Thank you again to our guest (not-so-)ghost writer Jason Abrams for his assistance on this article. Jason also maintains a personal blog where he writes about other topics in finance, which you can find here. (NB: linking to Jason's site does not imply we agree with or endorse the contents of his blog.)
Our approach to financial planning is about more than maximizing our clients' portfolios. We generally spend as much or more time with clients on financial planning. When done well, successful financial planning reduces stress and promotes feeling secure in your future.
In our practice, we've frequently found that new and prospective clients have many of the same questions.
Where do I start?
We encourage our clients to develop a plan to pay down existing debt. Most of the time when we meet a prospective client who has significant debts, particularly consumer debts like credit cards and auto loans, we recommend paying down these debts first.
Typically, making a budget and carefully tracking expenses are great ways to begin developing a debt payment strategy. Trimming expenses and using excess funds to pay down debt can be very beneficial to financial well-being. We recommend starting with some of the following resources:
Budgeting, particularly using the envelope method: YouNeedABudget, GoodBudget, and maybe Mint or many others.
Paying down debt (note: not his investing advice!): Ramsey Solutions.
But I have investments earning interest! I’d rather let them compound than pay down my debt.
This is a common feeling, but the rate of return on your investments will likely not keep pace with the interest rate on your debt. Credit card debt has especially onerous interest rates, often greater than 20%. For most debts, we find that our clients can get a better return by paying down their debt rather than deferring their payments and investing. Paying off debt (and saving up to 20% per year in interest expense) makes more sense than an investment that returns 5-10% per year.
When making the decision to invest or pay down debt, don't be tempted by the prospect of outsized returns. It is extremely rare to have a fund that can consistently return even 10% per year, and the few that do have such returns tend to take a lot of risk and get lucky. We advise clients to compare a guaranteed savings (equal to the real interest rate) from paying off debt to an uncertain return from making an investment.
Additionally, paying down credit card debt decreases your credit card utilization ratio, a measure of your total amount of credit that you’ve used relative to your total credit limits (the maximum amount of credit available to you). The credit utilization ratio is an important factor in your overall credit score, and a good credit score can grant access to lower interest rates on future loans. For these reasons, we strongly recommend that our clients pay down most debts as quickly as they can, providing they retain enough funds for everyday needs.
How large should my “rainy day” fund be?
We suggest holding enough cash for at least 6 months of expenses. 3 months of living expenses is the bare minimum. This fund helps to protect you in case of a layoff, unexpected medical leave, or other circumstances beyond your control.
I’m debt-free, I pay my credit card balance in full each month, and I’ve got my “rainy day” fund. What should I do with any surplus money each month?
We recommend that our clients start by taking full advantage of their workplace retirement plans (such as a 401(k) or 403(b) plan), especially if their employer offers a matching contribution. Since this money will compound tax-free for many years, this is a great opportunity to build long-term wealth.
We also recommend setting aside some money each month for any large purchases coming up in the future including a new car, house or major home repair, or college tuition payments.
My employer offers stock as part of my compensation. What should I do with it?
It can be tempting to want to hold on to your company’s stock. You may have very specific knowledge about their company’s operations and may think that your company is well-positioned to outperform the market. As financial advisors, we frequently refer to this as familiarity bias.
While an investor may feel more comfortable making investments in their employer than in other companies that they don't know as well, it's not usually a good idea to have any significant portion of savings invested this way. We frequently advise clients that their employment prospects tend to be correlated with their company's stock price: when the stock price goes down, their risk of being laid off goes up. One of the worst scenarios that we want our clients to avoid is to be forced into early retirement just as a tanking stock price eats into their retirement nest egg.
However, this is probably the most complicated of all the questions listed here. A qualified financial advisor can help you navigate these complications, including potential taxes that you may owe on stock-based compensation plans.
I’ve heard about an interesting investment opportunity that I think is too good to miss.
Often investments that sound very appealing are indeed too good to be true. When a client comes to us with an investment idea or a "hot stock" we frequently find that it's not necessarily fraudulent or even a poorly run company, but it's frequently a case of the client falling into a common trap: performance chasing. Investors tend to hear about hot stocks after a period of outsized gains, but these stocks may be overvalued as a result. Remember, past performance is not a guide to the future performance of any investment, investment manager, or investing strategy!
However, if a client has met the primary goals of paying down debt, maximizing retirement savings, and having plenty of money set aside for emergencies, then investing a small amount may be appropriate. As advisors, we can help our clients assess their ability to take risk and ensure that their portfolios remain adequately diversified even with one or two favorite investments.
Disclaimer
This post is for informational purposes only and is not intended to provide investment advice. Nothing herein should be construed as a solicitation, recommendation or an offer to buy, sell or hold any securities, market sectors, other investments or to adopt any investment strategy or strategies. This report may include estimates, projections or other forward-looking statements, however, due to numerous factors, actual events may differ substantially from those presented. This material is not intended to be relied upon as a forecast or research. There is no guarantee that any forecasts made will come to pass. As a practical matter, no entity is able to accurately and consistently predict future market activities. The opinions expressed are those of CJW Capital LLC ("CJW Capital") as of the date of publication and are subject to change at any time due to changes in market or economic conditions.
While efforts are made to ensure information contained herein is accurate, CJW Capital cannot guarantee the accuracy of all such information presented. As a result, CJW Capital bears no responsibility whatsoever for any errors or omissions. Additionally, please be aware that past performance is not a guide to the future performance of any manager or strategy, and that the performance results and historical information provided displayed herein may have been adversely or favorably impacted by events and economic conditions that will not prevail in the future. Therefore, it should not be inferred that these results are indicative of the future performance of any strategy, index, fund, manager or group of managers.
The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by CJW Capital to be reliable and are not necessarily all inclusive. Reliance upon information in this material is at the sole discretion of the reader. Material contained in this publication should not be construed as legal, accounting, or tax advice.