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How to start building financial, investment strategies

Scott Albright

A 2007-08 study by the U.S. Bureau of Labor Statistics found that only 27 percent of survey respondents could be considered financially literate. Many people even successful entrepreneurs are often not prepared to handle their family’s financial future, however well they may run their own companies. It’s a shame to lose opportunities that you have created throughout a lifetime of hard work especially because a straightforward process can be used to think through priorities, and create and maintain a family financial strategy that is likely to make the most of whatever the economy may bring.

Creating a financial strategy

To make the most of your opportunities, you need to lay out two things: What you might want from a personal perspective, and what your current and future assets might enable you to do, given the global economic and financial climate. If you can set and stick to those priorities, you have laid the foundation for a successful personal financial plan. There is a nifty way to do this, based on psychology’s well known Hierarchy of Needs, developed by Abraham Maslow.

This simple idea forces you to build what you want by starting with your fundamental needs (at the bottom) and adding things that are less necessary and more desirable until you get to your wildest dreams at the top. The idea, of course, is that if you can’t afford everything, you will be very clear on what you need to spend on first.

Once you’ve thought through your personal hierarchy of needs, you can start allocating your future budget from the bottom up. Doing things this way makes it less likely that you will spend on vacation homes and golf club memberships and then find that you can’t afford medical treatment or to help your grandchildren through college. The pyramid also shows how you need to consider spending your future budget. The safety layer, for example, really deals with forms of insurance or hedging risk … medical insurance, disability insurance, property and casualty insurance all the things that can make you resilient to the unanticipated.

One of these unanticipated issues is life expectancy, which is a primary concern of retirees. Looking at actuarial projections and working with annuities can create a useful backstop to this risk. Income risk that comes from losing a job or an unexpected downturn in your family business is another risk that is difficult to anticipate. Perhaps you should keep six months or a year’s expenses in highly liquid form. Once you work through all these risk-mitigation issues, you will be able to define more accurately how much you will have left from your job or your business to invest for long-term returns to meet your higher-tier goals.

This estimate, although rough, combined with prudent expectations on asset returns, will provide you with a guide to achievable income and net worth as time goes by. It will also guide you with regard to how much debt it is prudent to carry and on how much liquidity you will have. Many people’s residence and other real estate holdings make up a very substantial proportion of their net worth and represent to them their safety cushion for the unanticipated. As we learned here in northern Nevada, real estate values can fall quickly and substantially, which can drastically affect personal finances.

Creating an investment strategy

Once your pyramid has been well thought out, the next step is to create an investment strategy. The future is uncertain, but even during the most volatile and turbulent markets, thoughtful long-term planning, common sense and informed, objective insight can help reduce risks and assist you in meeting your financial and life goals. That’s investing.

To best cope with whatever lies ahead challenges created by emerging markets, the Euro Zone, or domestic economic and financial policies consider dividing your investable assets into at least two pools or buckets, one highly liquid, the other less liquid and considerably longer term. Both of these portfolios should be an integral part of a comprehensive, flexible financial strategy that also addresses your unique situation, risk tolerance and requirements.

The first portfolio should be highly liquid, created to protect your assets over a rolling three-year term. This portfolio is designed to complement the base (bottom two layers) of your pyramid, along with insurance components that meets your needs. Don’t expect a big return from this one; it’s designed to keep pace with inflation and help ensure you have the funds you need over the short term without eroding your principal. At the same time, options may be available that can help enhance your return without significantly affecting risk.

The second portfolio should be a long-term portfolio designed for growth. And by long term, we mean assets that you don’t plan to and don’t need to touch for five or more years. Think of retirement plans and long term personal savings. This portfolio should complement the top half of your pyramid and should have a core set of holdings allocated to global equities and bonds. In addition, allocations should include real assets such as real estate, infrastructure and natural resources. These major asset classes may be complemented by other strategic holdings selected based on the current economic outlook.

Logically enough, the younger you are, the more flexibility you are likely to have in building your personal pyramid and creating a realistic financial strategy. So start managing these fundamental financial issues now!

Scott Albright is a wealth advisor for Nevada State Investment Services. Contact him at Scott.Albright@nsbank.com or 775-688-7907. This article is intended for informational purposes only and is not intended to be a recommendation, offer or sale of securities.