Asset allocation is the process of dividing your investable dollars across broad categories \u2013 like stocks, bonds and cash and then \u2013 at a more granular level \u2013 into sub-categories that have been shown through rigorous research to deliver higher expected returns. For example, small company stocks have been shown to deliver higher returns over time than large company stocks, and value stocks have been shown to deliver higher returns than growth stocks.<\/p>\n
In contrast, strategies like stock-picking (trying to identify in advance stocks that will out-perform their peers or the market as a whole) and market-timing (trying to time your purchases and sales of securities in anticipation of market movements) have been shown to have a negative effect on portfolio performance.<\/p>\n
Mistake: Chasing Short-Term Performance<\/h2>\n
If you\u2019ve ever looked closely at an advertisement for a financial product, you\u2019ll have seen the disclaimer \u201cPast performance is no guarantee of future results\u201d. Yet most investors invariably assume exactly this \u2013 that good results must be a consequence of skill and will therefore continue, and that poor results are a predictor of ongoing disappointment.<\/p>\n
As a result, these investors will frequently move their dollars from one fund to another fund with a stronger performance track record over the past few quarters or years. In short, they\u2019re chasing short-term performance. Why is this a problem?<\/p>\n
Well, if past performance could predict future performance, it would be a great strategy. But when we look at the data, what do we see? Something called \u201creversion to the mean\u201d in statistics. In the field of investing this means that relative weak performance is often followed by outperformance, and vice versa. So, if you\u2019re considering switching from a fund that has recently under-performed to one that has recently out-performed, your decision may be worse than pointless \u2013 it may be the exact opposite of what you should be doing.<\/p>\n
It\u2019s also important to note that the perils of chasing short-term performance apply not only to switching between funds within a single asset class (for example, from US Large Value fund from manager A to US Large Value fund from manager B), but also to switching between asset classes (for example, from US Small Cap to US Large Cap).<\/p>\n
The chart below shows the relative performance of a series of asset classes over the time period 2005 to 2019. As you can clearly see, there\u2019s no pattern in the chart \u2013 it\u2019s a sort of mosaic. This suggests that attempting to predict in advance from year to year which asset class will be the best performer \u2013 or even one of the best performers \u2013 is basically impossible.<\/p>\n
![\"Randomness](\"https:\/\/springwaterwealth.com\/wp-content\/uploads\/2020\/12\/Randomness-of-Returns-300-dpi-1.png\")
<\/p>\n
Smart investors know that persistence of performance isn\u2019t a certainty and that the best way to improve the odds of reaching your financial goals is to invest in a well-diversified portfolio<\/strong><\/a> that\u2019s consistent with your objectives and risk tolerance. Stocks will provide expected growth but bring higher volatility of returns. Bonds and cash provide some income, and also dampen your portfolio\u2019s overall riskiness. From time to time, different asset classes will perform well and poorly. But just because one is doing well or poorly at any given time doesn’t mean you should include or exclude that asset class from your portfolio.<\/p>\n Young professionals typically have a number of competing financial demands that can potentially conflict with saving for retirement \u2013 perhaps saving for a new (or larger) home, or starting or expanding a family. With home prices continuing to rise much faster than the rate of inflation in Santa Cruz, Silicon Valley, San Francisco, Portland and Bend \u2013 where many of our clients live \u2013 simultaneously saving for a home and retirement may sometimes seem like a pipedream.<\/p>\n But the cold hard truth is that for the vast majority of Americans \u2013 and most certainly for young professionals on a successful career path \u2013 Social Security will fund only a small portion of their retirement income needs. Fortunately, most companies today offer an employer-sponsored retirement plan, like a 401(k), 403(b), 457 or profit-sharing plan.<\/p>\n These plans are not perfect, but they do offer you a tax-advantaged tool for saving for your own retirement. Here are the most important things you should do \u2013 and not do \u2013 with your workplace retirement plan:<\/p>\n Asset allocation is the primary driver of your portfolio\u2019s risk and return. It\u2019s important to make sure that you\u2019re well-diversified across a range of asset classes, but also within each asset class. You should, if possible, own US and international stocks (ideally large and small, valuer and growth), real estate, bonds and cash. It doesn\u2019t make sense to own more than one fund in each asset class, since you\u2019ll most likely just be duplicating investments \u2013 owning 100 shares of Coca Cola doesn\u2019t make you more diversified than owning 50 shares. How much you allocate to each asset class will depend on your investment horizon, goals and objectives, and risk tolerance.<\/p>\n Once you\u2019ve determined the right asset allocation, it\u2019s time to implement it. At Springwater, we believe you should look for funds that are low-cost (as measured by the fund\u2019s expense ratio), well-diversified, and \u201casset class-oriented\u201d. The latter is another way of saying \u201cnot actively managed\u201d. The fallacy of active management is a topic for another day, but you\u2019ll almost certainly be best-served by selecting funds that invest in a broad basket of securities in each asset class and don\u2019t attempt to pick winners or beat the market. Think: index funds. If your plan doesn\u2019t offer them, you should ask them to!<\/p>\n As we noted before, Social Security won’t provide enough income in retirement for you to live comfortably. So, you’ll need to save for your own retirement, ideally using tax-advantaged accounts like a 401(k) and an IRA.<\/p>\n Each year the IRS announces the maximum contribution limits<\/strong><\/a> for the various types of tax-advantaged retirement accounts it’s approved. These contribution limits are increased from time to time, to account for inflation.<\/p>\n For 2020 and 2021, the maximum a person under age 50 can contribute to an employer-sponsored retirement plan like a 401(k), 403(b) or Thrift Savings Plan is $19,500.