Retirement Planning

How to Develop Your Investment Plan

Investing is one of the most powerful elements within the financial planning process. Investing is so important that any financial plan which omits it is doomed to fail. While you can pay a financial advisory firm a bunch of money to invest your hard earned money. I think you should learn how to develop your own investment plan. This way you can take full control of your financial future and avoid a bunch unnecessary fees.

When first starting out, many of us make the mistake of thinking that it takes tons of effort to become a successful investor. I used to spend hours researching companies and trying to craft the perfect portfolio. After a few years of traveling down that road I learned the truth; successful investors only need two things: an investment plan and consistency.

Starting Your Investment Plan

When making your plan, you will first need to understand where you are going. In a financial plan, investment decisions usually stem from the need to save for retirement. However, many couples also invest for their child's future education expenses. Your investment plan can be used to help you achieve any financial goal you have, however for simplicity we are going to use retirement as an example.

The first step when developing your investment plan is to answer the following questions. These are intended to help determine your financial goals and capital needs.

  1. When do you plan to retire (age and year)?
  2. How many years do you have to invest before you need to start making withdraws?
  3. How long do you think you will live after retirement (plan to live until 100)?
  4. How much money will you need a year in order to live well in retirement?

Once you have an idea about how your retirement (or other capital needs) will look, its time to figure out how much you will need to save and invest in order to achieve your financial goal.

Calculating Your Required Savings Rate

The calculation used to determine how much cash you will need to set aside every month is dependent on how much time you have until you need the capital and your anticipated annual return on investment (ROI). To determine your required annual savings rate, I recommend using the Excel spreadsheet function "payment" or PMT. It's simple, just follow these steps:

  1. Open any spreadsheet and enter "=PMT" into any cell.
  2. Enter your estimated annual return on investment (i.e. assume 8% or 0.08).
  3. Input the number of years you have until you need the savings.
  4. Enter a comma, this will bypass the present value parameter.
  5. Input your investment goal future amount (i.e. $1,000,000).
  6. Finally, input a zero for the last parameter.

Your final formula should look like this: "=PMT(0.08,30,,1000000,0)" which equals -$8,827.43. So in this example, we would need to save and invest $8,827.43 a year and receive 8% ROI annually in order to have $1 million in 30 years. Performing these calculations always highlights the power of compounding and starting early.

Crafting Your Investment Strategy

So you've completed the hard part; goals have been established and budget adjusted. Now it's time to put that hard earned money to work. The next step when developing your investment plan is to determine what investments strategies you will need to employ to accomplish your goal.

While portfolio creation doesn't need to be complex; it can get tricky if you let it. The development of a portfolio is beyond the scope of this post, however let the following core investment tenants guide your investment decision making:

  • Build a diversified portfolio (easily accomplished with Exchange Traded Funds)
  • Leverage tax advantaged accounts.
  • Use direct deposit to make saving automatic.
  • Remember why you are investing and your long term goals.
  • Ensure your portfolio's risk profile aligns with your needs.
  • Monitor your investments and adjust as necessary.

Finally, your investment plan is a living document, meaning it should be updated as circumstances change. If you develop and follow your investment plan, there is no doubt in my mind that you'll be better off for it.



Investing Services: Betterment vs. Wealthfront

Recently two investment management companies, Betterment and Wealthfront, have gained an impressive amount of popularity. As you might already be aware, I'm quite skeptical of investment management firms as I've seen the dark side of the financial planning industry. Regardless, I wanted to research both offerings and compare the two in a "Betterment vs. Wealthfront" robo-advisor death match. I wanted to do this review mainly because I'm open to selecting one of these for my own personal use. Before we get into the details lets discuss the fundamental concepts that these services are based on.

What is a Robo-Advisor?

Despite what the investment industry will assure you (mutual and hedge fund managers, commission based financial advisers, stock brokers, etc.), investment allocation decisions can be made solely using various mathematical models. Sure, in the investment allocation decision process you will need to identify risk preferences (subjective assessment), but those are quickly quantified for use in portfolio construction. All other required data (such as investment time horizon, retirement needs, age, current income, etc.) is numerical.

With that said, a robo-advisor is a mathematical model that uses your data and individual circumstances to create a "personalized" portfolio. While a robo-advisor can eliminate the need for professional help to construct a long-term retirement portfolio, it will not satisfy the investment needs of everyone. If you require savvy arbitrage or hedging strategies in your portfolio then a robo-advisor is not for you. Additionally, you will not be able to choose what assets (stocks, funds, bonds, etc.) you invest in, the machine will do that for you. Betterment and Wealthfront are both robo-advisors and utilize mathematical models to automate asset allocation.

