First Things First | Duncan Financial Planning, LLC

First, an admission; before I went to school and started learning about my current profession, I made the mistake that I?m going to be writing about today. When you know better; you do better, as Oprah likes to say. So what?s the mistake you ask? It?s haphazardly selecting mutual funds or other investments in your retirement plans. I?m going to talk a little bit about why our normal investment selection process is not the best way to do it. Then we are going to look at a better process and why you should adapt this.

You are being responsible and investing in your retirement plan at work, and managing it the best you can. What are your criteria or the procedure you use to select the funds in which you?ll invest? The Vanguard group did a study and found that most people don?t truly understand the difference between the various funds, and tend to be guided by a recent past performance of the funds. In other words, people look at the list of funds and pick funds that have had the highest returns for the last quarter or year. [FYI: this doesn?t work very well!] As I mentioned before; been there, done that. This method is known as bottom-up portfolio construction.

At a bare minimum, you should learn about the different types of investments. You need to know the difference between stable value funds, bond funds (fixed income), stock funds (equities) and target date funds. Drilling down just a little bit further, you should understand the sub asset classes, especially as these are applicable and available for choosing in your retirement plans. There are many wonderful books written for the layperson that describes these differences and the basics for constructing a portfolio.

If you did nothing other than following the advice in the paragraph above, you would be way ahead of the majority of the crowd. However, there is a method for constructing a portfolio that will serve you much better in the long run. That would be by using the top-down portfolio construction method. If you are well disciplined and have the proper motivation, you may be able to learn the basics of this and do it for yourself. However, it would probably be helpful for most people to work with a fee-only financial planner that works as a fiduciary (fancy word for ?in your best interests?) for you.

Following is a basic overview of the top-down method of portfolio construction:

• First, you must have a well-defined goal. What are you trying to accomplish, how much will it cost and what is the timeline? Be sure to use financial calculators that will enable you to project the costs into the future.
• Second, how much money can you realistically save towards this goal and how sensitive are you to the fluctuations in the value of your portfolio? The sensitivity to the fluctuations of value can be described as your risk tolerance.
• Third, it is only after you work through these first two steps that you want to move on and develop the asset allocation for your portfolio. The asset allocation is the proportion of stock funds, bond funds and stable value funds (there may be alternative investment classes too) that you use to construct your overall portfolio. You want to build a diversified portfolio that will give you the best chance of meeting your goal while considering your savings rate and your risk tolerance.
• Fourth, within your asset allocation, you will have the sub asset classes. For example, in stocks, you will have domestic stock funds that can be further broken down into large-cap, mid-cap and small-cap stocks. You also have value, blend and growth stock funds. The various asset classes and sub asset classes have varying degrees of correlation to one another and certain combinations tend to help the long-term diversification of your overall portfolio. If you?re dealing with an employer-offered retirement plan, you will likely be limited to a smaller selection of funds.
• Finally, it is only at this point that you should choose the individual funds.

None of the above information is rocket science. If you have the time and inclination to educate yourself in this area, you may be able to go it on your own and produce excellent results. From my personal experience, knowing my friends and family members the way I do; most people don?t have the time and inclination. Sometimes they may have one but not the other. Developing a relationship with a financial planner is an option that should be considered by many.

If most of your retirement savings is invested in 401(k) or other employer-sponsored retirement plan you may not be able to obtain advice through many of the traditional financial planning service models. There are many excellent fee-only financial planners that are able to work with you on an hourly or project fee basis. Two national groups that are widely respected in the financial media may be able to help you. The first one is the Garrett Planning Network it has a national website through which you can find a planner that does hourly or project basis work in your area. That website is: www.GarrettPlanningnetwork.com. Some members of the National Association of Personal Financial Advisors (NAPFA) also work on an hourly or project basis, go to www.NAPFA.org to find an advisor in your area. Regardless of whom you choose to work with, be sure that they are working as a fiduciary for you.

If you are in the Las Vegas area and need help with your retirement planning process, I will be happy to speak with you about working together. Visit www.DuncanFinancialPlanning.com or call 702-835-6835 for more information.

The information in this post is meant to be educational and informative. It is not intended to be used as investment advice for your specific situation.

Source: http://duncanfinancialplanning.com/articles/first-things-first/

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