Financial Planning: Next Steps

Now you know what your $Z target is. You know how what your net worth is, and you know what return you require to move from the workaholic of today to the leisure person of tomorrow. Now what?

A lot depends on who you are and where you are.

The starter

If you're young - not me - and getting started, the very best thing you can do is invest on a regular basis. Every month some part of your paycheck needs to go into savings. Some experts have said that if you save 10% of your salary every month you will retire early and rich. I think that's true. Save more than 10% and you'll retire sooner or richer.

You need to select investments. If you're really good at it, you can read some books on investing and pick some stocks yourself. This takes time and some education. Good books to start:

Another approach is to choose several mutual funds and "pay " their managers to select investments while you put your personal time into growing your career so you get paid more so you can put even more money into your savings. One approach for The Starter is to select four mutual funds that are currently rated five stars by Morningstar. To diversify you could buy into a Large Cap Growth fund, a Small Cap Growth fund, an International fund, and an Intermediate Term bond fund. Some advisors recommend selecting mutual funds that have an Asset Base between $500M and $1B and have been in business with the same fund manager for at least five years. Among those funds, pick the ones with the lowest costs. Never pick a fund with a front end or back end load. It's ok to pick a fund that charges you a fee if you sell it in the next 90 days, because you're not going to. Split your portfolio into quarters and dollar cost average into each. Then each month rotate which fund you put your 10% savings into.

You're young and able to wait out market ups and downs. You have a long time to go and compounding returns will make up for little mistakes in asset allocation.

The Half Back

You're in your mid-thirties, early forties and are half way through working to retirement. You have a sizeable nest egg and you're savvy about investing. That 401k is bigger than you expected, and your investment account now seems like real money. You need to know if you can retire on time, or even early. You are to the point that some serious financial planning is needed.

If you are a stud(ette), you can get some software and do this all yourself. I am very impressed with the Quicken Financial Planner that comes with Quicken Deluxe. You can run through a simple plan in about 20 minutes. It was great. There used to be a more advanced version that cost another $19 - it was worth it. In the simple version you need to include the cost of your mortgage in your post retirement spending requirements. The complex version takes your mortgage into consideration when it imports your Quicken file. When you run the complex version, remember to reduce your post retirement income requirements to not include mortgage payments.

The best portfolio management software I've found comes from Financial Engines. Your company 401k might provide a link to a free version. I've heard that the free version will only advise you on your 401k. If you have a significant percentage of your investments outside of a 401k, then you'll have to pay them $300 per year for a premium account. DO IT. This will be one of the best investments you make. Seriously. Don't even think "oh no, three hundred dollars is a lot of money." Just spend the money.

If you're like me, you could use a financial advisor. They come in many flavors.

One type is a stock broker. They call you up and make recommendations on good buys, hot stocks, tips of the day. They sell you things they know about. In the old days I worked with a broker. I would sometimes follow their buy recommendation and see on the transaction receipt, "We make a market in this security." If you have that on your receipts and don't know what it means, ask your broker and don't stop asking until you are sure you understand. I consider it a code phrase for "I had to unload this stuff so I sold it to you." The downside with a broker is that they make money on every trade you make. They only get paid when you buy or sell something. If you buy and hold they don't get paid as much for what you're holding in the account. I'm sure they act in your best interest, but... why not get someone who is even more aligned with your personal goals?

A second type of advisor is the financial planner. These people help you put your plan together and help you set your goals. They sometimes recommend investments; in my experience they always try to sell me insurance. You will typically pay $500 - $1,000 to have a plan put together for you. They will often help you with the implementation, often making a commission on things they sell you. Some are also stock brokers and get a commission on every trade you make. Every five years or so I've paid to have a professional create a plan for me. For me it's worth it to have another set of eyes look over my plan.

A third type of advisor is called a "fee only" financial planner or manager. These managers get paid a percentage of your investment portfolio every quarter. Typically they get paid between one half and one percent of your average daily investment portfolio value. These advisors do not get paid anything when you make a trade. The more your portfolio grows the more they get in fees. If your portfolio goes down in value, they get less of a fee. Their interest is tightly tied to your financial growth.

A professional with a fiduciary responsibility is bound to look after your interests above their own. If you work with someone ask them directly if they are a fiduciary for you. If not, then ask "why not?"

Fee Only Asset Managers

You may already have a for-fee manager on your staff. Do you own any actively managed mutual funds? These funds all have a fund manager - someone you pay to make investment decisions for you. They don't (always) get paid on trades; they earn their keep by having the fund value grow. Even if you buy no-load funds you still pay a fund manager. There are index mutual funds and index ETFs; these have management fees too, but they are typically the lowest fee of all funds because they follow an algorithm to buy and sell - there is no active manager of these funds. When I added up all the fund manager fees that came out of my mutual funds each year it turned out I was paying 4.5% of my portfolio in management fees. That made the 0.75% I paid for a personal asset manager seem pretty reasonable.

