by Erin Lowry
HOW DO I KNOW MY RISK TOLERANCE AND ASSET ALLOCATION?
We all love a good rule of thumb, especially when venturing into a new endeavor like investing. It helps simplify a potentially challenging situation. The rules of thumb in investing are plentiful, but that doesn’t necessarily mean you should follow them.
A common one you’re likely to hear is that (100)–(your age) = the percentage of your portfolio that should be invested in stocks. In my case, that’s (100)–(29) = 71, so 71 percent of my portfolio should be invested in stocks.
But here’s the rub: that doesn’t account for my time horizon, goals, or risk tolerance.
“No, there is no rule of thumb,” says Schlesinger. “Everyone wants there to be a rule of thumb, so there are shortcuts, but I think it’s preposterous, in this day and age, that we’re looking for rules of thumb when doing a very quick questionnaire online or going through an app that will take all of two minutes; we’re still looking for shortcuts. The shortcut is that technology will do it for you.”
Many brokerage firms offer free tools online for both customers and non-customers. You usually have to answer about ten to fifteen questions, and up will pop a recommendation for asset allocation that will be far more specific than a general rule of thumb. These questionnaires will also force you to really think critically about your investing strategy.
I typed “asset allocation calculator” into Google and found Vanguard’s investor questionnaire in about fifteen seconds. The eleven-question questionnaire took me all of five minutes to complete and offered links to more information about what to know before reallocating and how my percentages compared to other allocation mixes.
HOW OFTEN SHOULD I CHECK ON MY INVESTMENTS?
Hazel had the misfortune of checking on her investments against her will simply because she needed to log in to her checking account. Checking on your investments frequently is not a good strategy for most people, regardless of their risk tolerance. “Don’t look at your portfolio every day or several times a day. It’s a long-term endeavor,” says Schwab-Pomerantz.
“Generally speaking, six to twelve months,” says Maria Bruno, CFP®, senior investment analyst at Vanguard Investment Strategy Group. “You don’t want to do it too frequently, because basically you’ll just [be] chasing your [own] tail—the markets do have bumps in the road and ups and downs.” She adds, “At a minimum, check once a year. And pick an anniversary date.”
Why do you need to even check in the first place if you have a buy-and-hold strategy, you may wonder? Because you’ll eventually need to rebalance your portfolio to ensure that your overall asset allocation continues to be aligned with your goals, time horizon, tax strategy, and risk tolerance. If you purchased stocks and bonds with a 60/40 split and then the stocks performed really well, you could suddenly be at a 70/30 split, so you’ll need to rebalance to get back to 60/40.
HOW TO PROTECT YOURSELF FROM YOURSELF
Ultimately, your biggest challenge is probably going to be learning how to put a line of defense in place so that you can protect yourself from yourself. Unfortunately, I don’t know your exact idiosyncrasies to help make that happen, but here are some suggestions that may help uncover what can work for you.
Separate Your Bank and Investment Accounts
If you’re anything like my friend Hazel, then you may want to invest with an institution that’s separate from where you do your banking. Don’t subject yourself to seeing what your portfolio is doing each time you need to access your checking or savings account.
Set Aside Cash in an Emergency Fund
“Always knowing you have a nest egg in emergency reserve will keep you from raiding that money you have invested for the long term,” says Schlesinger. “Don’t confuse your short-term, intermediate-term, and long-term money.”
Assign a Goal-Related Name to Your Accounts
One of my favorite tactics is to nickname my savings accounts. Instead of seeing “Account no. 384841,” I will change it to something like “Honeymoon: South Africa, 2019.” Being specific reminds me why I’m saving and throws up a little psychological block in case I’m tempted to skim just a little off the top for an indulgence today.
Schlesinger recommends doing something similar when it comes to your investments. “If you keep those goals in mind and you say, ‘It’s in my retirement account,’ that can be a really helpful way to prevent you from doing something dumb.”
Automate Your Contributions
You may already have experience with automating contributions if you contribute to an employer-sponsored retirement plan. Setting up automation means one less thing on your to-do list each month, and it increases the likelihood that you’ll consistently be investing money. Most brokerage firms have an option for setting up automatic investing that will pull your monthly contribution out of your checking account and put it into your investments.
Automating also provides a way for you to buy in to the market at various prices, a strategy known as dollar-cost averaging. “Dollar-cost averaging allows you to buy low when the market goes down and, obviously, you also buy when it’s high, but you get a better price on average,” says Schwab-Pomerantz.
Have a Plan
“The more you understand the market and the history of it, the more comfortable you’ll be,” says Schwab-Pomerantz. “Make an investing plan, stick with it, and try to avoid the noise. I remember 2008. It was such a scary time for all of us, even in the business, and I asked my advisor, ‘So, Mike, the phones must be ringing off the hook.’ And he said, ‘Actually, Carrie, no. Everybody has their plan. They know their risk tolerance, they’re well diversified, they know the market goes up and down, and they’re staying committed to their plan. There’s only one client who called, and he’s just a nervous Nelly who always finds an excuse to call.’ Having a plan and understanding it can help you ride out those ups and downs.”
Hire a Pro
We’ll discuss options for hiring help, but Schwab-Pomerantz recommends hiring a financial advisor if you need an accountability buddy or want the assistance. “I use a financial advisor. Even the pros get help,” she says.
Don’t Be Tempted by the Latest Hot Tip
“As humans there is greed and fear and following the herd. That’s not what investing is about,” says Schwab-Pomerantz. One of my favorite investing urban legends is that Joseph P. Kennedy Sr., father of John F. Kennedy Jr., famously sold his investments just days before Black Tuesday, when the stock market crashed in 1929. He claims that he knew it was time to get out because he’d received stock tips from his shoeshine boy. The line “When your shoeshine boy is giving you stock tips . . .” still gets used to this day.
