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Advisor’s Corner
Do you remember the Cheshire Cat’s dilemma with Alice, the main character in Lewis Carroll’s “Alice in Wonderland”? When Alice asked the cat about which road she should take, the cat replied, “Where do you want to go?” Alice answered, “I don’t know.”
“Then,” said the cat, “it really doesn’t matter, does it?”
What Alice may have really wanted from the cat was some kind of backstop insight, such as, “You really don’t want to end up there,” or, “Here’s something you might want to think about,” to help her avoid a poor decision or an undesirable outcome.
Investors look to financial planners for this kind of thought partnership to make wise investment decisions. Here are 10 investing strategies advisors love to discuss with investors:
Can you imagine if many Americans simply decided to wing it with their travel plans during the holiday season? Late connection flights, overbooked hotels and missed dinner plans with relatives (who insist the Pac-12 Conference this year has a better brand of college football than the Southeastern Conference) wouldn’t really be missed at all, right?
It’s a stretch to think this way because many Americans are quite deliberate with their holiday travel plans. In fact, the U.S. Department of Transportation estimates Americans make around 15 billion trips by land, air and rail, ranging from 50 to 500 miles, during the holiday season. Many travelers hit the road with predetermined destinations and schedules, and frustrations emerge when their plans take a detour.
Perhaps that’s why 60,732 airline passengers filed complaints with the U.S. DOT, travel agents and third-party booking sites like Expedia in 2022.
When it comes to investment strategies, though, many Americans appear to prefer the cruise-control option. In fact, nearly half of investors do not have a comprehensive financial plan for their investment strategies, according to a 2022 Philadelphia Business Journal survey. Nearly 3 in 10 say they do not see a need for a financial plan. Still, 32% say they do have a financial plan that is working well at this time.
What financial priorities do you want your investment strategies to support? When will you need to tap into your investments for income? How will other income sources, like Social Security, complement what you’d like to accomplish with your investments over time? These are the types of questions that are addressed in a comprehensive financial plan.
Do financial planners deliver value for their clients? Current research from Vanguard suggests that financial planners can add up to 3% or more in value to investors over time. (If you would like to explore what it may look like to work with a financial planner in your area, check out the “Let’s Make a Plan” resources provided by the CFP Board.)
More than 90% of financial planners currently use or recommend exchange-traded funds, or ETFs, for the benefit of their clients, according to a survey conducted by the Journal of Financial Planning and the Financial Planning Association earlier this year.
ETFs are quite popular among American investors, too. An estimated 16.1 million Americans, or about 12% of U.S. households, held $6.5 trillion in ETFs at the end of 2022, according to data from the Investment Company Institute. That’s a staggering 9,748% increase, up from $66 billion, in total ETF ownership since 2000.
ETFs typically hold a diversified pool of investments and can be purchased and sold like individual stocks during open market periods. Because ETFs trade like stocks, there are generally no requirements for investment minimums; investors can typically purchase at least one share at the market price during the day.
The Journal of Financial Planning’s survey also revealed that nearly 3 in 10 financial planners currently include alternative investments in their clients’ portfolios, or are actively considering alternative investments for the benefit of their clients in the future. Some examples of alternative investments include real estate, commodities, private equity and infrastructure. Alternatives are typically used by investors and financial planners to expand diversification beyond stocks, bonds and cash and to potentially improve portfolio returns over time.
Vanguard’s 2021 white paper on global investments suggests investors can potentially lower their overall volatility and possibly improve their long-term returns by including non-U.S. stocks in their portfolios.
Over the next decade, Vanguard anticipates that non-U.S. stocks in developed markets will yield returns in the range of 7% to 9% versus a range of 4.2% to 6.2% for U.S. equities.
Double-digit drawdowns in the stock and bond markets can impact an investor’s overall portfolio weightings across multiple asset classes. To stay on track with your desired allocation to, say, 40% in bonds and 60% in stocks, it’s a good idea to rebalance your investment portfolio at least once a year.
Russell Investments’ 2023 “Value of An Advisor” study suggests there may be additional benefits associated with a portfolio rebalance. From the beginning of 2003 to the end of 2022, financial planners reduced their clients’ portfolio volatility by 2% and enhanced their risk-adjusted returns by 0.27% simply by actively rebalancing clients’ investments over time.
In the same study, Russell Investments estimated that advisors can improve clients’ returns by as much as 1.17% through the use of tax-efficient investment strategies.
