A: It sounds like you are going through some significant changes in your life. Congratulations on your wedding, your new job and your determination to start thinking about the future.
The best place to start is with a financial plan. Finding a good planner will help you in three ways. First, she will help you gain a better understanding of your current situation by answering several key questions. Is your income sufficient for the lifestyle you are living? What are your financial goals? Do you have adequate life insurance, disability income insurance, etc.? Are you carrying too much debt?
Second, she will help develop a financial strategy designed to help you achieve your goals. The financial strategy will start with a budget that includes adequate savings for retirement and other goals. She will help you develop a plan to save for those goals, including determining the target level of return you need to earn on your investments over time. She will also help you determine how much life insurance you need and how to better manage your debt.
Third, she will help you stay on track with that plan and adjust it as your life circumstances change. To do this part well, you will need to stay in touch with your planner. You should try to review your plan and your progress each year with your planner.
You can find good financial planners in several ways, but I recommend starting with the National Association of Personal Financial Advisors (NAPFA). NAPFA is a professional organization for fee-only financial advisors. All NAPFA members are committed to financial planning and are prohibited by NAPFA by-laws from receiving commissions, finder’s fees, bonuses or any other compensation from third parties. When you work with a NAPFA advisor, you can have confidence that the advisor is working for you. Check out their website at www.NAPFA.org.
Q: I started investing a couple of years ago. How do I know how I’m doing? My advisor’s statement says I’ve earned 5.4% per year since I started, but how do I know if that is good or bad?
A: A common way to measure performance is to compare a portfolio’s return to the returns of an appropriate benchmark portfolio. The benchmark portfolio will contain asset class and style indices in proportion with your target portfolio structure. For example, if your target portfolio calls for 60% in U.S. large cap stocks and 40% in U.S. bonds, you would construct a benchmark portfolio with 60% in the S&P 500 index (or some other large cap U.S. index) and 40% in a U.S. fixed income index like the Bloomberg Barclay U.S. Aggregate Index. Be careful when you select indices for your benchmark portfolio. You wouldn’t want to use a large cap index like the S&P 500 if you are investing in small cap stocks.
For me, a more satisfactory way to measure performance is to track your portfolio return relative to your target return, or the return you must earn in order to accomplish your goals. This, of course, begs the question of how you know what your target return ought to be. The answer is simple: you need to start with a financial plan. Your target return is one of the most important features of a well-designed financial plan. If you don’t know what your target return ought to be, I suggest you sit down with a financial planner.
Steven C. Merrell MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., an independent wealth management firm in Monterey. He welcomes questions you may have concerning investments, taxes, retirement, or estate planning. Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to firstname.lastname@example.org.