There will always be the hot new stock or commodity everyone is talking about. From tulip bulbs to Beanie Babies to Bitcoin, it’s just a reality of investing. You need to be careful about staying true to your own goals and plan. Any dabbling in the latest hot tip needs to be done with the speculative part of your portfolio that you can afford to lose.
WHAT IF YOU JUST CAN’T HANDLE ANY RISK?
Despite all this advice on how to mitigate risk and protect your portfolio from your knee-jerk reactions, you may still be coming to the conclusion that investing is just 100 percent not for you. The idea of putting your money in any investment, no matter how conservative, sends chills up your spine and a pit of nausea floods your stomach.
“Know that if you can’t do it, it’s not the worst thing in the world. It’s just that you’ve got to save a lot more money,” says Schlesinger. “Your money, when you invest it, is doing some of the lifting for you. When you’re completely risk averse, it just means you’re going to have to save a lot more money to reach your goals.”
CHECKLIST FOR HANDLING RISK
☐ Embrace the fact that the market will go up and down.
☐ Put an investing plan in place that aligns with your risk tolerance but als
o helps you meet your goals.
☐ Understand the importance of asset allocation and diversification in your portfolio.
☐ Set up barriers to protect you from yourself when the market takes a tumble.
Chapter 4
I Have a 401(k)—Do I Need to Do More Investing?
“THEN YOU CAN log in to the benefits portal and learn more about how to set up your 401(k) as well as your pre-tax transit card and health savings account.”
I smiled tightly and nodded at my new manager as if I had any idea what she’d just said to me. The term 401(k) sounded familiar, but those other two terms meant nothing. I made a mental note to call my parents after work and ask what those were and if I should use them. Then I returned my attention to the piles of starting-day paperwork and informational videos on office safety (even though the biggest threat I faced was a paper cut in this open-floor-plan public relations office).
A couple weeks later, I finally got around to evaluating my benefits package. The retirement package one-pager outlined that I’d get up to a 4 percent match from my employer and that the contribution would be vested immediately. There were two options: Roth and, from what I could tell, not-Roth.
Still a bit dazed from all these terms, I created a profile in an effort to be an adult and figure it out myself. That’s when I found myself confronted with a scrolling list of investment options featuring names like large cap, small cap, and Dodge & Cox®.
Nope, this wasn’t going to get figured out solo. So, I did what any enterprising twenty-three-year-old would do. I called my dad.
Surely his thirty-plus years in the business world would mean he could translate these terms into regular English, I thought to myself.
I was sort of right. He knew how to help me set the account up, but the man was so far along on his own investing journey that his attempt at simplifying the process still felt too complicated. But he did give me advice on which funds would create an aggressive portfolio in a Roth 401(k), given my long-term time horizon and, at the time, very low tax bracket. (It’s okay if that last sentence overwhelms you. It meant little to me at the start of my investing journey, too.)
* * *
• • •
SAVING FOR RETIREMENT is not just important, but arguably it should be your first investing priority because:
It helps lower your tax liability either today or in retirement.
You’re (possibly) getting free money from an employer.
It can easily be automated, so building your nest egg is habitual, with minimal effort from you.
You’ll eventually want to achieve financial independence and be able to walk away from the need to earn a paycheck.
NOT SAVING FOR RETIREMENT YET?
If you’re not saving for retirement yet, I’d like to point back to the example of Stacey and Jake in the introduction. Jake tried to catch up to Stacey after waiting ten years to start contributing to his 401(k). Stacey contributed only 4 percent of her salary in order to get the employer match. Jake contributed 10 percent, more than double what Stacey did, but he was still $100,000 behind her when they both retire at sixty-two.
Now, allow me to momentarily stay on my soapbox a bit longer and refer you to the following scenario and table to explain why it’s imperative that you start now. Like, “Put this book down after my rant and go sign up for your 401(k) or open an IRA” kind of now.
Assume twenty-one-year-old Kim saves $300 per month (or $3,600 per year) from now until she retires at age sixty-eight and receives a real rate of return of 4 percent. She would have approximately $500,000 at retirement. If Kim waits ten years to start saving, at thirty-one, she would need to save approximately $500 per month (or $6,000 per year) to achieve the same balance at retirement.
Assumptions:
Real Return 4.00%
Savings Annually
Savings
Monthly
Balance after the following number of years
1
5
10
15
20
27
37
47
$1,200
$100
$1,200
$6,700
$14,800
$24,700
$36,800
$58,400
$101,800
$166,500
$1,800
$150
$1,800
$10,000
$22,200
$37,000
$55,200
$87,600
$152,700
$249,800
$2,400
$200
$2,500
$13,300
$29,500
$49,400
$73,600
$116,800
$203,600
$333,100
$3,000
$250
$3,100
$16,600
$36,900
$61,700
$92,000
$145,900
$254,500
$416,400
$3,600
$300
$3,700
$20,000
$44,300
$74,100
$110,400
$175,100
$305,400
$499,600
$4,200
$350
$4,300
$23,300
$51,700
$86,400
$128,800
$204,300
$356,300
$582,900
$4,800
$400
$4,900
$26,600
$59,100
$98,800
$147,200
$233,500
$407,200
$666,200
$5,400
$450
$5,500
$29,900
$66,500
$111,100
$165,600
$262,700
$458,100
$749,500
$6,000
$500
$6,100
$33,300
$73,900
$123,500
$184,000
$291,900
$509,000
$832,700
$6,600
$550
$6,700
$36,600
$81,300
$135,800
$202,400
$321,100
$559,900
$916,000
$7,200
$600