Are Investors Focused On The Wrong Things?
During my initial meeting with clients, I explain that I offer two distinct services - investment management and financial planning. The first one, investment management, is exactly what it sounds like. I help clients manage their investments. I help them understand market risk, we catalogue their financial goals to determine their time horizon for investment, and we select an appropriate asset allocation. Most people either intuitively understand, or after a brief description, can get the gist of what investment management entails.
The second service I offer is financial planning. This involves doing cash flow/budget analysis, developing a plan to pay down debt, deciding on how much life insurance to buy, planning for major purchases such as a home or car, developing strategies to reduce taxes, and building an estate plan. In general terms, helping clients find ways to be smart with money. Most clients underestimate the value of financial planning.
After explaining these two distinct services, many times people decline financial planning and say they are only interested in investment management. They offer one of the following explanations: 1) They already have those things under control, or 2) They don’t think it will make much of a difference. I have no answer for the first one. I have given up ever trying to convince anyone of anything. I am an educator, nothing more, nothing less. As for the second objection, I wanted to offer a little bit of evidence that conflicts with the notion that financial planning does not make a difference.
According to this article, the most important driver of investment success was savings rate. In fact, the study found that savings rate was 5 times more important than asset allocation, and 45 times more important than investment quality. What does this mean? Well to clarify, savings rate is how much money you are currently saving in relation to your income. Asset allocation is what percentage of your overall investment portfolio is in stocks, and what percentage is in bonds. Investment quality relates to the individual investments in the portfolio, such as a specific stock or fund.
My takeaway is simple. As investors, for every one minute we spend thinking about what stocks to buy, we should spend five minutes thinking about our overall asset allocation, and 45 minutes thinking about our spending so we can uncover ways to save more. Now, when first presented with this idea, most people immediately go into defense mode. Everyone hates the word budget. I am not saying to not spend money. But instead of spending hours listening to CNBC to find that next hot tech stock, why not take 45 minutes per month and print out a bank statement and review it.
Imagine you are currently saving $100 per month in a retirement account. You look over your bank statement. You think critically about your spending. You realize that while you have been binge-watching your favorite streaming video service lately, you have another service you haven’t used for months. Also, you realize that you have had the same car insurance for the last 5 years, and the rates keep going up. You decide to cancel the streaming service you are not using, and after calling around, realize you can get the same coverage limits for auto insurance for $35 cheaper per month through another carrier. Add that to the $7 you are no longer spending on the video package, and you can increase your monthly savings rate by 42%. What’s the difference? Well, if you have 30 years until retirement, and assuming a 7% rate of return on investments*, that extra $42 per month in savings amounts to an additional $47,608.24.
These small, simple decisions are what will lead to your success. I am not saying investment management is not important. It is. I am saying financial planning can be even more impactful if you give it the attention it deserves. Not only is the research conclusive on the topic, but clearly, with little effort, we can demonstrate very simply how this works in real life. So instead of racking your brain about which investments to buy and going bananas every day as the market goes up and down, why not just focus on something you control directly:
your savings rate.
*This is a hypothetical example and is not representative of any specific situation. Your results will vary. The hypothetical rates of return used do not reflect the deduction of fees and charges inherent to investing. Investing involves risks including loss of principal.