After a decent hiatus (but one that brought some other interesting blog posts), we want to return to the DIY financial plan with an installment on investments.

Here’s the catch:  We can’t provide investment advice here on the blog.  But we can provide general education and help you find resources to understand your risk tolerance and investment options.

We covered the goals calculator in the first post, and we also referenced some historical portfolio performance numbers that Vanguard put together.  If you haven’t completed the goals calculator (or maybe you need a refresher), it’s probably a good idea to cross-reference our first post as we talk about investments.

Risk is intimately tied to return, so it’s important to get a grasp on your personal risk tolerance.  We recently came across the University of Missouri’s Department of Personal Financial Planning’s free online risk questionnaire.  In exchange for collecting some anonymous data about your understanding of finances (the overall quiz is really quick and painless), you receive a risk tolerance score based on the work of Dr. Ruth Lytton at Virginia Tech and Dr. John Grable at the University of Georgia. 

You can check out the page here.

Armed with your personal risk assessment, you can then cruise over to Morningstar (an investment research company) to access their Target Risk AllocationsThis should help put your risk label (like whether you’re a moderate or aggressive investor) into the context of actual investments. 

Additionally, we encourage you to research target risk and target date funds to help broaden and deepen your knowledge about the options available to you based on your risk tolerance.

From there, you can look at the Vanguard historical portfolio numbers to gauge whether your return assumption that you’ve used in your goals calculator is reasonable.  For instance:

Let’s assume you learn that you’re a moderate investor from the risk assessment.  From the Morningstar data, you see that a moderate investor hypothetical allocation – and remember, this is just one company’s (Morningstar) opinion – yields a portfolio of about 60% stocks and 40% bonds.  Based on the Vanguard data from 1926 through 2017, a portfolio like this has produced an average annual return of 8.8%.  Again, this is only one data point and the Vanguard data isn’t perfectly aligned with the Morningstar target allocations.  But we’re largely validating assumptions here, so we encourage you to find more information about 60% stock / 40% bond portfolios, the composition of such portfolios, and the historical risk and return.

Also, keep in mind that your risk tolerance will probably change over the years…

As you approach retirement (and certainly once you’ve entered retirement), the sequence of your portfolio returns start to matter; that is, you’re exposed to what’s known as sequence of return risk.  While commonly associated with the retirement years, a decade-or-so worth of bad returns prior to retirement can have the effect of delaying your retirement date.  As your portfolio grows, the contributions you make have a diminishing effect on the growth of your assets – the portfolio returns dominate the change in value.

This is partially why target date funds have become so popular – they gradually decrease the amount of stock exposure as you approach retirement, thereby (in theory) reducing the volatility of the returns of the portfolio… at the expense of the returns themselves.

What nobody really talks about is that as a target date fund adjusts your risk exposure, your expected rates of return decrease as you approach retirement… which means that the static return assumption you made in your retirement plan may no longer be applicable.

To combat a reduction in expected returns, you can save more.  However, just as we mentioned earlier, a late-stage portfolio is less affected by contributions than by returns.  So your increased savings will have to be substantial. 

This is part of the reason why financial planning should be ongoing and dynamic – there are many, many variables at work.  However, we believe that this simple do-it-yourself financial plan outline can serve as a solid foundation to build good savings habits and financial responsibility.

As always, we’d love to hear from you:  

The information presented here is for informational purposes only. This document is not personalized investment advice or an offer to buy or sell securities. Targeted Wealth Solutions LLC does not provide tax or legal advice. Hyperlinks connect to other content that we believe to be from reliable sources. Targeted Wealth Solutions LLC is not responsible for the accuracy or content of outside information or links. The views expressed on external sites are not necessarily those of Targeted Wealth Solutions LLC.