Passive Management and Modern Portfolio Theory

Both Betterment and Wealthfront are built on Modern Portfolio Theory (MPT) concepts. Harry Markowitz founded this theory with the understanding that portfolios can be constructed to maximize expected return based on a defined level of risk. Modern Portfolio Theory also suggests that efficient portfolios (optimized based on risk and return) can be constructed by varying allocations to asset classes (i.e. stocks and bonds). This leads to an emphasis on choosing the right blend of stocks, bonds and cash verses choosing one stock over the other.

In addition to utilizing Modern Portfolio Theory to drive asset allocation decisions, Betterment and Wealthfront both take a passive approach to portfolio management. Eventhough they take a passive approach to investing, they will step in and rebalanced the portfolio as needed. Taking this approach keeps transaction costs and fees low. It's wise to take advantage of dollar cost averaging when using these service by setting up automatic investments.

Betterment vs. Wealthfront: The Duel

Now that we have a fundamental understanding of Modern Portfolio Theory and robo-advisors, it's time for Betterment vs. Wealthfront!

betterment vs. wealthfront
betterment vs. wealthfront

When comparing these two services it is clear that they are both extremely similar. The only differences that will matter to the majority of main street investors is cost and initial deposit requirements. The advantages of choosing one over the other truly depends on your individual circumstances.

If you are looking to start building a retirement portfolio from scratch, Betterment will allow you to open an account with no initial deposit. This is as long as you agree to automatically deposit $100 per month into your account. This is a huge advantage for those just starting out. However, the downside to starting out with Betterment is that their fees are higher for accounts under $10,000.

I would personally take advantage of Betterment's low deposit requirement if I didn't have the $5,000 Wealthfront requires as an initial deposit. Additionally, I suspect if you have the $5,000 to use as an initial deposit when using Wealthfront, you won't stay in their "free" account status for long.

I'm attracted to these services for the automatic allocation of investment funds. I'm a advocate of paycheck allotments used to contribute to investment accounts, however in practice it can become burdensome to manage. Thus paying a service like Betterment or Wealthfront to execute the transactions for me is a nice option to have.

Retirement Planning in 2014

Planning for retirement is one of the most important aspects in the financial planning process. However, only 64% of us actually takes the time to plan and save for retirement. There’s no doubt that planning for retirement can be a daunting endeavor, however not having enough resources to live comfortably during retirement is a far worse alternative. Many of us postpone retirement planning due to the perception that we will have plenty of time in the future. This is not usually the case as many retirees wish they started to save for their retirement sooner. As we start or adjust our retirement plans in 2014, it’s important to remember that we control our ability to plan and save for retirement.

Despite the fact that we can control some aspects of our retirement, there are a few that we can’t. This includes elements such as economic growth, inflation and retirement plan contribution laws. These limits can change year to year as they are dictated by Congress. In 2014 ensure that you consider the following limits in your retirement plan and adjust if necessary.

Contribution Retirement Plans Limits in 2014

Contribution retirement plans are employer sponsored investment accounts. These accounts are funded through automatic paycheck deductions. In these plans a employer sets a matching contribution policy in which they will invest a percentage of an employee's income as a retirement plan investment.

If your employer offers a contribution retirement plan, it is in your best interest to participate. Not only do these plan offer you a quick and easy way to build your portfolio, it also provides great tax advantages. Your personal retirement account contribution is deducted from your paycheck before taxes are calculated. This helps you reduce your annual tax bill.

In order to limit the amount of tax that is deductible from these retirement plans, Congress caps the amount in which can be contributed to these accounts on an annual basis. In 2014 you will be able to contribute up to $17,500 in your 401(k), 403(b) and most 457 plans. In addition if you are 50 years or older you qualify for a retirement “catch up” contribution of $5,500. This will set your total contribution limit at $23,000 a year.

Individual Retirement Plans Limits in 2014

Individual Retirement Plans or IRAs, are tax advantaged investment accounts. These common retirement plans are usually managed by the individual and can be opened at most financial and brokerage firms. While IRAs have a few advantages over contributions plans, such as investment flexibility, they do not include an employer contribution.

Individuals can contribute up to $5,500 to their IRA in 2014 and if over the age of 50 they qualify for the additional $1,000 “catch up” contribution. While the contribution limits to IRAs are limited, maxing out your contribution to your IRA is better than not having any retirement savings at all.

In addition to the limits for IRA contributions, the tax advantages are also capped by your Adjusted Gross Income or AGI. In 2014 the traditional IRA tax deduction is phased out for single taxpayers with a retirement plan at work when their incomes are between $60,000 and $70,000. However this limit is raised for married couples when their combined incomes are between $96,000 and $116,000.

If you do not have a retirement plan for 2014, it’s never too late to start. Many put off saving for retirement for a variety of reasons. Retirement is enviable and postponing preparing for it makes it more difficult.

Financial Planning for Newlyweds

The joining of two people in marriage is quite a significant event, not only for the families of the newlyweds, but for their finances as well. While bringing together two incomes is a pretty straight forward endeavor, bringing together various expenses, assets, liabilities and the possible emotion connection to them can be tricky.