Some asset managers will want the power to make trades for you. They buy and sell as they see fit. Since they get no commission on the trade you can pretty well assume they are working in your best interest to grow your investment base. If your assets double then so do their fees. Personally, I think that Modern Portfolio Theory does not require me to make "fast " decisions; I shouldn't be trading "when the market moves." I should review my portfolio on a regular basis and make trades to rebalance my asset allocations so that my portfolio is efficient for my personal target rate of return. These trades don't have to happen fast, so I don't let my asset manager make trades for me. Instead we meet, he makes recommendations, we decide what to do, then I do it. With a correctly allocated portfolio I don't think there's any need to be quick.

My advisor left the business in 2002 and I've been going it alone since then. With Financial Engines giving me advice I feel pretty good. However, it's been years since I paid for an advisor and in 2007 I signed up with a Charles Schwab Portfolio Consultant. They require discretionary access to my account. I guess my aversion to discretionary advisors is wondering what I'd do if they made trades I didn't approve of? With a big company like Schwab I feel less concerned about that. The advisor only places the trades after I've agreed to it. They make a big deal out of that service, but it doesn't add much value to me. We make just a few trades to rebalance and I could do that. We'll see how it goes.

I must admit that for-fee asset managers do sometimes get a commission on a few things but they have to be very careful to disclose this to you when they offer the investment to you. I recommend not buying anything they get a commission on. I always told my advisor that if he recommends buying into an asset class I'll agree, but he needs to find me an investment that doesn't pay him a commission. He will tell me that the one he's recommending is the best even if he gets some commission on it, but with me he always has a second choice that does not involve any commission to him.

Most fee based asset managers have a minimum portfolio they will manage. Some will handle as little as $50,000, some won't talk to you until you have $1M in the bank. Some require $10M!

Where are you?

Level 1

If you have a small nest egg and you have a long time to retirement, then using Morningstar to pick low cost funds and doing your own financial planning may be best. Buy Quicken Deluxe and go through the Financial Planner software.

Level 2

As you grow you may want to plunk down $500 for a one time financial plan. Maybe pay two planners and compare the results. If paying $1000 for this advice seems like a lot, then you are not yet at Level 2. At this level you should pay $300 per year to Financial Engines for an account. (Do I sound like a broken record on FE? It's just because I think they have a great system.)

Level 3

When you get serious bucks or get close to retirement you really need to have a professional on your staff. I have found that a fee-based asset manager is an excellent partner in managing my finances. I didn't just give him my money and say, "manage it. " I stayed actively involved. I asked questions, I posed hypothetical situations. He provides the knowledge and together we develop an understanding. I look at his fee partly as the cost of my on-going financial education.

Level 4

You know what you're doing and you use the tools available to make considered rebalancing moves by yourself. You occasionally pay a financial planner to review your current plans and as a sounding board to make sure you aren't missing anything important.

Sum It All Up

In the end, modern portfolio management is a slow, disciplined approach to investing. My financial planner should only make trades that I have personally approved because we should never have to move my portfolio so fast that we don't have time to get together first and talk it over. I am not following hot tips or timing the market. I hate momentum investing.

I am a precision investor who wants my assets aligned to meet my goals no matter what happens in the market.

You too can be a precision investor. Write down your goals. Figure out what you need and when. Decide how much professional advice you need. Then invest to get the return you require at the minimum risk.

If you are ready for a fee based asset manager, Charles Schwab has a great referral service for clients. They will put you in touch with several asset managers. Meet with them and ask them to explain to you what financial planning is all about. Play dumb and see if they are willing to educate you on the same topics I have here. If they are not, ask Schwab for three more referrals. You might consider Schwab Private Client services.

My own preference is for an asset manager who follows efficient portfolio theory to a fault. I want him to start with financial planning. I want to talk about my goals, my wants, my dreams, long before we talk about how much money I have now. I want someone who will do the complex calculations needed to plan my financial future from work hard, to downshift, to true retirement. I want someone who will plot an efficient frontier and show me how to allocate my assets to be on that frontier. I want someone who will watch the mutual funds we use for allocation and make sure they don't drift. If they drift I want my asset manager to recommend other investments that are true to the asset class we are using. I have a financial advisor that is working for me now, you can find one too.

You can get to your financial goals, but you must act. And you must act now, before it is too late. Sure, you can stick all your money into the Vanguard S&P Index fund and just "ride the bull (or bear)", but I recently read a quote attributed to John Maynard Keynes, "Markets can remain irrational longer than you can remain solvent."

Don't wait. Seize the day!

Lastly a little Q&A

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