Six Risks

A weak investment plan is a sure stumbling block. The effort and discipline required to articulate real investment goals and investment policy can give an individual the grounding to stay strong in an unsteady environment. A good investment plan will provide continuity and coherence to investment strategy and activity. It should have a target asset allocation and some restrictions based upon the investor’s age, need for income, desire for growth and tolerance for risk and it should lead to an investment strategy that can be pursued in a variety of market and economic environments. The plan must be written – unless it’s committed to paper, it’s not a real plan.

Over-concentration can be tricky because it can also be a real wealth builder. We all have heard stories of Microsoft or Google millionaires who put all their eggs in one basket, watched the basket, and became rich. They are vastly outnumbered, though, by those who put all their eggs in one basket and watched the basket disappear. Diversification is a grounding principle of investment discipline for good reason, yet it’s very often forgotten at the investor’s peril.

Self-defeating behavior may be the greatest risk of all. Some examples would be investing too much when markets are lofty; fleeing after prices have tumbled; becoming emotionally attached to a stock, a company or a market system; chronic overspending or irrational miserliness.

Researchers who study investment and financial behavioral have identified a number of characteristics, perceptional shortcuts that help us navigate daily life without thinking through each action in detail, but can lead us down a perilous path when it comes to investing. Overconfidence is one of the most insidious behavioral errors; the fact is, we know a lot less about financial markets and what makes stocks go up and down than we think. A number of recent studies have shown a persistent gender gap between stock market performance of men and women. A likely explanation: women don’t share the same investment (over) confidence as men: they trade less, pay fewer costs, and in many studies, their investments outperform.

Taxes. We can only spend after tax dollars, yet we often invest as if taxes don’t matter. Common errors include putting the wrong investments in IRAs and non-IRA accounts, putting the wrong beneficiary designations on IRAs and annuities, taking money from sheltered accounts when nonsheltered accounts would be more effective, and not making use of tax sheltered and tax deferred investment alternatives. A basic understanding of the main categories used in computing investment taxes (long and short term capital gains, qualified dividends, ordinary income) and the categories of tax advantaged accounts (annuities, IRA annuities, taxable accounts, traditional IRAs and Roth IRAs) is invaluable, and is sure to enhance after tax returns.

Discord can come in many forms, but two that most often derail investors are between spouses or partners, and among children and heirs. We develop our attitudes toward money and spending early in life, and our adult relationships almost always have a “division of labor” regarding finances and spending that may not address they needs of both parties.

Fortunately, the pervasive gender-based convention against women managing investments that afflicted an earlier generation is rapidly fading away, but spousal conflict remains a potent risk to long term success. Conflict among heirs is devastating, but can almost always be avoided by a carefully drawn up estate plan, regardless of how large or small your estate may be. A good plan must honestly equalize prior gifts to one child or another, provide for equitable division of heirlooms and personal property, and avoid putting one child in charge of another’s finances, no matter how sensible that may seem (except in cases of disability).

The services of a qualified attorney to help draw up an estate plan is a winning investment when it comes to family harmony, yet many wealthy people die intestate or with such poorly thought out or overly controlling estate plans that familial conflict is all but inevitable.

Finally, liability. Liabilities that destroy wealth can be unexpected, such as catastrophic loss, or lawsuits, or just unplanned expenses, such as health care or continuing care. Having adequate insurance, including separate flood insurance in our area, and umbrella liability insurance, can go a long way in protecting your estate.

Medical costs, even with insurance, are concentrated in the latter years of a person’s life, as are the expenses of long-term or assisted care. In fact, the lack of some type of plan for continuing care, whether funded by assets, insurance, or a combination of both, is often one of the most devastating risks to generational transfer of wealth. Recognition of these potential liabilities and adequate protection of assets through planning and insurance can’t totally disarm the risks, but can take some of the sting out of them. Investors spend a lot of time worrying about the market, which they can’t control, and perhaps not enough time tending to the things they can control. And these six risks to wealth accumulation and preservation: a weak investment plan, over concentration, behavior, taxes, discord, and liability are real and offer an opportunity to improve our situation as problems in the capital markets and the economy slowly work themselves out.

Steven Weber and Elizabeth Loda are investment advisors for the Bedminster Group, a fee-only advisor providing investment and financial counsel to clients in the Lowcountry since 1997 The information contained herein was obtained from sources considered reliable. Their accuracy cannot be guaranteed. In addition, this is not a solicitation to buy or sell any securities. Furthermore, the opinions expressed are solely those of the author and do not necessarily reflect those from any other source.