Make fun of this guy and his fellow investment advisors all you want, but what they lack in sexy they more than make up for in forbearance.
I need an investment policy? (yawn) Spare me, please. I just want to be rich.
An investment policy sounds like something that’s calibrated during long, torturous hours in someone’s corner office. Where you’re sitting across from a prim and effete financial advisor, fresh out of business school, all proud of his MBA and his new job and those reams of theoretical knowledge practically spilling out of his overcoiffed head. Do you seriously need that?
Almost certainly not. If you do, most likely you’re already rich and have better things to do than read a blog. In that case, you need an accountant, maybe a tax lawyer. A portfolio manager? Go away now.
Here’s a quiet truth about personal finance and many of the industries that have arisen surrounding it: there’s not a tremendous difference between the professionals and you. As a discipline, personal finance is similar to sociology and women’s studies in that there’s almost no hands-on knowledge involved. Unlike petroleum engineering, where you have to get oil on your fingers and have some physical representation of your data. Or medicine, where you have to treat real patients with ailments and sometimes risk their lives. What separates a professional financial advisor from an amateur is little more than a few officially administered multiple-choice tests.
Learning the details of personal finance can be intensive and demanding, but the basics are available to anyone with opposable thumbs.
For starters, you don’t merely throw money into the stock market and hope for the best. You don’t even read financial statements, invest in the stock market and hope for the best. You’ve got to look at when you’re going to die, and what you’re going to do before then.
If that sounds morbid, that’s what a formal investment policy is, for the most part. The way the professionals formulate and administer an investment policy, a client is supposed to sit down and list rules that the person in charge of her money then adheres to. But it can’t just be “I want to maximize my return and minimize my risk”, which describes every investor in the history of the universe. You need to be more specific, with regard to:
1. How old you are. Obviously, the more life you have ahead of you, the less conservative you can afford to be and the less calamitous it is if you lose everything.
2. How liquid you need to be. Having cash on hand and being wealthy aren’t always the same thing. Your average meth dealer has plenty of money in his wallet, and probably sleeps in a room that you wouldn’t feel comfortable entering without wearing a surgical mask.
In a famous story from the 1980s, baseball pitcher Rick Sutcliffe loaned $500,000 to Bruce Springsteen so he could close on a house. The Boss was at his apex of popularity at the time. He obviously wasn’t poor, but his money was tied up in investments that he couldn’t immediately get out of and convert to cash without paying a big penalty. Even if you have a billion dollars socked away in inflation-protected securities, you still need a few readily available bucks for day-to-day living.
In the end a formal investment policy will begin with something like this, only written in legalese and incorporating a service fee that’ll eat up part of your principal:
- I’m a 25-year old woman. I have no kids, and thus smaller expenses than a mother would. Also, I live with my boyfriend, so my expenses are even less than they’d be if I was living alone. We rent a townhome, while we’re waiting to build up equity to buy a house.
- I make $40,000 in annual salary. After taxes and expenses, I can save around $10,000 a year.
- My 401(k) is worth $2,500, but I don’t even know what it’s invested in and wouldn’t mind finding something a little more aggressive.
- I live in Chicago, which means I’m paying a relatively high cost of living. We want to get married and move to Nebraska, where the people are friendlier and everything’s cheaper.
- My job is unfulfilling but secure. It’s so secure that I know what I’ll be making for the next 5 years if I stay in it. I’m willing to invest in volatile stocks rather than super-safe T-bills if it means having a chance to reach my goals more quickly.
- Oh yeah, my goals. I want my investments to clear $75,000 a year when I turn 65, tax-free, and continue to until I die.
- I don’t have any dependents and won’t, so I don’t care about leaving a will.
You almost want to do this backwards, starting with the answer, and then work your way back to the questions. “I want a principal of $x, and an annual cash flow of $y. How much do I have to save, how hard to I have to work, what kind of return on my investments do I need to make this happen?”
You should be able to do this yourself – ask the right questions, and give yourself honest answers. And don’t limit yourself. Start big. Don’t designate the summer villa in Provençe as either achievable or unachievable – it’s simply a goal that you can devise a plan to reach, or not. The same goes for the 4 kids you want to have or the kitchen you want to renovate.
Let’s take the kitchen renovation. You shop around and figure that putting in new appliances, wall tiles, wooden floors with a decorative inlay and an island will cost you $10,000.
Sure, you could take it out of your available cash and pay for it today. But if you’re the woman from our example, you just wiped out your entire savings and had better hope that no unforeseen expense finds you.
If you’re willing to wait 9 months, you can invest $5,000 of that $10,000 in what you believe to be an undervalued stock. You can continue saving your salary at your current rate, which would net you another $7500. The stock might gain 20%, which means that the redone kitchen would make a far smaller dent in your nest egg then than it would now.
Some people choose to place such expenses on their credit cards and pay 19% interest on them until the end of time. Others like to do some calculations first. You can probably figure out which is the better idea.
**This article is featured in the Yakezie Carnival September 25, 2011**
