thanksgiving fruit basket

Financial Planning A La Carte

thanksgiving fruit basket's second book, Index Funds - Strategies for Investment Success by Will McClatchy, recently hit the shelves. The book is designed as a guide for investors of all stripes who want to learn more about the benefits of index or passive investing. The first half covers the philosophy and history of indexing, and exposes the conflicts that rarely align Wall Street's interests with investors' interests. The second half of the book, entitled "Taking Action," introduces investors to the practical aspects of selecting and managing indexed portfolios. Asset allocation, model portfolios, financial planning, fund selection, and portfolio rebalancing are just a few of the topics covered. A helpful review of available indexes and passive fund providers is also included in this section.

The following excerpt is taken from the opening chapter of the "Taking Action" section.


The best thing that an investment advisor can do for you is to assess your financial needs and design a tailored program to meet them.                                             - William A. Sherden, The Fortune Sellers

Not surprisingly, this book recommends spending a far greater percentage of one's time and money in the critical planning, asset allocation, index selection, and product selection phases than most investment professionals. Since there is no wasted effort from endless absorption of market trivia, fruitless stock picking, or selection of star fund managers, plenty of time is freed up for proper financial planning and for picking assets, indexes, and products.

As a practical matter, filtering out the financial media noise will free up the most time. Investors spend hours every week filling their heads with useless trivia. If anything, it can lead one to costly or risky trading. Following overall economic activity is still useful. With the free time, I recommend investors spend it with their family, friends, and community. They certainly will be happier for it, and I predict they won't be any less wealthy.

Planning is absolutely critical but underappreciated by many Wall Street professionals. This is no surprise, as they do not benefit from planning. It is a relatively unprofitable business because it is often required infrequently, can be done by small firms such as CPA practices or small financial advisor offices, is viewed by investors as a commodity, and offers no steady annual income. Investors will be better off if they turn the normal approach on its head. Financial planning and objective advice are not commodities, but rather a highly differentiated product. Stock picking is not a highly differentiated product but rather a commodity (and one worth very little if anything, aside from keeping the market reasonably efficient for indexers). The cost of performing planning should be considered. A simple graph of how much to spend based on one's portfolio offers a rule of thumb for how deep a financial plan should be. Some example portfolios, which we'll present later, show typical suggestions for various types of investors.

At some point it is necessary to put discussions of the merits of indexing and various asset class weightings aside and actually invest. On the one hand, the indexer is keenly aware of the importance of placing investments in the right asset allocations and the right funds so as to avoid costly trading. On the other hand, any delay in investing somewhere creates cash drag. Simply parking one's cash in money market funds will barely cover inflation.

Making a wrong early asset allocation is less of a concern for active traders because they will likely have turned over their entire portfolio within a year. However, the indexer struggles over this. Many active investors are taught to construct a good financial plan once, perform crude asset allocation, and really focus on finding a great star mutual fund manager. Oh yes, when that manager fails, they spend a lot more time finding another star manager.

Indexing reverses this recommendation. Develop a good financial plan once, and again every five or ten years or at major life milestones. Then, do a really thorough job determining asset allocation. Finally, take a modest amount of time selecting fund brands, and be sure to rebalance occasionally. Perhaps the most ignored aspect of indexing among those who enthusiastically call themselves indexers is rebalancing. In particular, reassessment of risk versus reward upon major market run-ups is where I allocate any extra energy.

Since there are many excellent financial planning books out there, the subject is treated briefly here with a view to the indexer. Indexing makes financial planning so easy and thorough because:

1. Time previously spent picking stocks or funds is now freed up.
2. Assets are explicitly delineated, so nonfinancial assets can be easily meshed into a comprehensive plan.

A comprehensive plan is not as easy to do when your portfolio drifts from one style to another as managers change their minds and as you switch between funds.

A standard checklist of goals to develop includes:

1. Retirement income
2. Medical care for life
3. Comfortable housing
4. University education for children
5. Travel or hobbies

For each goal, a time period must be attached, along with a degree of importance. Having excellent medical care and comfortable housing for life should rate very highly, along with a modest retirement income at normal retirement ages. Assistance for children's education would come next for most persons, followed by travel and hobbies.

A typical list of resources and tools to achieve these goals might include:

1 . Tax-sheltered retirement fund
2. Taxable retirement fund
3. Home equity
4. Income stream
5. Life insurance
6. Medical insurance

At this point planning is often a matter of trying to match the right resource and tool to the right goal.

The key to thorough financial planning is comprehensiveness. What are all the goals you have, what are all the resources you have at your disposal, and what are all the tools that you can use? Do not carve out your investment fund from the rest of your financial life, but rather include it in an overall plan.