<\/p>\n Of all the benefits offered by your employer, matching contributions to a retirement plan like a 401(k) are arguably the most valuable. A matching contribution is literally a \u201cfree lunch\u201d \u2013 a risk-free return on your retirement savings that\u2019s impossible to get anywhere else.<\/p>\n If you find that you\u2019re unable to maximize your own contributions in a given year \u2013 perhaps because your income was down, or you had some unexpected expenses that impacted your cashflow \u2013 you should be sure to contribute enough to receive your employer\u2019s full matching contribution.<\/p>\n Employers will often offer a 3% dollar-for-dollar match, meaning that you\u2019ll receive a dollar from your employer for every dollar you contribute to the plan, up to 3% of your salary. For example, if you earn $100,000 and contribute $19,500 for the year (the maximum for 2020 and 2021), your employer will add another $3,000 to your account (since you contributed more than 3% of your pay to the plan, your employer matches that up to 3%, which for a salary of $100,000 is $3,000). Other employers may offer a 100% match up to 3%, plus a 50% match for the next 3%. This type of match is intended to incentive employees to contribute more of their own pay to the plan.<\/p>\n It\u2019s probably fairly intuitive to you that not every investment in your portfolio will generate the same return every year. Instead, performance will vary between funds (or asset classes), often dramatically. Rebalancing is the practice of systematically bringing your portfolio\u2019s mix of investments back to its intended target allocation.<\/p>\n The reason you should rebalance is that if your portfolio drifts too far away from its target allocation it will end up with very different risk and return characteristics. Your portfolio may end up being far too aggressive, or too conservative, depending on which asset classes have done well and which have done poorly since you last rebalanced.<\/p>\n One way of looking at rebalancing is to say that it\u2019s the same as, \u201cbuying low and selling high\u201d \u2013 which everyone would agree is a great strategy. So why do studies show that so many investors don\u2019t systematically rebalance, and instead let their portfolios drift further and further off target? It\u2019s because the flip side of \u201cbuy low and sell high\u201d is \u201cbuy what has done poorly and sell what has done well\u201d. And we know that many investors chase performance, and so will be reluctant to sell perceived \u201cwinners\u201d or buy perceived \u201closers\u201d. One way to avoid this bias is to rebalance in an objective, disciplined manner, without looking at recent fund returns, and only at their \u201ccurrent versus target\u201d weights in the portfolio.<\/p>\n Roth retirement accounts are one of the best wealth accumulation tools for young professionals.<\/p>\n Roth accounts differ from traditional retirement accounts in one significant way \u2013 when the account owner pays tax.<\/p>\n With traditional retirement accounts \u2013 like IRAs and 401(k)s \u2013 you receive a tax deduction for the amount you contribute to the account. Your account balance, comprised of your contributions as well as the earnings on those contributions, will grow tax-deferred. Then, when you begin taking withdrawals \u2013 typically when you\u2019ve retired \u2013 the money you withdraw will be taxed as ordinary income. This makes sense, because you didn\u2019t pay tax on the amount contributed, nor on the earnings over time. And the IRS eventually wants to collect what it\u2019s owed.<\/p>\n With Roth accounts \u2013 Roth IRAs and Roth 401(k)s \u2013 the timing of taxation is reversed. You don\u2019t receive a tax deduction when you make your contributions. Your account balance, though, will grow tax-deferred, as it does with a traditional account. Then, when you begin taking withdrawals, the money you withdraw comes out tax-free.<\/p>\n So, with traditional retirement accounts it\u2019s \u201cno tax now, but pay tax later\u201d, and with Roth accounts it\u2019s \u201cpay tax now, but no tax later\u201d. Since you\u2019re most likely in a lower tax bracket today than you\u2019ll be in when you\u2019re older, it\u2019s better to pay tax now at lower rates then you would in the future.<\/p>\n Another benefit of Roth accounts is that they don\u2019t have minimum required distributions. This means that when you\u2019re older and in a higher tax bracket, you won\u2019t be forced to take mandatory distributions from your Roth account, as you would with a traditional account. Not having minimum required distributions also means that Roth accounts are excellent wealth transfer tools. If your beneficiaries eventually inherit your Roth account, they won\u2019t be required to pay tax on withdrawals, either.<\/p>\n As a young professional whose income is increasing as your career blossoms, it\u2019s important that you make smart decisions around saving and investing for the future. We highlighted a number of these smart decisions in a previous writing. But it\u2019s equally important \u2013 if not more so \u2013 that you avoid making some critical mistakes […]<\/p>\n","protected":false},"author":2,"featured_media":5878,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_et_pb_use_builder":"","_et_pb_old_content":"","_et_gb_content_width":"","_mi_skip_tracking":false,"footnotes":""},"categories":[3,5,7,11],"tags":[21,48,81,86,87,107,140,162],"aioseo_notices":[],"_links":{"self":[{"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/posts\/5877"}],"collection":[{"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/users\/2"}],"replies":[{"embeddable":true,"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/comments?post=5877"}],"version-history":[{"count":0,"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/posts\/5877\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/media\/5878"}],"wp:attachment":[{"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/media?parent=5877"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/categories?post=5877"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/tags?post=5877"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}Mistake: Not Fully Using Your Workplace Retirement Plan<\/h2>\n
Get Your Asset Allocation Right<\/h3>\n
Pick the Right Funds<\/h3>\n
Maximize Your Contributions<\/h3>\n
Get Your \u201cFree Lunch\u201d No Matter What<\/h3>\n
Rebalance Every Year<\/h3>\n
Mistake: Not Using Roth Retirement Accounts<\/h2>\n
Do you have questions about saving for retirement, or about building a robust plan for your financial future? Contact us today to see how our team at Springwater Wealth can help you.<\/strong><\/a><\/span><\/h2>\n","protected":false},"excerpt":{"rendered":"