Don’t let different views obstruct financial planning

Doug May
Doug May

I’m glad I know sign language, it’s pretty handy. I used to have a fear of hurdles, but I got over it. Have you noticed that writing with a broken pencil is pointless? I love puns. Words have so many meanings. Sometimes the multifaceted perspective about a single word causes confusion, but other times it’s the basis for humor. 

In financial planning, we often allocate money among different asset classes, security types, tax types and buckets with each bucket having a different purpose and time horizon.  We view each dollar from about four different angles — so many different perspectives sometimes it no longer makes cents. (Get it?)  Your financial advisor might take it for granted you understand which point of view is being discussed at any point in time. In reality, though, the four-faceted view of each dollar is as often as not a source of confusion.

A dollar might be invested in a certain asset class. It could be invested in stocks, for example. And that same exact dollar might be invested in a mutual fund, as opposed to an individual security. It’s just a different way to slice up the portfolio pie. The dollar could be invested in an Individual Retirement Account. This is just a type of tax-deferred investment account. The IRA could be in a portfolio “bucket” designed to grow and protect the investor against the ravages of price inflation. Other “buckets” might be designed to provide income, college money, “fun money” or “pin money” for Christmas. 

We’re constantly sorting money among different buckets.  Sometimes, however, these different ways of viewing a single dollar can cause confusion.

For example, we sometimes ask clients how their money is invested, wanting to know if it’s allocated in stocks or bonds. They tell us the money is in an IRA or a mutual fund. And no doubt the language of money is an equal opportunity obfuscator, perplexing and bewildering clients at least as often as it happens to us. 

While each situation is different, our solution is often to begin with a financial planning exercise to determine what overall asset allocation mix — which combination of equities, fixed income securities, real estate and other classes — helps clients meet their long-term spending goals. Next, we look at the taxable nature and investment purpose for each of the different portfolio “buckets” available for investment.

For some people, an IRA offers the perfect place for tax- deferred, higher-risk investments, like equities. Moreover, we might try to postpone taking IRA distributions as long as possible and take as little out as we can to pass the asset on to heirs. For others, an IRA might already be so big and the deferred tax liability so great we might want to slow down the growth by investing in fixed-income securities and tap the account hard during the income distribution years of retirement.

Only by looking at both the goal of each account and the tax status of each bucket can we determine where we should allocate our growth dollars (what we call “red money”) and where we should place the less risky fixed-income (“green money”) types of investments.

At this point, we still haven’t recommended whether to buy a stock, invest in a mutual fund or exchange traded fund or buy an annuity or bank certificate of deposit. Each individual bucket has its own unique purpose, asset class, tax status and, finally, type of security recommendation that would be appropriate.  Unfortunately, recommending securities first without taking the requisite planning steps is all too often the industry norm. When a broker looks at a bucket of money and sees only the potential for a product sale, the joke is on the investor — and it isn’t funny.

This planning process can be short-circuited by investing each bucket in the same allocation or always using the same type of securities in every bucket. Financial planning software rarely differentiates which bucket will be tapped first for distributions and which will be last in line. In a good financial plan, however, your advisor has helped you determine the order of distribution, the funding plan and distribution schedule for each bucket. Each portfolio strategy is tailored to each individual bucket while still working together at an aggregate level to present clients with an appropriate asset allocation well suited to their risk profiles and unique investment goals.

With a unique, but cohesive, planning strategy, it’s easier to evaluate whether each portfolio bucket is meeting its goals and objectives. It is also easier to make sure clients remain on track to reach their long-term spending goals for retirement. Finally, clients are less likely to drastically change asset allocation —cutting back on stocks at the worst possible time, for example — because the overall strategy makes sense to them and makes them less likely to change horses mid-stream.

The last thing we want for investors is that they “kick the bucket” and “upset the apple cart” at the wrong time, which could threaten the viability of their long-term plan and ultimately result in far too much spilt milk.

Okay. Now I’m just mixing metaphors and abusing altogether far too many puns.  You can bet your bottom dollar it’s time for this treatise on buckets to end. I really need to get a handle on this if readers are going to grasp what I’m trying to say. Please just make it stop.