In 1994 I finally took a course sponsored by George Mason Adult Education. I thought the course was good enough that I made copies of the course notes and sent them to my children. It would probably be best if each person took the course themselves, but if that isn't possible or until you do take a course the following paragraphs are intended as a primer. Financial Planning is something you have to do for yourself. You can't purchase advice. Anyone you seek advice from is selling something and they will tell you the answer that maximizes their commission. Time is the most powerful parameter in financial planning, if you put off planning you waste your most valuable asset-- your relatively young age. One of the common discoveries in classes like the one I took is that people discover that they should have started 25 years earlier.
The following are what I think are the most important things to think about.
1. Establish a life plan and adapt it continuously. What are your objectives? What should you do first?
2. Save for the long term every payday take full advantage of company matching plans and tax deferral programs.
3. Protect yourself with modest amounts of insurance for health and accident protection. Bad things will happen make sure that you are covered and that your life isn't disrupted in a major way from an unexpected happening.
4. Get the most return on your savings long term. Minimize taxes paid. Understand inflation and its impact. Understand the principles of diversification of investment. Understand interest compounding.
5. Be an interest earner not an interest payer on balance. Everyone pays interest over the long term, try to earn more than you pay. The difference between paying 10% and earning 10% is 20%.. Twenty percent doubles the principal in 3 and a half years.
6. In your life financial plan prepare for major cost items – buying a home, college expenses, and retirement. Automobile purchases are also major but more distributed, 10 cars at $20,000 would be $200,000 over your life and if you buy them with a loan they are eve more expensive. Buying an expensive new car before the person can really afford it is probably the most common first major planning error.
7. Don't fool yourself into thinking that you can figure out the stock market. The individual investor doesn’t have enough time to acquire the necessary information nor the sources of information required to make good decisions. The unknowns always turn out to be the determining factor. Instead I recommend that you purchase a couple of balanced mutual funds and maybe a S&P 500 Index fund.
8. Understand how you are spending your money. Are you covering the items that are most important – savings, health, education? It is easy to spring financial leaks that add up to major expenditures over the long term. In many cases the leaks aren’t really that important. Always be careful in purchases to get value. The larger the purchase price the more careful your decision.
9. Financial planning is a family activity, your spouses need to have the same objectives or at least accept a balancing of their individual objectives with yours. Resources should be shared or pooled; but individuals should have some portion of the family resources over which they have discretion. Money can transfer between generations -financially what happens to your parents and children affects you. Inheritance isn't a wind fall it is something you should plan.
10. Maximize your financial flexibility and protect it. What this means is keep the maximum amount of your income discretionary. Don't get tied down with monthly payments that equal 100% of your income. When you think about what you can afford don't consider all your resources to be available for payments – think in terms of 70% of our take home pay to pay your bills and 30% as discretionary and to deal with the unexpected and the long-term. Maintain liquidity in your investments – don’t buy land, gold mines, works of art or anything else that can’t be resold quickly. Your house may or may not be an investment. It depends on the Real Estate Market and the rate of inflationary increase.
INVESTMENT STRATEGY
What is my Investment strategy?
The purpose of saving and investing is to augment my retirement income from my government pension. Not necessary so that it can be spent on a monthly basis, but rather to have a reserve to protect my income from the inflation or depression of the economy. Most of what I have saved to this point in my life has gone to meet what I view as my obligations to provide a home for my wife and family and to provide for educations for my children. My home is essentially paid for, I have a small home equity loan on the house primarily to have some established borrowing power. My children’s’ education are paid.
My approach to investing has always been very conservative. That is to say that I have not sought out high risk, high return investments. My goal is to make a good rate of return on my investments and be protected from downturns in the economy. Short of taking a wild chance or winning the lottery, I don’t see an investment option that could make a significant impact on my life style. If I suddenly came into a million dollars, I wouldn’t buy myself a fancy car, I wouldn’t quit my job, I might sell my current home and move to a different location in Reston, I might help my children buy homes, I might travel a little bit more, I might buy a Spa for the backyard, I might get new cars a little more frequently, I might upgrade my computer more frequently.
What are the elements of sound investing (getting a good return)?--- a consistent long term strategy, regular periodic investment, and diversity. My strategy is defined above. I have the discipline for regular investment. So that leaves diversity. What is it? How much of it do I want?
Diversity of Investment means investing in different vehicles. Stocks, bonds and mutual funds are examples, and of course there are many more specific variations on each. Inherently you get more diversity in mutual funds. You are also supposed to be getting some expert assistance in the person of the fund manager. You are certainly getting opinions. Index Funds give even more diversity. The S&P 500 fund is basically an investment in the American economy or at least the big company part of the economy. There are special funds that cover various sizes of companies, that cover various industries - science, banking, medical and there are funds that cover various parts of the world. Global diversity is another kind arguably if something goes wrong in US; Europe, Asia or the Third World might fair better. But global investments have other complications like exchange rates and local political problems.
How much diversity is too much? Diversity into areas that you have a strong reason to believe won’t do well probably is not wise. Although the basically principle of diversity is that you can tell what is going to happen, that is why you pick diversity in the first place. So you might choose to not select some areas because you don’t like them or because you feel that they are unethical. Liquor, Cigars or slum housing might be examples. The current situation in Japan is another example. Although I believe that the Japanese Economy will eventually get itself sorted out, it would not be a priority area for me to invest in right now. I would find other areas that I “felt better” about buying. This gets to the point that at any given time you are making a decision about what to buy or sell next. Unless you have a formula that you stick to rigorously, the investor makes choices. It is also my experience that often your investments make decisions that undercut the reasoning that lead you to invest in them in the first place. You invest in a mutual fund that focuses on small cap companies. It is successful, but when these companies get larger if the fund holds them you have a different type of investment. There are also fund closing, mergers and restructurings to deal with. The fund manager, the brains behind the funds success can change. What do you do?
What to do, is make a set of decisions. Yes, I want to have a big portion of my funds in the S&P 500. Yes, I think I should also have some money invested in small companies. Yes, I think I should have money invested in foreign funds --- Europe, Asia and the Third World. Yes, I think there are some specialty areas like ---Technology(cutting edge science -- computers, Internet), Banking and Health that I might want to have a special investment in. Yes, there are some area like Japan right now that I don’t feel comfortable investing in. So the question then is what is the balance. This will probably vary with time but right now I have about 66% in S&P and the total stock market portfolio, 33% in foreign mutual funds and special topic funds - Medical, Internet, and Europe.
Good Online Resources
The Interactive Addition of the
Wall Street Journal is the best source for business news. The Washington
Post Online version has some additional features that are good. Right now
it is free, but they will eventually start charging. In the case of both
the WSJ and WP they have huge archives of information that can be searched
and they are both adding more to their
archives. Just as an example of
one article. Best Mutual Funds by Glassman of the Washington Post has a
good column.
There are also good web pages for Vanguard and T. Rowe Price. These are my favorite mutual fund families. Overall they have low cost and high quality. Plus they have a wide assortment of choices.
Morningstar has also finally gotten
a website online and it is fantastic. It allow you to keep multiple portfolios,
but best of all it performs a great set of analyses on your portfolios.
For particular mutual funds it will list the largest holding, and it will
show performance plots versus S&P 500. I keep all my record stored
there right online. It allows me to have access to
them at anytime and from any place.
Copyright © 1996 Wayne R. Hudson
This Home Page was created by WebEdit,September
6, 1996
Most recent revision Jan. 26, 2000