OK – it’s back to school and time for a Pop Quiz:
What factor has the single greatest impact on the success or failure of a person (or family’s) financial success?
- Stock market growth
- Stock picking ability
- Market timing ability
- Annual income
- Interest rate trends
- None of the above
As you probably guessed from this not-so-tricky-trick-question, the answer is “6”. The reason? Because I believe the greatest factor impacting a person (or family’s) financial success is themselves. In short, it is my contention that your ability to assemble, then sustain a fundamentally sound and comprehensive financial strategy has a greater impact on where you will be at the “finish line” (retirement and beyond) than any of the factors listed above. Why? Because very often, we are our own worst enemy when it comes to damaging our personal balance sheets because we don’t focus enough on endogenous factors (internal, or things we can control) factors which have a disproportionately high impact on us when compared to exogenous factors (external, or things we can’t control).
So what are those factors that we focus on and why? I think there are several major factors (listed below) but this is by no means an exhaustive list.
1) Live Below Your Means: This should not be a shocker but it is critical. In my opinion, people should save at least 10% of what they earn. Remember, even if you have a high income, there is no shortage of cool and exciting things to spend money on. Establishing the discipline of spending less than you earn (which can be automated) ensures that you are not only consistently building savings but you are also more insulated from inflation, which is a topic for another time.
2) Fully Fund Your Retirement: Taking advantage of the tax deduction from contributing to employer sponsored retirement plans (401(k), 403(b)) helps limit tax liability, which is nice. Fully leveraging the employer match on contributions (if applicable) could be the only “free lunch” in investing, which is outstanding.
3) Ample Liquidity: Having a nice stash of cash squirreled away means when (not if) those unforeseen or emergency expenses come up, you won’t have to “sell low” on your investments to get proceeds for your expense(s). In addition, having ample cash affords you the peace-of-mind that allows you to increase insurance deductibles, which is likely to lower your annual premiums.
4) Eliminate “Bad Debt”: As most know, consumer debt such as credit card or even car loans are not very productive. They are usually characterized by higher rates, the interest is not tax deductible (like with a home) and the enjoyment from the purchase is usually long gone after those “envelopes with windows” continue to arrive in your mailbox every month.
5) Right-sized Home and Mortgage: A home is a significant investment and striking the balance between being “house poor” (payments too high) and “under-levered” (house so small, not fully utilizing leverage) can be tricky. This strategy evolves as you move from the earning years to retirement years and is a significant component in peoples’ entire “portfolio”.
6) Stick with a fundamentally sound investment plan: As noted in prior posts, I passionately believe that trying to “pick winners” or “market time” because some hot-shot told you an “insider” tip simply does not work over the long term. The Wall Street Journal had a great article on this last week (click this link if you subscribe), essentially stating that over 15 years, U.S. mutual funds averaged about 6.6% annual return while investor returns in those same funds averaged 4.4% per year. This shows the impact of chasing hot performers and giving up on underperformers. Not a big deal you say? Starting with $100,000 that difference in annual return means an extra $70,061 (or about 37% higher) in your investment portfolio- real money if you ask me. In addition, I am a firm believer that investors are best suited to diversify, keep expenses low (by not using active management) and re-balance. The data is overwhelmingly on my side so if you’d like to discuss or debate this with me, I love talking about this so please call me to discuss anytime.
7) Avoid “snake oil”: Somewhat related to #6, I believe “hot investments” or “exclusive investment opportunities” that attempt to play on the ego, usually end badly. Usually, these “opportunities” are opportunities for the salesman, not the investor. While this isn’t always the case, I believe investors are best served starting any evaluation with a healthy dose of skepticism and lots of questions. It would also help to have an unbiased advocate on your side of the table to help evaluate any opportunities (that’s me- sorry- had to throw that in).
People often ask me “where do you think the market goes from here?” or “when do you think the Fed is going to start tapering or raising interest rates?” In reality, nobody knows for sure and more importantly, we can’t control those things. More relevant questions people should be asking are “What’s a good asset allocation strategy for this stage in my career?” or “What legal tax advantages am I missing?” or “How can I reduce my investment expenses?” or “Am I paying too much for life insurance?” These are things we can control and the answers to these questions have a direct and quantifiable impact on our long-term financial health.