Diversification – the Retiree

In my last two posts I looked at the personal cases of the Young Professional , the Rising Executive, the Manager and the Senior Executive and how they can diversify their resources across different resource. In this post, I will consider the case of the Retiree.

Retiree
Characteristics
Age: 60 plus Income: GHc 15,000 (Ghana) $100,000 (US)
Net Worth: GHc 225,000 (Ghana) $1.5million (US)
Risk tolerance:
Low Goals: Preserving capital

Assert Allocation
Cash and cash equivalents………….…………………..…..10% to 20%
Fixed-income vehicles……………………………………….40% to 50% Equities………………………………………………………..25% to 35%
Hard assets…………………………………………………... 5% to 15%

Financial Profile
Since you no longer take home a salary or pay cheque or expect to in the future – your tolerance for risk is low. For the same reason, your need for current income from your investments have increased.
And your planning time is shorter, so you can afford to reduce your inflation hedges. Also, you might find yourself needing some ready cash – for unexpected illnesses as an example.

Investment Strategies
You’re satisfied with a modest return on your cash, since you want to reduce the volatility of your portfolio and maintain readily accessible cash reserves.
You expect a lower return on you fixed-income investments than you’d get on shares or common stocks. But their lower volatility and higher current income make the trade-off worthwhile.

You still want to keep a significant portion of your portfolio in equities. You like the growth potential.
You also want to stay diversified in the event of a drop in the value of your fixed-income vehicles.

Since you’re more concerned about predictable income and your need for inflation hedges is low, you have few funds committed to hard assets.
Besides, most hard assets have low – or – no current income and liquidity, making them particularly unattractive for a retirement portfolio.

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How to diversify your resources among various resources – Part 1

So far we have considered what asset allocation is and why it is important to diversify your assets. In this post I will break down asset allocation into two parts. First, we will address the general principles of asset allocation (just a quick review). Then I will show you how you can apply these principles to your specific situation.

In thinking about asset allocation in general, two questions pop up. First, among what kinds of investments should I be allocating my resources?Well, if you read the ads you would think there were hundreds of kinds of investment vehicles – all of them tailored ‘just for you’.

The fact is, you can easily boil down all investment into only six categories:

• Cash and cash equivalent, such as money-market funds, treasury bills, current and savings account and short term certificates of deposit.
• Fixed-income vehicles, a grouped that includes tax-exempt bonds, corporate bonds, mortgages, and long-term certificates of deposit
  
• Equities, including both domestic and international stocks
  
• Real estate• Natural resources, including oil and gas
• Tangibles, such as gold and silver

Obviously there is a wide variation within these categories. Utility stocks / debentures, for instance, may behave at times like fixed income vehicles, because they yield such a steady rate of return. And some short-term, fixed – income vehicles may behave like cash. You must take these variations into account when you are ready to adopt specific investment strategies.

What to allocate

The second question that pops up: what resources should I be allocating among these six investment categories? There are some assets that you definitely want to exclude from your investment portfolio – your personal assets – and some that you definitely want to include – your investment assets.

The exclusions?

A cash reserve is a sure one. You should set aside some funds for emergencies in a secure, very liquid investment vehicle that does not fluctuate in market value. Examples include saving and current accounts.How much should you set aside? That depends. Many financial advisors suggest two or six months’ living expenses. But that advice does not apply to everyone.

You may, for example, be employed by a small company in a volatile industry. If that’s the case, you are more likely to face an extended period of unemployment than your neighbour who works for an established company in a secure industry. Or access to short –term credit such as credit cards may reduce your need fro cash on hand. However how much you eventually decide belongs in you emergency funds and should be excluded from founds you intend to invest.

What other assets to include?

You may want to consider as investment assets some items that you don’t ordinarily think of in this way. Among them:

• Insurance policy cash values
• IRA OR Keoghs (USA) SSNIT contributions (Ghana)
  
• Company – sponsored 401 K (USA) Provident fund (Ghana) and other savings plans
• Other Company defined – benefit plans

You should include these assets in you diversification plan because they are resource on which you will rely in the future and because they may be affected by market forces between now and the time you are ready to use them.

In my next post I will continue with this article and will show the diversification base case.

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Constructing Your Financial Profile – Your Financial Resources

So far we have discussed Your Stage of Life, Your Life-Style , Your Tolerance for Risk, and Your Responsibilities - four of the five steps in building your financial profile. Your Financial Resources is the fifth and last in this process

Your financial resources come down to three broad categories: your net worth, your cash flow and your other resources such as fringe benefits, Social Security and anticipated inheritances.

Adding your net worth is a vital element in creating a solid financial plan. You must know what all your resources are before you can manager them properly. As the saying goes: ‘Even if you know where you are going, a map is of no use if you don’t know where you are standing’.

Figuring your net worth also serves another purpose. It shows you how you’ve allocated your resources. For example, you may have invested most of your resources in various types of bank accounts or personal property – or may have put the bulk of your assets in the stock market.

