Actually Stocks Matter, Just Not as Much as Many Believe
As a registered investment advisor, it would seem to be sacrilege to suggest that stocks are not important. However, I’m going to try to make the point today that, while individual equities are important in investing, they are WAY DOWN on the priority list of things an investor needs to consider.
My assertion is based on the process that we at F5 Financial advocate: to go about building an Investment Policy Strategy (IPS). The steps in sequence are outlined below.
Investing Step 1: Determine Your Goals and Objectives
Any investor needs to “begin with an end in mind” to quote Stephen Covey. The “end in mind,” in our opinion, translates to goals. Every family has their own unique set of goals including but not limited to:
- Retiring “on time” at 65
- Retiring “early” at [pick your age]
- Paying for the kids’ education
- Taking the trip of a lifetime
- Buying a car (Tesla seems to be a popular one!)
- Starting a business
- Paying off the house early
- Giving to charity
- Starting a private foundation
Only after you define your goal can you move to the next step in the process.
Investing Step 2: Determine your Cash Flow Requirements and Cash Flow Availability
The reality of our world is that most all goals require cash to fund. While your mental well-being is one area where cash is optional, even here appropriately managed financial resources can be quite helpful. As we develop an IPS we need to consider the cash flow requirements necessary to “pay” for the goal AND the cash flow availability to “fund” the goal.
I like to paint the picture of “filling a bucket” as the accumulation phase and “opening the spigot” as the decumulation phase. Understanding (i) the inflow of “water”, (ii) the outflow of “water”, and (iii) how much “water” needs to be in the bucket to put out the “fires” associated with each goal is critical.
Investing Step 3: Divide your allocation between Equities and Fixed Income Vehicles
After deciding on the cash requirements, we turn our attention to the macro allocation of resources. At a high level, this relates to the allocation between equities (stocks) and fixed income (bonds) vehicles. In general, we find that equities have a higher expected return over the long term AND also a higher degree of volatility over the long term.
Conversely, we find that fixed income vehicles have a lower (relative to equities) expected return over the long term and a lower degree of volatility over the long term. While nothing is 100% guaranteed, these patterns have held up historically. The allocation between these two asset classes drives the (i) expected return of the portfolio and (ii) the expected volatility of the portfolio.
It’s the ability of a family to handle the volatility of the portfolio over time that is normally the major driver in this decision. While everyone accepts that the long-term historic returns favor equities, the discomfort associated with a fluctuating portfolio often drives families to adopt a slightly lower stock allocation and a slightly higher bond allocation.
Investing Step 4: Determine the Equity and Fixed Income “Tools” that you will use
Finally, we come to the decision on what I refer to as the “tool” that you will use in your portfolio. Here you have the choice of individual securities or pooled investment vehicles such as mutual funds or ETFs. Within this universe, you have the option of various geographical regions, of active versus passive management styles, and a variety of financial and company characteristics (e.g., growth/value, big/small, sectors, etc.).
A multitude of factors play
into the equation and must be considered
prior to investing.
While a particular security can have a massive impact on the portfolio if held in concentration, most investors pursue a degree of diversification. As a result, the individual security is not nearly as important as the other factors discussed.
The key point that I wanted to make/share today is that the individual stock is often NOT the most important decision when investing. Rather, a multitude of other factors play into the equation and must be considered prior to investing.
Would You Like More Support?
- Do you have a well-defined Investment Policy Strategy that is used to drive your investments in support of a comprehensive financial plan?
- If not, would you like to partner with someone who is used to helping people get through these struggles and (then, with confidence) implement portfolio strategies in a systematic manner while focusing on your desired outcomes?
If so, feel free to send us an email or give us a call. We’d love to have the opportunity to help you find a bit more peace of mind when it comes to investing.
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F5 Financial is a fee-only wealth management firm with a holistic approach to financial planning, personal goals, and behavioral change. Through our F5 Process, we provide insight and tailored strategies that inspire and equip our clients to enjoy a life of significance and financial freedom.
F5 Financial provides fee-only financial planning services to Naperville, Plainfield, Bolingbrook, Aurora, Oswego, Geneva, St. Charles, Wheaton, Glen Ellyn, Lisle, Chicago and the surrounding communities; to McDonough, Henry County, Fayette County, Atlanta and the surrounding communities; to Venice, Sarasota, Fort Myers, Port Charlotte, Cape Coral, Osprey, North Port, and the surrounding communities; and nationally.
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