Financial planning and investment management often require personalized solutions to complex topics. I spend a lot of my time crafting recommendations in which one size definitely does not fit all. However, there are several key tenets of personal finance that require no customized strategy. These are topics that can’t be communicated too broadly or often enough, regardless of the personal situation.
If you can follow these principles, you’ll have a much higher likelihood of achieving financial security and likely a need for more personalized planning.
• You need to understand your goal and work backward from it to define how much planning, money and time is required to achieve it. Figure out where you need to be and determine the path to get there. It’s a better route than letting whatever money you end up with determine how you get to live.
• The more you save, the less you have to rely on investment returns to do the heavy lifting of getting you where you need to be. Save 10 percent of your income over a 40-year working lifetime and even moderate investment returns without taking extraordinary risk could make you a millionaire.
• Investing early in life — providing the opportunity for more years of compounding growth — is more important than investing larger sums later. For example, a person who invests $5,000 per year from 25 to 65 ($200,000 total) at 5 percent returns will accumulate more than someone who invests $18,000 per year from 45 to 65 ($360,000) total with the same return.
• Never pass up an employer retirement plan match. According to Financial Engines, employees forgo $24 billion in annual matching contributions by not participating enough in 401k accounts. It’s free money.
• Financial planning is imprecise and ongoing. A financial plan provides a framework to make decisions by. The specifics (investment return expectations, life expectancy, spending rates) will all be inaccurate as life proceeds. But the planning process gives you targets and lets you know when to correct your course along the way.
• Outperformance of a benchmark is elusive — especially if you’re comparing your investments to the wrong benchmark. Strong performance from certain segments of the global stock and bond markets, or from certain fund managers, will not be persistent. It is fleeting. All investments move in and out of favor. The only truly relevant benchmark for your investment decisions is whether or not you feel they will help you make progress toward your goals over time.
• Average returns rarely appear. Prepare for an investment return experience that is far different than any historical guide might convey. I track a balanced portfolio of 60 percent global stocks and 40 percent bonds. Since 1973, this diverse allocation has produced a 10.4 percent average annual return. But only seven of the 42 calendar years have produced returns within even 2 percentage points of the long-term average. The high annual return was 31.6 percent in 1985. The low was -21 percent in 2008.
• Aggressive growth, conservative income ... the investment portfolio that is best for you isn’t the one that has top performance over the past year. It’s the one you can stick with for many years. Switching from aggressive to conservative and back again trying to time changes in investment opportunities will only make your pursuit of financial security more difficult.
• Don’t start Social Security at 62 unless you are in poor health or unable to work and absolutely need the money. The safest investment you can make is postponing Social Security. Each year you wait you receive deferral credit, and your future payments receive a cost of living adjustment based on the higher earned benefits.
• Understand your eligibility for spousal Social Security benefits and use them to maximize your own personal benefit, switching to it later when it has grown in value. According to the Center for Retirement Research at Boston College, underutilization of spousal benefits leaves $10 billion in unclaimed Social Security payments annually.
• A quick route to hardship is being underinsured. Adequate life, disability and health insurance is the foundation of financial security, especially early in a working career and if you have dependents who rely on your income.
• Be charitable. Whether you give $20 or $20,000, giving money to an organization you care about makes you feel good. Brain chemistry research has made philanthropic happiness clear. Make it a component of your financial plan.
• Make financial decisions as if you are the chief executive officer of You Inc. Lifestyle and finance decisions should be made as if you are attempting to run a profitable business for your family. Live below your ongoing means and put the subsequent profits to good use toward things you value.