Unfortunately, many people who after twenty year of graduating from the university can still remember their student’s ID number don’t have the slightest notion of how much they’re worth.

You’ll find a net worth work sheet here so you can add up your assets and liabilities and calculate your bottom line. You can’t grow financially – no matter how high your income – unless you take in more that you spend.

So you next step in evaluating our current financial situation is to look at your cash flow to get a notion of where your money is going.
This information is vital to your financial plan. The idea is to see what flows in and what flows out over and entire year and determine how much money is available to achieve your financial goals.

Get a handle on your cash outlays by keeping a journal or diary of your expenditures for a week or – better still – for a month. You’ll see how daily expenses, such as taxi fares, and soft drinks drain your pocket.

The final step in determining your financial resources is nailing down all those ‘other resources’. This task may involve the cooperation of others – your company human resource department, for example, may help you get a handle on you retirement benefits.

Many people have no idea of the value of their ‘hidden assets.’ Social Security is only one example. You must know ho much you will receive. Other wise, planning is impossible.

I suggest you also read the preceding articles that set the tone for this article:
Building a Firm Foundation

Constructing Your Financial Profile - Your Stage of Life

Constructing Your Financial Profile – Your Life-Style

Constructing Your Financial Profile – Your Tolerance for Risk

Constructing Your Financial Profile – Your Responsibilities

Email me with any queries or comments.

Constructing Your Financial Profile – Your Responsibilities

So far we have discussed Your Stage of Life, Your Life-Style and Your Tolerance for Risk, the first three of five steps in building your financial profile. Your Responsibilities is the fourth step in this process.

If you’re like most people, you have responsibilities- children, perhaps, who look to you for support, or elderly parents who require financial help.

But everyone defines responsibilities differently. For example, do you consider it your responsibility to supplement your parents’ retirement income? Do you think you owe it to your children to help them buy their first car?

When it comes time to develop your financial profile you must take your responsibilities – as you defined them – into account. They influence how you spend, save and invest.

Here’s an example. Let’s say you are married, the father of two teenagers and in your view, it is your responsibility to foot the entire bill for your children’s education. Lets assume that a friend a friend approaches your to invest in his small business. The contribution required of you is Hc50,000 ($50,000).

You refuse to enter into the business, because you can’t afford to invest in anything that’s less than 100% secure. Why? You want to use the GHc50,000 ($50,000) for your children’s University education. And if you lose any part of that money, you’re in trouble.

To assess how best to meet your responsibilities, you must examine your financial resources – both present and future.
I suggest you also read the preceding articles that set the tone for this article:

Building a Firm Foundation
Constructing Your Financial Profile - Your Stage of Life
Constructing Your Financial Profile – Your Life-Style
Constructing Your Financial Profile – Your Tolerance for Risk

Email me with any queries or comments.

Constructing Your Financial Profile – Your Tolerance for Risk

So far we have discussed Your Stage of Life and Your Life-Style the first two of five steps in building your financial profile. Your Tolerance for Risk is the third step in this process.

You must ask yourself tow questions when it comes to assessing your tolerance for risk: Do you HAVE any money to risk? If you do, what promised rate of return would it take for you to risk it? The first is a question of resources; the second a question of attitude.

To some extent, of course, it really doesn’t matter if you’re the type to stake all on a spin of wheel – or inclined to tuck your money under the mattress. What is vital though is accurately assessing how much you can afford to loose – the resource side of the risk coin.

If you can afford to lose all or part of the amount you invest without undue hardship, the odds that your investment will pay off are vitally important.

If you can’t afford to lose your investment, the odds are irrelevant, because you can’t make the investment no matter how great the potential payoff.

Let’s say you have the opportunity to invest GHc1,000 (or $1,000). And you stand a chance of making GHc10,000 (or $10,000) or losing the entire amount you invested. You go ahead with the deal. You like the possibility of earning a 1000% returns on your investment and you can afford to lose your GHc1,000 (or $1,000) stake.

But suppose the same opportunity required a minimum investment of GHc100,000 (or $100,000).And you could make GHc1million (or $1million) or lose your entire investment. Although the odds are identical (i.e. 1000% interest rate) and you would like the chance to earn GHc1million (or $1million), you let the opportunity pass. Why, the reason is simply: You can’t afford to loss the GHc100, 000 (or $100,000).

Once you analyze your resources and figure out what you can afford to lose, your attitude comes into play. And be advised: if you think you are a risk taker, you could be in for a surprise.

Researchers have found that the risks people take with their money differ from the chances they take in other areas of their lives. There are skydiving enthusiasts, who invest sorely in well established and reliable shares and kindergarten teachers who regularly trade in shares of newly established companies with no magnificent history.

Some risk takers who say they wouldn’t hesitate to put money into a new business that could fail – as long as the possible return was high are the same people who steer clear of investing in ‘safe’ shares – those with steady returns but little potential for appreciation.

Here are a few differences between high-risk takers and the risk averse:

Risk takers are better money managers.

Risk takers spend more time reading about money and investments.

