GENERATIONS

CEO John Dowd's Question of the Week:

What is my “risk tolerance,” and how can I measure it before I start investing?

08.01.2018

Preparing for the Journey Ahead

Throughout our history, one of Fiduciary Trust’s top priorities has been educating future generations. Our goal is to help young people lead productive lives and manage wealth wisely.

As part of this commitment, CEO John M. Dowd addressed a group of graduate students who are members of the Fortis Society, an organization that provides networking opportunities based on merit rather than privilege. In John’s guidance on financial and professional success, summarized here, one message comes through loud and clear: Success requires planning.

Successful Investing Begins with a Plan

Q: When is the best time to start investing?

JOHN: There’s an old saying that the best time to start investing was 10 years ago, and the second-best time is right now. And I think there is some truth to that, assuming you have money to invest.

Everyone has different financial needs, but the general rule of thumb is that 50% of your after-tax income should be reserved for essentials like food, clothing and shelter; another 30% goes toward travel, entertainment and other things you want but don’t necessarily need; and the remaining 20% should be saved or invested.

Assuming all your bills are paid and you have adequate savings (six months of living expenses as a buffer), it is usually best to start investing as early as possible. The earlier you start, the more likely you are to benefit from compound interest—a force so powerful that Albert Einstein called it the eighth wonder of the world. When you continuously reinvest the income earned by your investments, time can be a powerful ally. 

Q: If I’m ready to start investing, where do I begin?

JOHN: First, it is important to have a plan. Put your personal goals in writing and sketch out a strategy for how you expect to accomplish them. And, be sure to take advantage of your company’s 401(k) retirement plan, especially if your employer makes matching contributions. Professional guidance may also be helpful, especially if you could use more discipline in your financial life or want more guidance on investing. For example, you may have heard that you can estimate how much of your portfolio should be allocated to stocks by subtracting your age from the number 100 (meaning that a 25-year-old should have 75% of his or her portfolio in stocks). While this rule of thumb is helpful, a professionally developed financial plan will tell you exactly how your investments should be allocated.

Q: What are the most common mistakes made by younger investors?

JOHN: Not having a financial plan—and then making emotional decisions when markets are rocky. Over the last 20 years, an investor who stayed fully invested in the S&P 500 would have received close to a 10% average annual return.

However, if they missed the 10 best days of the market, their return would have fallen to 6%. I often think about investors who headed for the sidelines during the global financial crisis in 2008 and locked in their losses, only to see the US stock market fully recover by the end of 2009. We often tell our clients to focus on “time in the market” rather than “timing the market.”

Q: If I am an active investor, what should I know about the economy?

JOHN: There is so much information out there that it is critical to build a framework to make sense of what you are seeing and hearing in the news.

It took me a long time to develop my own framework, but I generally take six key economic factors into consideration when investing: 
  • The strength or weakness of the dollar, which influences so many investments.
  • The direction of interest rates and the policies of central banks like the Fed.
  • Inflation, which affects the consumer’s purchasing power.
  • Corporate earnings growth, which reflects the general health of the economy.
  • Employment rates, which influence personal consumption (responsible for 70% of our economy).
  • Gross Domestic Product, which is our country’s economic scorecard.
Best Practices for Your Personal Finances

Q: Do you have any advice on how to manage my personal finances?

JOHN: Build financial discipline early. Read the book Titan: The Life of John D. Rockefeller, by Ron Chernow. It explains how Rockefeller became the first billionaire in history through a life of discipline, determination and meticulously recording every financial transaction he made.

If you are an investor, avoid the wisdom of the crowd. As Warren Buffett said, “Be fearful when others are greedy and greedy when others are fearful.”

Q: What are the most important skills I should develop for a successful career?

JOHN: Curiosity and creativity. In this fast-changing world, with so many day-to-day “work problems” that need to be addressed, it is important to maintain a sense of intellectual curiosity and continue learning throughout your career.

I find it extremely helpful to study business leaders in other professions and apply the lessons they have learned to wealth management. Yes, it is important to have drive, ambition, talent and self-confidence. But I think it is equally important to admit that you don’t have all the answers to life’s questions.

Q: What is the most challenging aspect of running a business?

JOHN: I am responsible for moving this company forward by leading broad initiatives and discussions that can sometimes continue for months, or longer. The challenge is to stay sharp, keep my energy levels high and remain fully present and engaged in the tasks that are in front of me 100% of the time while those broader discussions are moving along.

Managing people can also be challenging and rewarding at the same time. When I am coaching and mentoring in the office, I have to make sure I am not only encouraging and rewarding people but also challenging them to step outside of their comfort zones. This can be risky because you never know how an individual is going to react. Everyone has different strengths and weaknesses. Finding a way to leverage those strengths and then watching them shine is especially gratifying to me.

Q: I want to hire a financial advisor. What qualities and skills should I look for?

JOHN: There are plenty of well-qualified advisors available, including generalists who carry designations such as Certified Financial Planner (CFP) or Chartered Financial Analyst (CFA). But for many individuals, I recommend working with an advisor who adheres to the fiduciary standard rather than the less stringent “suitability” requirements. Fiduciaries are required to not only recommend investments that are appropriate for you, but they also have a legal and ethical obligation to put your interests ahead of all others, including their own interests and the interests of their firm.

Many more complex wealth management clients appreciate working with a team of specialists rather than an individual advisor. Each member of the team brings specific skills to the table—such as investing, tax management, and trust administration—and each team has a coordinator who serves as its “quarterback” as well as the client’s primary point of contact with our firm.

