You've probably heard the phrase "timing is everything". There is a great deal of truth in that statement. Timing is important in sports, cooking, relationships, catching trains and planes and even financial planning.
Being at the right place at the right time is always helpful and it isn't always "good" luck that gets you there. More often than not it takes forethought, hard work and natural ability to make the best choices and to take advantage of opportunities. We can't predict when we might get lucky or have good timing. Having good luck on a consistent basis is beyond our control and unreliable.
Timing is one of the most important aspects of financial planning. It frames your thought process and provides a reference to measure progress. Understanding how time affects your chances of reaching your goals is a vital component of the decision making process.
There are many time-sensitive questions and issues that are addressed in the financial planning process. Oftentimes, there are no simple answers to these questions. What makes the process so complicated is that every question has a number of variables and issues tend to overlap. Moreover, no one (not even your financial planner) can predict the future. We can only make projections based on reasonable assumptions.
The most important and relevant of these assumptions will always include your goals. Some of the assumptions you may control or influence, others you don't. For example, discretionary living expenses, by definition are not fixed and pre-determined. Since they are discretionary, you can decide what is appropriate for your situation and make changes when necessary. You might choose the age you retire, but this decision could be forced upon you by management or poor health.
Since assumptions drive the financial planning process, reviewing and analyzing your goals and objectives to confirm they are reasonable based on various time horizons is vital. Our experience is that life's goals changes each year, sometime a little, sometime a lot. Consequently, it is necessary to conduct an annual review to verify assumptions and confirm you are still on target to reach your goals.
Below is a brief discussion about some important time-related questions:
- Cash Reserves - When will you need them?
This is probably your most important investment question. If your income suddenly stopped, when would you need to liquidate some of your investments? How quickly could you turn them into cash? Will it be a good time to sell? Will you have to pay income or capital gains taxes upon liquidation? Can or should you borrow cash from the bank or credit cards?
We believe the best way to frame this issue is to consider your monthly living expenses. First, consider your expenses over the next 6 to 18 months plus any additional probable expenditures over the next 24 months. Secondly, how much available cash will make you feel comfortable. This is both an analytical and an emotional issue for most people. Finally, determine the opportunity cost of keeping large sums in safe but unproductive investments (savings, money market funds and CD's) that might not help you meet your long term investment goals.
- How long will you live?
It is an understatement that dying young, living too long or becoming disabled prior to retirement can significantly impact your financial plan. If you die prematurely, you leave survivors that might have relied on your income or your ability to care for them. If you live long past retirement, your money might not last as long as you do, especially since the final years of life can be extraordinarily expensive due to long term care needs. Will your retirement assets support you and your spouse for ten, twenty or thirty years after you stop working? Have you quantified these risks (dying prematurely, living too long, becoming disabled, needing long term care)? Many people would rather put their head in the sand, but we think it is best to understand how these risks affect your financial lives and the lives of your survivors. Is insurance (life, disability, long term care and income annuities) an appropriate tool to fill financial gaps that might exist? If so, buy insurance before you need it and remember insurance becomes more expensive due to age or unavailable depending upon your medical history.
- When should you retire?
Retirement is one of the most difficult transitions in life. There are many considerations and they are not all financial. What does retirement mean to you? How will you replace your income stream and will it be adequate to meet your goals? When will you need to withdraw from retirement accounts, start social security and pensions? How reliable are these income sources? What happens if your investment returns are well below historic averages, as you may have seen over the last ten years. How will this affect your income?
Consider what will happen to your income and future planning if the stock and bond markets drop in value significantly, especially if this happens over multiple years when you might be withdrawing income. Unfortunately, steep market declines are a reality of the stock and bond markets. It is hard to forget the stock market declines during years 2000 through 2002 and the most recent bear market that started in October 2007. While the markets have bounced back significantly as of September 2009, we have not come close to full recovery. If you are withdrawing funds from retirement accounts and markets decline in value, you may start withdrawing principal (not just income) and it becomes that much more difficult to recover losses.
Will you retire during a bull or a bear market? Unfortunately, we'll only know the answer to that question as we look in our rear view mirror. In the meantime, don't give up on stocks and bonds. Recognize that the timing of your withdrawals is vital and prepare for the worst. As you approach retirement, set aside an appropriate amount in cash and bonds and reduce your exposure to the volatility of stocks. Diversify your income sources with certain guarantees so you know your core non-discretionary expenses will be paid even when the stock market performs poorly. Review discretionary expenses, especially during bad markets and reduce expenses. Run your personal financial life like a well-run business by reducing expenses during difficult times. This will make a big difference in your long term retirement income planning.
- When do you want your heirs to have access to their inheritance? Before or after you die?
There are significant estate tax advantages of gifting assets to heirs while you are alive. It also feels good to help people. However, most clients agree that giving children too much too early may not inspire them to work hard, take risks, and achieve their own good fortune. But when will they be old enough? Age 25? 30? 50? These decisions become difficult as you watch your children make their way through life. If you want to provide for your children but also protect their inherited assets from themselves and creditors (including former wives and husbands) consider establishing a specialized trust.
- When will tax rates go up (or down) and how will this affect your financial decision making?
Tax decisions should be secondary to your overall planning goals and objectives. Unfortunately, we often see that clients regret past decisions made primarily around tax-deferral or tax-avoidance. Your exposure to stocks or real estate that have appreciated in value and represent a "large" portion of your total net worth should probably be managed from a risk perspective first and from a tax perspective second. Guessing the direction of tax rates is usually not very productive so focus on your overall priorities and consider the possible affects of higher or lower taxes. It should be a factor, but not necessarily the primary factor. Don't let the "tax tail" wag the "planning dog".
- Should you try and "time" the market?
"Buy low and sell high" is a reasonable investment philosophy, but putting it into practice and being successful on a consistent basis is easier said than done. It is very difficult to accurately predict the direction of interest rates, currency values, the economy, inflation, investor sentiment, etc. If "time is on your side" and you can afford to stay fully-invested for at least ten years, the timing of your investment becomes less important. Timing is more important when the investment time horizon is shorter.
That's not to say, an investor can't make tactical asset allocation decisions that are based on an objective, analytical view of the world at certain moments in time. Some investment professionals believe that over a variety of market cycles their tactical decisions can reduce portfolio volatility and/or enhance portfolio returns. Nevertheless, active tactical investors can be early or late as they make adjustments to portfolios. Don't expect success 100% of the time.
Investment time horizon, income needs and risk tolerance should be the primary determinants of your overall investment strategy. These three factors should determine your asset allocation (percentages invested in cash, bonds, stocks, real, estate, etc.).
These are just a few of the time-related decisions that need to be made over our financial lives. Financial planning is complicated because of the variability of the financial decisions that confront us every day. The one consistent theme seems to be "time". We believe thoughtful ongoing planning puts "time on your side" and helps you feel confident that you will succeed in meeting objectives.