23 – Saving for the Medium to Long Term


Episode Overview:

So you’ve begun saving for the common scenarios of your day to day life. You’ve accumulated cash to cover credit card float, living expenses and anticipated costs or emergencies. What about the long term? Say tuition costs or even retirement? When looking to the future to save for these types of expenses that are 10 to 40 years down the road you must factor two things: Investment Objective and Tolerance for Risk. Ken dives into these concepts and where best to place your assets depending on these factors.

Transcriptions are auto-generated, please excuse grammar/spelling!

Happy Day to you. This is Ken Kaufman CFO, and I’m thrilled you’re here for episode number 23 – Saving for the medium to long term. This is all part of the series I am doing on this roadmap to cultivating your assets.

Just a quick reminder to reset what we’ve covered in the last two episodes. First, you need to get out of the credit card float. And you do this by saving cash each time you make a credit card purchase, and you keep that earmarked for paying off that credit card bill when it comes. Second, you are saving enough money so that eventually you can be living on last month’s income. And third, is to save for the non routine along with an income protection amount set aside. And all of a sudden, you’ve got this bank account that is just filling up with cash, and piling up with cash, your credit card float is all sitting there, your last month’s income is sitting there or however much has accumulated so far. And then all the non routine things and your income protection and unplanned things, all the potential emergencies that you could imagine that would happen, you’ve saved for all those and you’ve accounted for all those.

Because of the short term time horizon you have a need for high liquidity, meaning you need this ability to access the funds immediately, or as quickly as possible. This is in lieu of trying to invest into higher risk type investments, or less liquid investments, investments that are much more volatile, that can go up and down and ultimately could lose quite a bit of value right at the time that you needed to have access to your precious savings.

So you care more about not losing any of your money, or what’s called preserving your capital, than you do about seeing it grow at some high rate of return. You care about safety. You might even be okay if inflation eroded some of the purchasing power of the money in exchange for knowing that you’re not going to lose it, that it will all be there when you need it. And there’s nothing wrong with this, it’s the right thing to do.

But what about when you have money that you’re saving for something that is going to be five or 10 years down the road, or 15 or 20 or 30 or 40 years down the road? Or maybe this is money that will be left to your family. So where should we put all of this money? It really comes down to two things. What is your investment objective? And what is your tolerance for risk?

So let me start by jumping into investment objectives. There’s really three categories here.

The first one is safety or preservation of capital. This means you want to make sure that you’re not losing the value of your savings, like I mentioned earlier. Generally this investmetn objecitve invests in bank accounts that have FDIC insurance, US government T-bills and short term bonds, certificates of deposit (CDs), and money markets. Now in addition to those short term savings, all the credit card float and everything that I just mentioned before, the other place where I see people get very focused on safety and preservation of capital is when they are about to retire or when they are retired. They need that money, and they don’t necessarily want it to have the opportunity to lose its value. And in some instances, it’s even okay to have it not keep up with inflation in exchange for the safety of knowing that that money is there.

The second of these investment objectives is income, meaning you want your assets to be generating income to you that you can live on or use for whatever it is that you need it for. This is generally comprised of highly rated bonds, stocks that pay high and frequent and steady dividends, and sometimes real estate and real estate investment trusts, or REITs.

The third investment objective is growth, or capital appreciation. You want your assets to grow in value over time. People who have growth and capital appreciation as an objective, even if their portfolio or their investments are generating income, they generally have those dividends or that interest reinvested back in rather than taking that money out so everything can just grow and the value of all those investments can grow over time. Growth investors want to beat inflation, and they are willing to take some risk and expose the assets to volatility to try to gain a higher return. Generally there’s a longer time horizon attached to objective.

And technically, there’s a fourth investment objective. It’s called speculation. These are day traders, these are people that are trying to play with the market and time the market. And they’re taking high risk, and they’re willing to lose everything that they’re speculating with. Speculators need to able to afford losing the money they speculate with. And losing said funds would not put their financial security or financial plan at risk in any way.