Risk takers have confidence in their money-making schemes.

Risk takers have leadership abilities

Risk takers are good sales people.

Its been proven that when it comes to risk taking, stereotypes don’t hold water. Women, for instance are no more risk averse than men

But people are less likely to take risks with their money as they grow older. The simple reason: Their fear of loss is greater than their hope of gain. In other words, it is not the returns on the money that matters but the return OF the money.

Like Life-style choices, there are no absolute rights and wrongs when it comes to attitudes about risk. The important point to remember: Know your own tolerance and make financial decisions accordingly.

Email me with any queries or comments.

Constructing Your Financial Profile – Your Life-Style

In the previous article we discussed the first of five steps in building your financial profile i.e. Constructing Your Financial Profile - Your Stage of Life. In this article we will consider second step in constructing your financial profile.

One significant aspect your life-style is your career choice. When you select a career, you lock in, to some extent, your earnings potential.
For instance, if you opt for a career as a librarian or teacher, you’re unlikely ever to earn a six-figure income. By contrast, if you work in investment banking or sales, chance are good that you’ll become a high earner.

Or maybe you are one of those people who are willing to make less money in exchange for more leisure time. Their decision also is a life-style choice.
Your spending and saving habits are another aspect of your life-style that will significantly affect your financial planning decisions. Are you, for instance, oriented towards immediate or deferred gratification? Are you more concerned about living for today of planning for the future?

We all differ on how we view finances. And frequently these differences crop up within family. In fact, surveys have consistently shown that money is number one on the list of items married couples ague about.
Usually, our disagreements focus on trade-offs. With a limited amount of resources, do we save or spend- and what do we spend our money on?

Our decisions usually boil down to personal preferences. What’s more important? A nicer car or a better home? A vacation house or an exotic vacation?
These decisions also involve confidence – or lack of confidence – in the future. Can you spend more than you earn today because you know that as some later point you will earn more than you spend?

Life-style decisions by their very nature are personal. They are no absolute rights and wrongs. Whether you choose to spend your money on entertainment or clothes is your business. Again, the important point: You should know yourself and not try to fit into someone else’s mould.

I suggest you also read the preceding articles that set the tone for this article:
Financial Planning - Part 1
Constructing Your Financial Profile - Your Stage of Life

Email me with any queries or comments.

Constructing Your Financial Profile - Your Stage of Life

This article is the continuation of the earlier post 'Financial Planning - Part 1'

When you sit down with a professional financial planner, the first thing he or she does is construct your personal financial profile. You should begin there, too.

A financial profile is a snapshot of your life as you live it day by day. And it is the cornerstone of your personal financial plan.

Your financial profile is more that just your income and net worth - although income and net worth are certainly part of the picture. Rather your profile is a composition of your stage of life, life-style, tolerance for risk, responsibilities, and financial resources. In this article, we’ll start stage of life and how it affects your financial planning.

Your Stage of Life

Evaluating your stage of life is the first step in building your financial profile. What we mean by 'stage of life’ is simply your age and circumstances - general sense of where you are today.

Why is this information so important? Knowing where you stand helps you set your financial priorities.

Say you are thirty years old, single and with bright career prospects. You obliviously have different goals and needs than a retired person of seventy.

Here's one simple way of looking at your stage of life: Are you accumulating assets or disposing of them?

If you are in the accumulation stage, you are building wealth. But if you are in the disposition stage, you are building wealth. But if you are in the disposition stage, you are consuming your assets. Typically, you remain in the accumulation stage until retirement, and then shift to the disposition stage.

Another way of categorizing stage of life is by decade. In our twenties, most of us begin our career and possibly, a family. By our thirties, we may be advancing in our careers and raising your children. In our forties, we’re probably earning – and spending – more money and beginning to pay for college education for our children.

During our fifties, most of us cease contemplating career changes, and our earnings peak. We think seriously about retirement. And, if we have children, they are becoming more self-sufficient.

What about the sixties? This is typically the bridge to retirement. Estate planning becomes more impotent to us, and our grandchildren may be a priority. By our seventies, the majority of us are retired, and one focus of our financial planning may be making gifts to our families.

Naturally, theses patterns don’t apply to everyone. Far from it. You may, for example, be a late boomer – someone who did not start a career until your thirties. Or you may have retired very early – in your middle forties, to say.

More over, the circumstances of people’s lives today are almost infinitely varied.

Here are some typical categories into which you may fall:

• Single
• Married with no children
• Married with children
• Single with children
• Living with a significant other – with or without children
• Divorced with children
• Divorced without children
• Divorced and remarried with stepchildren
• Divorced and remarried without children
• Widowed

As you see, the list can go on and on. And each of these categories requires different approaches to financial planning. What is important: assessing our own stage of life and circumstances and tailoring our financial plan to meet them. The next article looks at the second of the five tools needed to construct your personal profile – Your Life Style

You can also read the preceding article that set the tone for this article 'Financial Planning - Part 1'

Email me with any queries or comments.