Comprehensive Advisor

Managing risk

Generally, risk can be conceived as getting a result different from what you expected.  Risk can be looked at as variability in returns of your investments for example.

Now, risk is not always a bad thing in these contexts.  Suppose, due to risk, your investments returned more to you than you expected.  This sounds pretty good, right?

It's the other half of the risk problem we're really concerned about.  Few people want their investments to return less than they expect or hope for.  This is the bad kind of risk most of us stay awake at night worrying about.  This is the risk we have to address.

So we don't want to avoid risk, or the variability of returns.  Instead, we want to manage risk to avoid the downside, or reduced return component of risk.  Don't we all want the upside or increased returns component of risk?

Generally, the best way for most individual investors to manage risk is through an appropriately allocated and diversified portfolio.  This means accessing different asset classes, including stocks, bonds, cash, real estate, minerals, financials, and others.  On the other hand, managing risk does not mean over concentrating in any one area or selecting investments without the guidance of experts.

In the next section, we'll talk about determining risk tolerance.

Plan goals, objectives and strategies

The very first and most important component of any Investment Policy Statement (IPS) is to figure out the goals and strategies.  With a destination, you arrive where, when and how you want to.  Without any idea or just a vague idea, well, any road will get you there, or not!

The IPS should fit into the larger goals of the organization, or family, or maybe, the individual.  This broader context is the fabric of your life and what makes you happy.

The decisions made in selecting and evaluating investments must be made to support this broader view.

Specific goals should be set for investments using appropriate benchmarks.  The benchmarks will help to evaluate your investment choices.

Next time, we'll look at managing risk.

Investment Policy Statements

An Investment Policy Statement (IPS) is a business plan for your investments.  Think of an IPS as a roadmap for achieving your investment goals.  Further, consider your investment goals as one of the pillars of your financial life.  Some of the other pillars include estate plan documents, risk management techniques, college/education, retirement plans, and approaches to tax savings.

An IPS is the single most important tool an investor has to achieve investing goals.  An IPS lays out your objectives and your strategies to achieve those objectives.  A well-written objective might be to gain 10% per year, while experiencing 8% standard deviation to accumulate $500,000 by the end of 20 years.

The IPS will address your asset allocation including aset classes that are allowed and those that are prohibited.  The IPS will tell you your rebalancing approach and your cost monitoring methodology.  Also, the IPS will address the responsibilities of each party involve in implementing the IPS.

The parties include the investor, the investment managers, the investment advisor, the custodian, and others.  Each has an important role to play.  The earlier those roles are defined, the less chance of losing money while investing.

Another critical feature of the IPS is the cost control procedures.  No doubt many stockbrokers with no fiduciary duty will be glad to sell unsuspecting investors load=heavy mutual funds.  As you know, the fiduciaries in the audience will help you to control costs through the use of no-load mutual funds.

In our next entry, we will get into the details of an IPS by describing the individual key sections and components.

Net worth, so what?

As we said earlier, cash flow is important because it pays the bills.

The other half of this equation is net worth.  Net worth allows you to demonstrate to the world your successes without ever saying a word.  Net worth is calculated by adding up the value of all the material things you own.  Sometimes, the value of insurance and te good will aspects of a business can be added to the things you own.  This total amount is the amount of assets you own.

Then, add up all the debt you have.  This debt includes your credit card bills, mortgage, student loans, car loans, business debts, and even what you owe your family members.  This total amount is the amount of debt you have.

Subtract your debt from your assets and voila, you have your net worth.  The really big important thing about net worth is, if ever needed, at least you could liquidate (sell) some of your assets to pay for things you need, like food.

Since you can turn net worth (stuff) into cash to pay bills, net worth is a handy thing to have!

In the next entry, we'll discuss an important investing tool, the Investment Policy Statement.

Cash flow for retirement

Whether you are decades away from retirement, or it's just around the corner, your cash flow is key to building and keeping your nest egg.

When you're young, knowing where your money comes from and where it goes are essential to putting away a little bit every month to build your nest egg.

Putting away as little as $2,000 per year for your years between 23 and 65 can build a nest egg of more than $1.3 million!  Wow, that's a lot of money.