In any case, a critical quality to look for in a financial advisor is the ability to listen effectively and be responsive. I don’t expect my advisor to be an expert on every financial discipline under the sun, but I do expect him to be open-minded and resourceful when he answers my questions and offers advice. 

Finally, I would avoid advisors who are subject to quotas or sales targets, because it opens the door to potential conflicts of interest. The best way to know if this might be a problem is to simply ask the advisor how he or she is compensated. 

Q: I’m joining my parents for their next meeting with our family’s wealth manager. Should I ask questions?

JOHN: Great question. Yes, absolutely, and don’t hesitate to ask basic questions such as: What is your main objective for our family’s wealth? Your presence at the meeting creates the perfect opportunity to make sure your parents and your advisors are all on the same page. But don’t be surprised if there is  disagreement over the response. As the “newbie” in the room, you can ask questions that should have been asked a long time ago, but might have been overlooked. It’s always worth checking. 

Also, don’t be shy about asking the team to explain any terminology you don’t understand, even small things. Frankly, it always surprises me when our fixed income managers talk about the yield curve or the inverse relationship between rates and bond prices and nobody asks them to explain these concepts in plain English. Specifically, I would ask the portfolio manager questions such as:

  • Have you made any short-term or “tactical” shifts in the portfolio recently?
  • How closely does the management of my family’s portfolio align with your best thinking, or the views of your firm?
  • What has worked, and what hasn’t worked, as far as performance goes so far this year?

If your family has trust assets managed by the firm, I would also ask the trust officer or trust counsel a few questions:

  • Who are the trustees and what are the provisions regarding successor trustees?
  • Will the trust’s assets be subject to estate taxes upon the passing of my parents or grandparents?
  • How will distributions be made and what standards must the trustee consider before making the distributions?

Smart financial professionals actually enjoy answering questions like these. It keeps them on their toes!

Q: How can I become a better investor than my parents or grandparents?

JOHN: Well, first it’s important to acknowledge that the older generations have done very well over the years. For example, if your parents or grandparents invested $10,000 in the US stock market in 1960 and reinvested the dividends, it would be worth almost $150,000 today.1

But we can always improve. Probably the best advice I could offer anyone who is new to investing is to work with your advisor to build a comprehensive financial plan aimed at your goals and then stick with it. History tells us that trying to time the market—heading for the sidelines when prices drop and then trying to get back in at just the right time—is an expensive and ineffective strategy. Mark Twain once quipped that the worst month to be in the stock market is October; followed closely by July, January, September, April, etc. The point is, timing the market is difficult, at best, and discipline pays off. If you were fully invested in the S&P since 1995 your returns would average out at approximately 10% per year. But if you missed its 10 best-performing days, your return falls to just 6.7%.2

On the other hand, I would also caution against a purely passive approach—simply buying and holding stocks. I prefer buying and actively managing my portfolio, with guidance from an experienced portfolio manager who focuses on fundamentals such as a company’s earnings, stock price, and its competitive advantages. The right portfolio manager can assemble a portfolio of high-quality, globally diversified stocks and bonds that is aimed specifically at your goals and risk tolerance. When the market changes direction or your goals change, your manager can rebalance the portfolio, reduce your exposure to risk, and keep you on the right track.

Q: What is my “risk tolerance,” and how can I measure it before I start investing? 

JOHN: There are a number of ways a wealth-management professional can help you assess your risk tolerance—or your “appetite for risk.” Some are quantitative and can be measured fairly easily, and others are qualitative, based on how you respond to certain questions. Basically, we want to know if you would continue to invest if the economy stalled, we entered a recession, the market declined or a full-blown market correction happened (stock prices falling by 10% or more). And when the economy is growing and stocks are surging, we want to know how much of the market’s gains you’ll be willing to give up in order to manage those risks.

Your overall risk tolerance usually depends on your investment objective and time horizon—in other words, your goals and your timeline for accomplishing them. If you are young and saving for a long-term goal like retirement, you can usually afford to take on more risk because you have more time to recover any losses. But keep in mind that these are broad generalizations that might not apply in your particular situation.

Here’s another generalization, or rule of thumb, that is still mentioned fairly regularly: To determine how much of your portfolio should be allocated to stocks (i.e. “risky” investments for growth), subtract your age from 100. So, a 30-year-old, for example, would have 70% of her investments in equities. Sounds reasonable. The problem with his rule is that people are living a lot longer today, which means retirement can last for 30 years or more. So a 50-year-old who follows this advice, putting half of her retirement account in stocks and the other half in Treasury bonds for safety, might not see the type of growth she needs. She runs the risk of outliving her money.

While this rule of thumb can be helpful, to some degree, a professionally developed financial plan will tell you exactly how your investments should be allocated.


This communication is intended solely to provide general information. The information and opinions stated are as of December 21, 2018, and may change without notice. The information and opinions do not represent a complete analysis of every material fact regarding any market, industry, sector or security. Statements of fact have been obtained from sources deemed reliable, but no representation is made as to their completeness or accuracy. The opinions expressed are not intended as individual investment, tax or estate planning advice or as a recommendation of any particular security, strategy or investment product. Please consult your personal advisor to determine whether this information may be appropriate for you. This information is provided solely for insight into our general management philosophy and process.Historical performance does not guarantee future results and results may differ over future time periods.

IRS Circular 230 Notice: Pursuant to relevant U.S. Treasury regulations, we inform you that any tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. You should seek advice based on your particular circumstances from your tax advisor.

1 https://dqydj.com/sp-500-dividend-reinvestment-and-periodic-investment-calculator/ 
2 Strategas


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