Mo Vidwans
We all know the famous saying: A picture is worth a thousand words. There is also a corollary to that which says: A good map is worth thousand pictures. These days not many people use maps. We are so much into GPS that we don’t think much about the utility of maps. In this case I am thinking more of our life’s “Financial Map” that will lead and guide us to a successful financial life. Once properly created, such maps or strategies are very valuable.
Our investment strategy is a financial map that reminds us constantly not only of our objectives and goals in life but also how to achieve them. Granted some goals transform, and they should, as we progress through life. Also the tactics to achieve those goals would change and hence the actual actions to follow those tactics would also change. All this is still following the same investment strategy that we set forth in the beginning.
Does everyone need a strategy? The simple answer is positively yes if our future needs (as defined by us) have to be satisfied. Not doing anything at all and just keep rolling with the punches is also a strategy but it would not work too well. I notice that the very word investment creates all kinds of emotions: fear of loss of principal, fraud, some trepidation, and strange feelings like “scary” come to mind. To top that every one has an opinion about investments, nevertheless, and they generally stick to it.
What basic events need to happen for our strategy to be successful? The prime event has to be that we must save; actually save much more than we do today. Over the last 50 years, most Americans have not saved much, generally somewhere between -1% to +5%. Citizens of other countries save much more. China, Korea, and Japan save about 25 to 35%; India and far-east Asia 20 to 30% and so on. I would assume that it is mostly embedded in the culture and the environment we live in. This itself can be a topic of some serious discussion. Basic fact is that we need to save more in order for our strategy to work. Saving is only the first step, albeit an important one; then the next step is to make these savings grow. Growth rate can be anywhere from 3% to as high as 15% depending on where our comfort level is for risk. And it will also depend heavily on our future needs and health conditions, starting now to the end of life.
Such strategies would break down into at least three groups. First with 25 to 50, then from 51 to 67 and from 68 to the rest of our lives. For each group the planning and tactics would change.
The first group implies: new job, getting married, young children and perhaps some graduations and aspirations for a new business.
This time frame also suggests: max savings, not only because it is possible to do so and we need them later but also because the savings get a chance to grow for a long time (like 20 to 60 years), which suggests the power of compounding. The longer we can make our money grow the better off we will be. Which means we need to start early to make it grow longer. Compounding is a very powerful force. If you save at the rate of just 6%, that money will double in 12 years (taxes ignored for now) and double again in next 12 years giving us four times of our original investment in 24 years. If it can grow at 9% then the process happens in 16 years.
The second stage is from 50 to 67 years of age: during this period, we have less personal responsibilities and we earn most and should save the maximum. Some major events also happen in this period like weddings, grandchildren, travels etc. Major planning also happens for retirement.
The third stage of age 67 onwards is for spending the wealth we have accumulated. Enjoy friends, hobbies, the time of good health and then plan for controlling inevitable health issues.
For most of us saving is the hardest part. It needs some sacrifice, determination and a lot of applied discipline. Today we cannot count on any old fashioned pension plans. There will be Social Security but that would make only a small contribution to our total needs. It is, indeed, going to be our own savings (whichever form they are done: 401k, IRAs and/or taxable saving accounts) that will be used by us to support ourselves when we retire. It will also depend on what we would project our expenses would be at the time of retirement and later but if we are not saving in the vicinity of 25% of our gross income in all stages of our life, then we are shortchanging ourselves.
There are myriad ways available to invest. Of course it depends to a great extent on our risk tolerance make-up. I spend much time with my clients on this very same issue and generally I do not recommend any investments unless I know where the comfort level of my clients is. Once that is established, then a variety of investment vehicles can be suggested. Beginning with simple CDs to investments in high quality stocks for long-term and everything in between. It is critical that the thinking has to be long-term, which means 10 years and longer but never less than 5 years. If anybody wants to follow the quick-money schemes, then they would be on their own. One of the reasons we plan so far in advance is to take advantage of the long time span available which allows us to do the long-term planning.
The other point that needs to be well understood, in fact needs to be permanently etched in every mind, is that investments can be risky (even when the money is sitting under the mattress). We mitigate risk by thinking long-term but it still does not completely go away. Remember that long-term perspective gives the time to recover from it too if something has to go wrong. This should not deter anybody from investing properly. It is said that when we are thinking of investment “the bigger risk is not taking any risk at all.”
Mo welcomes any questions on this article or previous ones, also the suggestions for any future financial subjects of your interest that you would like to know more about.