In my previous post “You’re Engage, Create a Financial Plan”, I discussed some of the advantages of having a financial plan before you’re actually married. In short, creating a financial plan can help you and your future spouse explore your life’s goals and objectives before tying the knot. This will help significantly reduce the possibility of disagreements when managing your finances in the future.

If you are a newlywed or recently became engaged, start the financial planning process by defining your combined goals and objectives. Once complete, the following steps will help you merge your finances and create a joint financial plan.

Data Collection and Analysis

During this memorable time in your lives, it’s important to locate all of the data that will impact your financial well being. This information will be used to construct your financial planning statements and determine the strengths and weaknesses that exist in your current financial situation.

The first step is to gather your qualitative financial planning data. This information will help you explore and document your risk tolerance, past experiences with money, feeling towards different investment products and your retirement expectations. This data is mostly used in the consideration of shared values and the emotional connection to various financial decisions.

In contrast, quantitative financial planning data is more numerical in nature. Gathering this data can be accomplished by listing the title and value of your cash accounts, insurance policies, estate planning documentation, and historical tax returns. This data will be used to develop forecasts and determine the affordability of your goals and objectives.

Once you have gathered and listed all of your financial planning data, it’s time to determine which accounts and policies should be merged, eliminated or simply left alone.

Merging Accounts and Financials

The decision to merge accounts and other financial planning tools, can be difficult. This is not only due to the volume of forms that will have to be filled out, but also the fear of losing control over a very important aspect of your personal life.

To begin merging accounts, it’s important to understand the advantages and disadvantages of each one. This will help determine if there could be any savings or added complexity from merging accounts (such as consolidating insurance policies or changing beneficiaries).

Once all of your options have been laid on the table, it’s time to merge the accounts that have the most advantages. When merging accounts, remember you don’t have to do it all at once. As long as there is open and honest communicate accompanied by a clear action plan, you can merge your financial accounts when it’s best for you and your schedule.

In today’s fast moving and advanced world, marriage is more than a romantic commitment to the person you love, it’s a business arrangement as well. Newlyweds should take the time to create a financial plan. This will ensure that the business side of you relationship is healthy and moving in the right direction.

Improve Your Financial Decision Making

In my experience, financial success is gained through two key actions that we all have the ability to leverage. The two keys to financial success is hard work and sound decision making. Over time if we consistently make unwise decisions, we will find ourselves in a situation that is difficult to recover from.

Just like other things in life, achieving financial success is more about hard work and making the right choices rather than circumstances outside of our control. Making savvy financial decisions starts with understanding why we make bad financial decisions in the first place and making a conscious effort to change the way handle our money.

None of us are perfect as we are all human and are guided through life by a mix of ideals, morals, instincts and emotions. These factors can have a large influence on the financial decisions we make everyday. Some help us make good decisions and others not so much.

Savvy financial decision making begins with understanding that emotions and other elements of the human experience can impair your ability to make good financial decisions. The following list of savvy financial decision examples can help you improve your financial situation and avoid making poor financial decisions in the first place.

Making Better Financial Decisions

Create a Financial Plan - You know my first piece of advice will always be to create a financial plan. A plan will automatically help you increase your financial decision making savvy by showing you the impacts of the decisions you make on a daily basis.

Difference Between Needs and Wants - Far too often we buy the things we do not need. When we spend money to buy frivolous items or overpay for things we do need, we are throwing away the opportunity let our savings and investments grow at a faster rate. Take the time to explore the concept of needs and wants, let your conclusions guide your future financial decisions.

Don’t Max Out Your Mortgage - In the past, many of us have bought as much house as the bank would let us. We let the lenders and mortgage companies tell us what we could afford. This decision put many of us in a rough financial situation that we are still working through. So if you are exploring the opportunity to buy a house, don’t max out your mortgage.

Automate Your Budget - Taking the emotion out of budgeting and spending less is as easy as opening a bank account. When separating your discretionary and nondiscretionary expenses into two banks you will make it easier to save money by removing the temptation to buy the things you don’t really need.

Invest a Little Each Paycheck - Consistent investing is the best long-term strategy for making your money work for you. If your company offers a 401k or other defined contribution retirement plan, take advantage of it. Investing 5-10% of every paycheck is a great way to build a solid nest egg and easily increase your net-worth.

Don’t Ignore Insurance - One large bill, from a car accident for example, can wreak havoc on your financial plan and severely limit your chances of ever being financially independent. Ensure that your insurance covers you from any large unavoidable bills in the future. I know paying for insurance is not on the top of your to do list, however you will thank me if anything ever goes wrong.

More than just logic plays a role in the financial decision making process. Sometimes emotion reduces our ability to make the best decision concerning our financial situation. Regardless of your circumstances, the above mentioned savvy financial decisions will help you improve your finances and way of life.