Your Money’s Dynamic Duo: Investing & Financial Planning

Victor Colella: Hi, everyone. This is Victor Colella, and I am a financial planner here at Adviser Investments. Welcome to another Adviser You Can Talk To Podcast. Today, I am joined by two esteemed colleagues of mine, Jeff DeMaso, who is our director of research.

Jeff DeMaso: Hey, Victor.

Victor Colella: Hi, Jeff. And, of course he’s back: Andrew Busa.

Andrew Busa: Good to be back.

Victor Colella: Andrew’s a financial planner here in our central planning group and we’re happy to have him back. Today, our topic is a little more big-picture than we’ve covered in the past. It’s looking more broadly about finance and what it is and how you should think about finance. Really, the reason why we’re covering it is that finance means a lot of different things to a lot of different people, and depending where you are getting your information that might not be the best definition to inform how you spend your time thinking about planning for and running your financial lives. Hopefully, today, you walk away with a better idea of where you should be focusing your time in the finance world.

Victor Colella: Let’s jump right in. Finance means something different to everyone. What do you see out there as different definitions of finance?

Jeff DeMaso: For me, the big one is investing and investments and the stock market. Probably for worse, but better or worse in the media this is often portrayed as a sport almost. It’s like ESPN with numbers when you watch CNBC. Every tick in the market’s talked about—all the different data releases. It’s always “you have to act now.” We even have investment superstars, the Warren Buffetts of the world, so there’s another sports angle there.

Andrew Busa: The other definition that I think has become more relevant in the last 10 to 15 years is financial planning. Investment generally gets all the press. It’s frankly more exciting sometimes than financial planning. You don’t often find yourself at a neighbor’s party talking about how well your insurance performed for you last year. You’re talking more about your investments, right?

Victor Colella: Speak for yourself, Andrew.

Andrew Busa: Well, you’re a different breed.

Victor Colella: That’s for sure.

Andrew Busa: But financial planning is becoming more relevant in people’s lives, and I think this is the other big definition that we see out there of what finance is.

Victor Colella: And those are really the two main definitions that we find in a lot of conversations around finance: Investing and financial planning. Let’s dive a little bit deeper. Jeff, why don’t you start by giving us a little more on what investing is and perhaps what that looks like.

Jeff DeMaso: Investing, let’s just say, is growing your savings. Within that, it’s thinking about how much in stocks am I going to buy? Which stocks am I going to buy? What bonds to own? What not to own? All those types of investment selection or security selection types of questions…

Maybe a way to frame this is the thing about investing in isolation. You may just have an investment strategy but no financial plan. What does that look like? In that case, you’re just focusing on your return, and how big can a portfolio can be. You might be thinking, “Well, of course, what’s wrong with that? We all want to have the biggest portfolios we can.”

There’s a few issues with that. One of them is it just doesn’t line up well with some of the reasons you might be investing. Trying to maximize your return going all the way forward doesn’t work if you are investing for something that has a due date like Junior’s college fund.

Victor Colella: Exactly. It also makes it harder to weather the ups and downs as you are going along. If the down happens right before Junior’s freshman year at Harvard, you have a problem because now you have to start spending from that account. Alternatively, what happens if at the absolute wrong time, a tornado comes through and swoops your house away and you didn’t have the right insurance to cover it. That’s also not a good time, so it doesn’t work well in isolation.

Jeff DeMaso: Absolutely. That’s the behavioral component to that, as well. Those are specific times and events, but behaviorally, if you are just focusing on investing, all you did was think about your return. Then you are probably defining success as beating the market, beating the S&P. Is that really why you are investing? Does that define meeting your goals and hitting those marks? It probably doesn’t. Then what do you do in a bear market when your portfolio is down? Are you okay? Are you not? You can’t answer any of those questions. Behaviorally it’s very tough. All you’re thinking about is to maximize that return.

Victor Colella: So it doesn’t work well in isolation. Andrew, let’s look at the other side of the coin. Could you give us a little bit more specifics about what we mean when we say financial planning. Let’s take an example in isolation like Jeff did with investments.

Andrew Busa: Sure. Financial planning, as we define it, is a lifelong process that you go through as you’re managing your entire financial picture to ultimately achieve your goals, your dreams—however you define them. I think the heart of financial planning really is goal planning. There are a lot of sub topics within the financial planning umbrella, including tax management strategies, estate management and risk management. We could go on, but really at the center of this is defining what success means to you.

Jeff, you talked about how investment strategy can’t work in isolation. Financial planning is the same way. If you are someone who, let’s say you are saving a lot every month: You’re minimizing your taxes. You have a solid estate plan. You’ve insured every major risk in your life. Because you didn’t have the correct investment plan for you—let’s say you didn’t have all of your money invested as it should have been, you weren’t diversified. Jeff, you’re the expert here but perhaps you weren’t able to retire when you wanted to because you weren’t letting the market work for you.

Victor Colella: If you’re not taking advantage of that compound interest, sometimes you just don’t have enough “oomph.” Then what?