Similarly, when you retire, you want to know all about your expenses and incomes so you take as little as possible out of your retirement nest egg.  Keeping your nest egg as big as possible during retirement offers you the ability to handle unforeseen emergencies such as medical bills or home repairs.  Further, you may be able to create a legacy or fulfill charitable intents that might otherwise go unfulfilled.

In the next entry, we'll discuss net worth and it's importance to your retirement.

Collect your insurance and estate information

While not specifically retirement oriented, each and every one of you should be putting together a set of files with all of your important documents.

For example, does your appointed executor have a copy of or know the whereabouts of your will, trusts, powers of attorney and other estate documents can be found?

When was the last time these documents were reviewed by competent counsel?  Hopefully, it was not the last millennium!

On the other hand, consider your insurance.  Even with the recent downturn in home prices, you may still be underinsured in many ways.  Go beyond looking at the replacement cost.  Consider the riders you have (or need) for artwork, collectibles, jewelry, and more.  You may not realize all the valuable stuff you have until you do an inventory.

And speaking of inventory, complete one now.  If you have an inventory of (at the minimum) the important items, it will make the process of creating your estate plan that much easier.

In the next installment, we'll discuss how your cash flow information and net worth data can help you build and keep your nest egg.

Retirement income and your advisor

Let's say you're nearing retirement or recently did retire.  If you're one of the many lucky government employees with a guaranteed pension, you may be set for life.  That's great.  On the other hand, you might be one of the great masses who saved for retirement and is now wondering what to do to make ends meet for the next 30 years.

You're first step is to write down what you spend every month.  Your advisor can help you with forms to do this.  It may take a couple of months to get the numbers correct.  The sooner you start, the sooner you can reap the benefits of this knowledge.

To this info, consider what you want to spend your money on that you have not yet done so.  Further, what about costs you expect to incur in the future?  Don't forget to assign dates or time frame to these expenses.

Unless you have a glaring problem (all of your money in pork belly futures or in the mattress), don't take any significant steps until you've completed documenting your expenses.

In the next entry, we'll discuss some financial housekeeping actions you can take during this two or three month expenses data collection effort.

Center for Fiduciary Studies

The Center for Fiduciary Studies fills the substantial void surrounding the nearly 5 million fiduciaries in this country.  The Center is focused on research into fiduciary duties and providing training for investment fiduciary responsibilities.

The overwhelming majority of fiduciaries in this country receive no formal training whatever.  The Center looks to rectify this notable shortfall.

In conjunction with the Center is the Foundation for Fiduciary Studies.  The Foundation is not-for-profit and devoid of any links to investment companies.  While fiduciary legislation clearly calls for a due diligence process in selecting investments, until the Foundation developed a series of handbooks, there was no process at all.

With the proper handbook and by taking the actions indicated in the handbook, any person with fiduciary duties can meet those obligations in a repeatable, justifiable, and sufficient manner.

To learn more about the Center and the Foundation, visit www.fi360.com.

Additional roles for the fiduciary

What about the roles of loyalty, diversification, impartiality, investment costs, and delegation for a fiduciary?  What do they mean?

In summary, fiduciaries must place the interests of their clients ahead of their own.  Fiduciaries must be loyal to their clients.  Not necessarily slavish, but be aware of the needs of their clients.

Of course diversification is a must when it comes to managing investments.  Diversification's main benefit is to reduce the risk of concentrated positions.  Anyone remember Enron and the employees who lost all of their retirement savings due to the concentrated positions these people had in Enron stock?  The fiduciaries at Enron didn't have a clue about their duties.  It may even be true the administrators of the Enron retirement plan didn't know they had a fiduciary duty to the plan's participants.  Now you know better.

As for investment costs, it is critical for a fiduciary to monitor the costs of investments.  For example, there can be no sales of load mutual funds by a fiduciary.  Since any fiduciary knows about the existence of no-load mutual fund equivalents for many excellent load bearing funds, fiduciaries cannot sell those loaded funds.  I know this is my soapbox and I'm on it!

Finally for today, fiduciaries should know what they don't know.  Unless a fiduciary is an expert in selecting investments, the fiduciary should delegate this activity to an expert.  The expert might be a CFP practitioner, CFA, or other accredited individual.

The next entry will discuss the role of the Center for Fiduciary Studies.