Now. Let’s talk about risk for a minute in terms of cultivating assets and these investment objectives and risk tolerance. These are the two things we’re talking about today. Within each of these investment objectives, there’s this spectrum of risk to which you can expose yourself. And there are countermeasures that you implement can that will allow you to mitigate at least some of the risk.

Academic studies clearly outline the positive correlation between risk and return. And this goes back to the 1950s and 1960s studies that have been done. And basically it says that for each unit of risk you are willing to take there’s a theoretical return that you should receive. Think of it this way, there’s this positive correlation that exists where the more risk that you are willing to take, the higher return you should expect and plan for. By the way, the closer to inflation you get, that introduces a new risk, meaning if you’re taking lower and lower risk, your start to introduce a new risk, which is inflation and that it could erode the value of your money. So there’s this top end and low end set of guardrails, if you will.

You just have to think about this up into the right, that says, for every extra unit of risk that I’m willing to tolerate and take on, the better return I should expect. Now that depends on the money being invested properly, and all of those things, and we’re going to talk about some of those principles in the future. But what you need to understand about risk is this positive correlation between the more risk you’re willing to take the more return you should expect. And then we find what’s called the efficient frontier that makes sure that we’re setting ourselves up to maximize the potential return for the risk that we’re taking.

So with investments, risk is measured by how much your assets may go down in value during a specific period. In the investment world that is generally measured on an annual basis. So when I refer to taking a lot of risk, it means your assets could lose a big chunk of their value. Could you tolerate the money that you’re saving for retirement to drop in half, and not sell them, not emotionally react and sell them when its worth half of what it was? Depending on how you’ve invested these retirement funds, the stock market should, over time, be able to recover the loss and still produce a great return. That’s according to what the what the academics say.

So let’s go ahead and address the time horizon element, the less time that you have to invest your money untill you’re going to need it, the less risk you’re likely going to be willing to take, the more time the more risk. So there’s this positive correlation here as well. The more time you have, and if you can have the emotional fortitude to withstand the volatility that comes when you take more risk, meaning it could drop way down or go way up, and not react in the way of selling when it’s down and and then trying to buy when its way up, the more risk you should be able to take. This time horizon for your assets dovetails into your overall tolerance for risk, and what can you take on but the longer time horizon should help us be willing to take on more risk.

A lot of my thinking on this subject is influenced by someone that I want to introduce you to. He’s one of the best, most unbiased, conflict free sources of information I found out on the internet on investing. And his name is Paul Merriman. He was a stockbroker in the 1960s, did some investment banking until he became the CEO of a manufacturing firm in the early 80s. And then after that, he started his own independent advisory firm. And then he sold that practice, and he’s now retired. And according to him, he’d say he’s working more and harder in his nonprofit foundation for advancing financial literacy than he did before he retired.

This nonprofit, called The Merriman Financial Education Foundation, nonprofit is curating content and developing research around investments for Do It Yourself investors. Some of his research, I think, is pretty cutting edge. And he’s focusing on the DIYers, and he wants to educate the world about what makes sense when it comes to investing.

And specifically, I want to refer you to the first in a series of three ebooks that he wrote a few years ago, and it’s called First Time Investor: Grow and Protect Your Money. And I encourage you to read it – it is a great foundation for everything we want to talk about in terms of cultivating assets.

So there it is an – overview of investment objectives and risk, which is the beginning of understanding where you should put your medium and long term savings. We have much more to come on the subject, including asset allocation, diversification, active versus passive investing, management expenses, the emotional and behavioral sides of investing, and so much more. All of these topics are critical to cultivating your assets for the medium and long term.

Many, many thanks to you for joining today. This is a wrap for Episode 23. Happy day.

Transcribed by https://otter.ai

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About the Podcast

Join Chief Financial Officer Ken Kaufman as he helps you track and hack your net worth. For those seeking financial independence, your net worth is one of the most significant measurements of success. Using his two decades of financial experience, Ken Kaufman helps you overcome your financial obstacles and look onward towards a better, brighter financial future.


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