Andrew Busa: Right. It’s that idea of you’re building this car, but if you don’t have the engine inside of it (with the engine being investments), the car’s not going to take you anywhere.

Jeff DeMaso: That’s great. I really like that one and I’m going to try and put some numbers behind it a little bit of an extreme example. Also, for people who are more visually oriented, here’s an image that you can take a look at. Let’s take two twins. Take them back 42 years, and they are age 25 in 1977. They both decide to make a pact. They’re going to say, “We’re going to save $100 every month for the rest of our lives.” One of them is a little more nervous and decides to put all of his savings in a money market fund. The other twin decides that he’s going to put it in the stock market, in the Vanguard 500 Index fund. Our nervous investor, all in cash but consistently saving, at the end of the day after 42 years, he has just over $115,000. That’s pretty good. He’s done all right.

Victor Colella: It’s better than nothing. That’s for sure.

Jeff DeMaso: Compare that to the twin who is investing. He has just under $790,000: $115,000 versus $790,000. That’s almost seven times! That’s that power of having the car with the engine driving you towards your destination.

Victor Colella: Another twist to your example here, Jeff… There was a third sibling, a triplet. That triplet was disowned by the other two because they called themselves twins apparently but that triplet was at the casino when that pact was made and likes to spend money so he didn’t make this pact to save $100.

I probably don’t have to tell everyone that compound interest on zero doesn’t really work. You need to be saving. That’s the engine without the car, so to speak. If he had the money saved he would invest it, but he didn’t have his financial planning house in order, so he wasn’t really doing the saving. We were talking about financial planning and investments as two separate things. They really aren’t, which is hopefully the point that we’re getting across here. Let’s get a little more specific on the goals piece. Let’s talk about the destination for each goal. Let’s talk about a couple of investment considerations and financial considerations that would really make this goal most likely to be achieved.

Victor Colella: Let’s start with, and we’ve touched on this before, college funding. This is one we see all the time. Jeff, what are a couple investment considerations we should think about with this type of goal?

Jeff DeMaso: I’d say the first one they were probably thinking about is just the time frame. Are we saving for a toddler who has years ahead before college comes around? Are we talking about saving for a high school senior and college is right around the corner? That’s going to dictate how much risk we’re taking in the portfolio. Other considerations are if you are investing through a 529 plan, which I am sure you guys will talk about on the financial planning consideration side. But the investment side of that, you might have a limited suite of mutual funds to choose from, and so part of it comes under the selection of what are we buying.

Victor Colella: Andrew, what are some planning considerations with a college goal?

Andrew Busa: Well, I think back to some client conversations that we’ve recently had about this. They recently had a baby and they were wondering, “What sort of account should I be contributing to start saving for college?” They were ready to start doing this. They had extra cashflow at the end of every month that we determined. We took a look at it, and Jeff you mentioned 529 accounts, we took a look at those. Of course, those tend to be more tax-advantaged and specifically designed for saving and paying for college. Then you have UTMA accounts, which stands for Uniform Transfers to Minors Act. These are accounts where a parent can give assets to their child while maintaining control over those assets until the child reaches the age of maturity. These are accounts, and they come with their own set of advantages. You have a little bit more flexibility with a UTMA than with a 529. You have more investment selection.

Andrew Busa: It doesn’t come with the same tax advantages that a 529 does. You have to weigh the cost benefit there, but for this particular client situation we determined that 529 is the way to go. There are other considerations, too. There’s financial aid research that we’ve done for clients to figure out what sort of eligibility a student is potentially eligible for. This was a client whose student was closer to going to college. The horizon was a bit shorter. Those are some of the considerations that come into the financial planning piece.

Victor Colella: Part of the financial planning piece could be how much should I be saving? How much can I afford to save? Also, what are the tax implications of those accounts? What are the estate planning implications of those accounts? Can I access this money if something else happens and I need the money? Or is it exclusively for the kids. So there are a lot of things to think about there.

Jeff DeMaso: Then it informs the investment decisions you might make. If you earn a position where you can save a lot for that college fund, maybe you don’t need to take on quite as much risk. If you have other money outside the 529 plan that can go towards college that can influence the investment side. Again, it’s kind of circular: They inform each other.

Victor Colella: Our next goal that we’ll talk about is retirement. We talk about retirement all day long just because so many of our clients are thinking about retirement, on the verge of retirement or are already retired. Let’s do the same thing here. Jeff, what investment considerations, in particular, apply to the retirement goal?

Jeff DeMaso: Number one, it starts with risk and you notice that’s also where I started talking about the college plan. That’s not what we talked about with what’s portrayed in the media. We think risk is a big component for how people invest, and what types of portfolios you’re going to own and try to hold through time. With risk, there are two components. One is how much risk can you tolerate? That’s really a behavioral question. That’s kind of the sleep at night question. Everybody’s different on that. Some people are risk-takers. Others just aren’t by nature. Then, the other component, and it gets into the financial planning side, is your capacity for risk. Do you have an emergency fund set aside? Do you have insurance policies in place? Is your job stable? Now I’m probably stealing some of your thunder, but that just shows how intertwined these two components are.

