Four Ways To View A Dollar

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 that sometimes it no longer makes cents (get it?). Your financial advisor may take it for granted that you understand which point of view is being discussed at any point in time, but in reality 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. The same dollar. It’s just a different way to slice up the portfolio pie. The dollar could be invested in an Individual Retirement Account (an IRA). This is just a type of tax deferred investing 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, or college money, or “fun money” or “pin money” for next Christmas.

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

For example, sometimes we ask clients how money is invested, wanting to know if it’s allocated to stocks or bonds, and they tell us that it 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 client 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 asset 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 the Individual Retirement Account may be the perfect place to have tax deferred higher risk investments, like equities. Moreover, we may try to postpone taking distributions for as long as possible and take as little out as we can, to pass the assets on to heirs. For others, the IRA may already be so big and the deferred tax liability is already so great that we may want to slow down the growth by investing in fixed income securities, and tap the account hard for income 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 then, finally, type of security recommendation would be appropriate. 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 know the order of distribution, the funding plan and distribution schedule for each bucket, and 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 each client’s personal risk profile and unique investment goals.

With a unique but cohesive planning strategy, it is easier to evaluate whether each portfolio bucket is meeting its goals and objectives. It is also easier to see that clients remain on track to reach their retirement long-term spending goals. Finally, clients are less likely to drastically change asset allocation, say cutting back on stocks at the worst possible time, 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 that it’s time for this treatise on buckets to end. I really need to get a handle on this article if readers are going to grasp what I’m trying to say. Oh, editor. Please just make it stop.

Douglas B. May is President of May-Investments, LLC and author of Investment Heresies.