As a wealth strategist, people come to me to manage their investment portfolio. But what I really do is manage the clients’ expectations of their portfolio and show them how to preserve it from the outside forces that create “drag” on their portfolio. “Drag” consist of outside forces that erode your investment dollar.
The purpose of this article is to make you aware of the outside influences that create “drag” on your portfolio and how creating an overall wealth management strategy can create a quality desired outcome to a successful future.
I always like to show people four desired outcomes that could occur over the next 10 years.
- Outcome #1 - your portfolio grows by 10%. This outcome makes you happy as you projected 10% and you’re on track to fulfill your goal.
- Outcome #2 - your portfolio grows by 20%. This outcome you are ecstatic. Your portfolio performed well beyond what you thought was even possible.
- Outcome #3 - your portfolio does not do so well. In fact, over the 10-year period it lost 10%. This doesn’t make you happy and you need to re-evaluate your financial goals.
- Outcome #4 - your portfolio does awful. It is down 35% from where it was 10 years ago. Your extremely unhappy, and you are very uncertain that you will be able to fulfill your financial goals and objectives.
Can the above four outcomes all become reality? Of course they can. Back in the 2008, people saw their portfolio’s drop 35%-50%. 2000-2010 was considered the lost decade, where you made no money in equity markets.
The problem is, we don’t see these types of events happening. You can be 5 years into a market cycle, and everything is ok, then the next 5 years you can erase all gains from previous 5 years and lose an additional 35%. If you started your investment program at age 50, and were planning to retire at age 60, seeing 35% of your investment account disappear can be devastating.
So, obviously market loss is one factor that “drag” your portfolio. But let’s look at other influences that have an effect on your investment performance.
Inflation – Over the past few decades, inflation has not been something that has had a dramatic effect on your portfolio. But as we write this, inflation is lurking around 9%, think of the drain that has on your portfolio. You must achieve a 9% return just to keep up with inflation. A 10% return, less inflation, means your inflation adjusted portfolio return is only 1%. This would be further amplified if you’re taking a distribution from your portfolio.
Taxes – Taxes have a tremendous drain on investment returns and your portfolio is vulnerable to future tax increases. Suppose you start out in year 1 being in a 20% tax bracket, and taxes rise and in year 7 your now in a 40% tax bracket. This means you keep less of investment earnings. If you are taking income from your portfolio, this means your after-tax income is less. Assume a $50,000 distribution from your 401k - in a 20% tax bracket you take home $40,000. If taxes rise to 40%, you’re now bringing home $30,000. If you combine rising taxes with rising inflation, we call that a double whammy. Your after tax, inflation adjusted income or investment return is now considerably less.
We all know about market risk, we even have a reasonable expectation with regards to taxes, and people today are beginning to realize the effects inflation has on there purchasing power. Market Risk, Taxes, and Inflation are the most talked about topics that drain your money and reduce purchasing power. But let’s examine other ways people’s portfolios are susceptible to loss.
Sequence of Return Risk – Very simply, markets don’t know what you plan to do with your money. Sequence of return risk is - assume the day you retire you were planning on taking $50,000 a year from your $1M portfolio. But the day you decide to begin income your $1M portfolio goes down to $750,000. You have a few options here. You can reduce your income to 5% of $750K or $37.5K a year. That doesn’t help if you need $50K from the portfolio. You can delay taking income and go back to work. That also doesn’t help if you were planning on retirement. Had you not had an immediate need for income, your portfolio could grow back, but that won’t help you. If you take the $50K you need, what do you think will happen to your money in the future? It will probably run out.
Longevity Risk - This is a fear people have, outliving their money. This will happen if investment returns are poor, and your withdrawal rate is too high. This happens many times, as referenced above, when people who suffer investment downturns hope it will come back and select to maintain the income they need.
Health Care Risk – I call this “not preparing for the unexpected”. A long-term health care issue is not covered by Medicare or health insurance. These expenses for long term care need to be covered out of pocket unless you have long term care insurance. Needing care for a chronic illness can cost up to $10,000 per month. The average need for care is 36 months, according to AARP. This would drain a portfolio by $360,000. Can you sustain this kind of loss? If you did, would your spouse continue to stay in the lifestyle you are accustomed to?
Building an investment program based on your objectives, your time horizon, and your risk tolerance is the paramount factor in advisors building portfolios for their clients. But think of your investments as your Castle. Back in futile times people built huge Castles, and they had all their riches in those Castles. But what did they do to protect their wealth from outside influences? They built moats around the castle with drawbridges. Today, I see a lot of people accumulating wealth, but not doing any moat building.
An investment plan must have the key cornerstones that coordinate with your risk tolerance, your time horizon, and be aligned with your objectives. But through extensive planning you must build contingencies to help preserve your money from the ravages of potential tax increases, inflation, market downturns, longevity risk, health care risk and sequence of return risk. A practitioner specializing in Wealth Management can help you feel confident by putting together not just a good investment program, but a plan to help conserve your assets from the outside influences that can take it away.
Please feel free to contact me at email@example.com to learn more how you can start building a sound wealth management strategy today.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
Any examples are hypothetical and are not representative of any specific investment. Your results may vary.