Jeff DeMaso: From there, once you know your risk levels, we can think about what types of funds will help you get there. Get to that point. Build that portfolio with all the security selection. Those are the types of decisions we’re making.

Victor Colella: One note on the risk tolerance is that it changes across your life. I’ve seen this happen a lot of times where clients who are very comfortable with risk while they’re working. Their portfolios are very much equity: Stock balanced over bonds and other asset class. As soon as their paychecks stop and the market goes down for the first time, it feels really uncomfortable. That’s something that we have to keep an eye on. Am I as comfortable with risk as I was 10 years ago? That would be a good question to ask yourself. Let’s shift gears. Andrew, from a planning standpoint, there’s a lot of meat on this bone of retirement planning, but what are a few of the things that you like to have our clients think about?

Andrew Busa: Victor, you just touched on one really good one and that’s if someone’s right around the corner from retirement and they’re no longer going to be getting a paycheck every other week, they now have to live off of their portfolio. We’re going to help them visualize their retirement over the rest of their life expectancy to see do they have enough to make it based on their retirement lifestyle that they want to have. A lot of it is cash-flow planning. I think that’s a common topic we talk about with folks. Another topic that comes into play is making sure that people’s estate plan is solid. Looking at people’s risk management—this comes into play with insurance. Making sure that they are avoiding the big mistakes… I know, Victor, you like to talk about that as well.

Victor Colella: Sure. This really does apply to risk management because your financial plan is really only as good as the weakest link. How does your plan hold up if you get sick? If you’re disabled and can’t work? If you get sued? You get in a car accident? You hit a school bus, and you get sued for all of your net worth? The more that you have as you get closer to retirement, frankly, the more you have to protect; so making sure the risk side of the equation is covered is such a big part. Part of that is taxes as well. There really are a lot of aspects here.

Andrew Busa: They really do go hand in hand—financial planning and investing, especially in the retirement planning goal. I know we’ve run plans for clients where they are invested maybe too conservatively. We can show them, if you invest a little bit more aggressively you can improve the odds of your plan based on how much you want to spend and how long you’re likely going to live for. That’s the kind of visualization we can give to folks.

Victor Colella: I think it’s worth talking about now. We’ve talked about how they are so closely intertwined, but you talk about this a lot, Jeff. When does the combination of a good investment plan and a financial plan really shine?

Jeff DeMaso: The time they shine is at those difficult moments. Whether that’s a bear market or—heaven forbid—one of those emergencies: You have a tree fall on your house. It’s these difficult times where the combination of the two really comes through.

Victor Colella: When talking about risk specifically, which we’ve talked about it a lot here, there are two reasons that folks sell all of their assets at the bottom of a bad market, which is about the worst time you can sell them. That’s one: Because they are scared. They are nervous and the emotional side that Jeff talked about. The other reason is because you have to. This same tree has fallen on a lot of houses today, but that’s a good example of you have to put your roof back together at the absolute worst moment. Guess what? That means you’re going to have to sell some of your assets at the worst possible time. So those moments where we’re tested is where the two really work together well.

Andrew Busa: And we run a lot of financial plans when the market isn’t cooperating, when there’s a lot of volatility on the downside. If it’s down 10 or 15% folks are getting uncomfortable. Victor, you mentioned that. So that’s a common time for us to hop on the phone with a client, run their financial plan and say, “You’re still on track to meet your goals. Don’t worry about what the market’s doing.”

Victor Colella: It’s a good way to refocus.

Jeff DeMaso: Yeah. It ties into something we haven’t talked about: Communication. The financial plan is a really good communication tool for a client on how they’re progressing along their path. On the investment side, we try and communicate as well, and that’s part of that behavioral side of “bear markets happen.” We built the portfolio that knows that and is built to inevitably take care of it, also knowing that those are temporary and that the markets tend to go up over time.

Victor Colella: I love this quote: “The worst time to do a lifeboat drill is as the ship is sinking.” From the financial planning side, we’re saying this is what your portfolio would look like if it went down by 20%. You’re still okay to meet your goals. Doing that before those tough times is really critical.

Victor Colella: All right, guys, thank you very much for your input here. We’ve communicated that financial planning and investing are two sides of the same coin. If you have any questions about either, we’re happy to help. I hope you got something from our podcast. This has been Victor Colella, Jeff DeMaso and Andrew Busa from Adviser Investments and we thank you for listening to another Adviser You Can Talk To Podcast. If you’ve enjoyed this conversation, please subscribe. Review our show. You can also check us out at www.adviserinvestments.com/podcast. We love getting your feedback, and it truly is always welcomed. It helps inform our future episodes. If you have any questions or topics you’d like for us to explore, please e-mail us at info@adviserinvestments.com. Thanks for listening.