Though there may be little you can control in the realm of investing, there are at least four things that you can. They include knowing your risk tolerance, being aware of how tax rules affect your investments, being mindful of the fees you pay, and looking for conflicts of interest in your advisor. Tending to these four considerations will increase your chances of success.
Doctors are aware that they can’t control all patient outcomes, and they focus on the things they can control to produce the best results.
The same goes for investing, a field fraught with unknown factors that can affect returns. Amid this vast cosmos of uncertainty, the only intelligent approach is to focus on the factors that you can control.
Sure, you can study stocks and other investments into the night, and sometimes this study will pay off — despite the myriad unknowns. But regardless of how well you do, the results are ultimately beyond your control. This makes controlling what you can critical to your ability to influence portfolio outcomes.
There are only four factors that you can control, and all four have a significant impact on investment returns. These factors are:
1. KNOWABLE RISK
The degree of risk investors take should be consistent with their individual risk tolerance and, once they retire, their cash flow needs. Many people wrongly assume that they can identify their tolerance for investing risk, but this can actually be a difficult thing to determine, in part because it’s often different than tolerance for other types of risk. Then you must determine the types of investments that are consistent with your tolerance. The higher the risk tolerance, the more investment volatility exposure you can take to seek potentially higher returns than are likely with lower-risk, lower-volatility investments. Cash flow is related. A higher need for cash from your portfolio during retirement tends to dictate a lower risk profile so that your assets have more protection. To determine this need, do a cash flow analysis or ask your advisor to do one.
This subject has many nuances, but one important fundamental is to be aware of the different tax rules assigned to different types of accounts. Too many investors fail to take full advantage of tax-deferred accounts, such as 401(k) plans and individual retirement accounts (IRAs). Even if they do, many lack a strategy for what kinds of investments to hold in tax-deferred accounts versus taxable accounts. A good rule of thumb is to keep stocks in taxable accounts and corporate bonds in tax-deferred accounts. By doing so, you lower your tax bill by minimizing ordinary income, while retaining the advantage of offsetting equity gains with any equity losses. Known as tax loss harvesting, this is a classic tax-efficient investing move.
Too many investors have no clear idea of what they are paying in fees. This is unfortunate, because, like taxes, fees have a huge impact on net returns — the money you ultimately get to keep. First, if you have an advisor, fully understand what these charges are and how they’re determined. For advising you and managing your assets, it’s not uncommon for advisors to charge 1 percent of the assets under management, though portfolios worth $1 million or more often go for less, perhaps .75 percent. Then, get a grip on the charges from your investments. On funds, lift the hood to determine expense ratios, and the expense from turnover. In a fund, the more of the total portfolio that turns over in a year, the higher the trading costs will be. All costs are passed along to shareholders. Ideally, you should limit this to 15 percent to 25 percent per year. If a fund is annually turning over a significantly greater percentage, this not only gets expensive, but also raises questions about the integrity of the fund. While some funds do well with a certain degree of turnover, those whose managers don’t seem to believe in assets with good long-term investable propositions may not be running funds for individuals seeking to be long-term investors.
4. DETERMINING ADVISOR CONFLICTS
Not only do you want an advisor who does not charge exorbitant fees, but you also want one whose advice is reliably free of conflicts of interest, so you can be assured that the advice is in your interest, not the advisor’s. Some advisors wear two hats — the advisory hat and the sales hat, as they earn commissions from the companies holding some of the investments they may recommend. This is not inherently a negative situation, especially if the advisor discloses all commissions and objectively explains why an investment is suitable for you and your portfolio. If they don’t bring this up, ask for written disclosures.
If you tend to these four considerations, you’ll go a long way toward controlling the only controllable items in investing, greatly increasing your chances of success.
David Robinson, a Certified Financial Planner®, is founder and CEO of RTS Private Wealth Management, an SEC-registered advisory firm in Phoenix, Arizona, that provides fiduciary services to help pre- and post-retirement clients achieve their financial goals. He specializes in helping wealthy individuals — such as physicians, executives and professional athletes — prepare for the future by creating custom-tailored financial plans that employ a holistic approach including growing/protecting wealth, managing taxes, identifying insurance solutions, preparing for retirement and managing estate plans.