Beyond portfolio diversification, how you have your investments allocated across different types of investment accounts can also potentially improve your outcomes over time. This approach is often referred to as a tax-smart strategy, and includes investments such as municipal bonds and ETFs in taxable accounts and more active investment strategies, like multi-asset income funds, in tax-deferred accounts such as IRAs.
Tax-loss harvesting is commonly known as the “lemonade approach.” In a year like 2022, when the stock and bond markets dipped into double-digit territory for an extended period, this strategy helped some investors make proverbial lemonade out of their sour circumstances. Here’s how the strategy works:
An investor sells an underperforming investment, like an ETF or an individual stock, in a taxable investment account. Any realized loss can be used to reduce realized capital gains and potentially offset up to $3,000 in ordinary income. The deadline for realized, reportable gains and losses is Dec. 31 of each year.
Next, an investor can reinvest the proceeds into a different investment that is better aligned with his or her financial objectives. The key guardrail investors must keep in mind for this strategy is the “wash-sale rule.” To avoid running afoul of the wash-sale rule, an investor must not sell a security at a loss and buy the same or substantially similar security within 30 calendar days before or after the sale.
It’s hard to fully quantify how many investors take advantage of this lemonade approach in any given year, but there are ongoing reports that attempt to measure its impact on investors’ financial plans over time. For example, Vanguard’s “Tax-Loss Harvesting: A Portfolio and Wealth Planning Perspective” white paper reveals that from 2000 through 2019, tax-loss harvesting helped many investors earn an average annual benefit of 0.95%, an equivalent of almost an extra 1% in portfolio return.
A different study by the Massachusetts Institute of Technology covering 92 years, from 1926 to 2018, found that tax-loss harvesting gives some investors an average benefit of 1.1%.
The International Federation of Accountants estimates that the “lack of financial literacy cost Americans a total of more than $436 billion in 2022.” It leads to such outcomes as higher debt and bankruptcy rates and lower savings and investments.
One way to help children develop good money habits, like investing regularly to reach a financial goal, is to talk with them about your own experiences with money. How did you start your retirement account? When did you buy your first stock? Why does it make sense to invest money in a Roth IRA?
Children can also improve their financial literacy by listening to other children talk about money topics. Check out a podcast called “What Is the Stock Market?” hosted by the Ca$h Kid.
When you think of Sir Isaac Newton, the words “brilliant” or “genius” likely come to mind. Newton’s theories on the laws of gravity and motion helped explain planetary movements around the sun, and he’s even credited with inventing the reflecting telescope.
But when it came to managing his personal investments, some of Newton’s decisions were less than stellar, according to a popular anecdote. Swept away by the widespread enthusiasm for the South Sea Company, which had commercial ties to South America, Newton invested nearly 40% of his wealth in the company’s shares. When things went – well, south – and Newton sold his shares in 1720, his losses totaled more than $3.6 million (in today’s dollars). Looking back on this experience, Newton apparently quipped: “I can calculate the motions of the planets, but I cannot calculate the madness of men.”
If this story sounds familiar, then you are on to something. The story of Newton’s investment behavior 300 years ago is one that many investors can relate to today. Newton impulsively joined the masses in both buying and selling shares of the South Sea Company, despite the adverse outcomes. This kind of investment behavior is what behavioral psychologists call “herding.”
Herding is one of the key contributors to a common malady called the investment gap – that is, getting shortchanged on overall returns over time. The investment gap is a shared experience among many workplace retirement-plan participants and other personal investors today. For example, from 1993 to 2022, the average annual return for the S&P 500 was 9.6%; yet, during the same period, BlackRock estimates that investors who decided to buy into the stock market only when others bought shares were shortchanged with an average return of only 5.5%.
Consider annuities for income protection. Research from the Life Insurance Marketing and Research Association, or LIMRA, revealed that 70% of workers believe the in-plan guarantee (or an income annuity of some kind) should be an option in their workplace retirement plans, like 401(k) and 403(b) retirement plans. Longevity is a key planning priority. In fact, the Social Security Administration estimates men and women will live another nearly 17 and 20 years, respectively, after they reach age 65. Low-cost annuities (yes, they do exist) can be an effective strategy to mitigate longevity risk for some retirement investors.
Takeaway
While these 10 investment strategies are not exhaustive, they are intended to establish a framework for deeper levels of customization for your own investment considerations and financial goals. They also reinforce how many aspects of the portfolio outcomes you want to achieve are within your control.
U.S. News makes no representations or warranties in connection with the information provided herein, nor to the accuracy or applicability thereof. U.S. News does not give, offer, or render tax, credit, or legal advice. Before making financial or investment decisions, U.S. News recommends that you contact an investment advisor, or tax or legal professional.
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