers (taxable, tax-deferred, and tax-free). It also means developing tax-efficient withdrawal strategies.
The goal is never to pay the least amount of taxes; rather to make more money after taxes. Thus, a cost-benefit analysis of paying taxes now to get out of expensive funds may make sense. Roth conversions have tax consequences now but may build wealth in the long run.
Taxes are fees, too, but complicate investing. In fact, tax analysis is a major part of what I do.
8. Saving money on insurance. Inertia is the most powerful force in the universe (it’s likely a myth that Albert Einstein said it was compounding). I tell clients to reduce or drop insurance. For example, I’ve had many clients in their early 60s still paying the same premium on disability insurance even though they would only collect a year or two in payments if they became disabled that day.
I advise clients to insure only for what they can’t afford to lose. For instance, I have no collision or comprehensive insurance for our cars. We do have liability and umbrella as a claim could have devasting impact on our net worth.
Shopping for insurance can pay off. The Geico commercial is spot on – 15 minutes can save hundreds. It did for me (though it wasn’t from Geico).
9. Flexibility in estate planning. The only thing harder than predicting the stock market is predicting what politicians will do. What will the exemption be in a decade or two? Will Congress change the law so that grantor trusts or the like are suddenly recaptured as part of the estate? There are an infinite number of permutations and combinations that are possible.
I’ve seen far more errors being made based on what clients and attorneys think will happen than estate tax savings. Don’t get me wrong, I have some very wealthy clients that benefit from such things as intentionally defective grantor trusts, family limited partnerships, and the like. Yet I more often see people that have created unnecessary complexity and very expensive ongoing costs such as trustee fees and tax preparation fees.
Though I’m not licensed to practice law, I generally suggest to clients that they keep things flexible as they work with their estate planning attorneys.
10. Reframing Social Security as buying an annuity. Many advisors rightly recommend the spouse with the higher benefit wait until age 70 to start collecting. But clients don’t like spending down their portfolio. They have worked their entire life to build their nest egg and spending it down is psychologically difficult.
I tell clients what, from an economic perspective, they are really doing – they are buying the only inflation-adjusted longevity annuity on the planet that happens to be backed by the U.S. government. A few years ago, when insurance companies offered a CPUI-adjusted single-premium immediate annuity, I could show clients that waiting for Social Security was the equivalent of buying this annuity at a 30-45% discount. I’ve worked with a lot of actuaries in my career, and they are smart people. If they won’t take inflation risk then we should work to minimize that risk.
By reframing waiting to claim Social Security as buying this wonderful annuity, people feel more comfortable delaying Social Security as they can go to opensocialsecurity.com and see their net worth increase.
It’s more fun to be right than wrong. But more lessons come from the latter. You never know, many of these “rights” may turn out to be “wrongs” in the future. But the odds are good that these will continue to benefit clients.
Allan Roth is the founder of Wealth Logic, LLC, a Colorado-based fee-only registered investment advisory firm. He has been working in the investment world of corporate finance for over 25 years. Allan has served as corporate finance officer of two multi-billion-dollar companies and has consulted with many others while at McKinsey & Company.