MMM Newsletter and Website Header 10.2.15

By Anthony Davidow, Charles Schwab & Co., Inc.

Meet Allison and Keiko, longtime friends in their late 40’s who also have been fierce competitors since their days on the college track team. Over drinks one night, Allison tells Keiko about a “hot” stock she owns that has delivered impressive returns. It was up 35% in 2013, she says, and while it was down 10% last year, she’s confident it will surge to new highs in the year ahead.

Keiko thinks that sounds volatile, but she’s intrigued and a little envious. When was the last time her returns got anywhere near 35%? Why didn’t her financial advisor tell her about this stock? She wonders if she should consider a new advisor — or a more aggressive equity allocation like Allison’s.

Comparisons can cause trouble

The scenario above may be hypothetical, but this sort of comparison happens all the time. There’s a risk when you’re trying to beat the market — or beat your best friend’s portfolio, for that matter. When you stray from your own well-thought-out plan to chase higher returns, there is a chance that your portfolio’s performance will get worse, not better.

Why is that? Because strong emotions are rarely the best guide for making smart investment choices. Consider a phenomenon commonly called “the behavior gap,” which refers to the difference between market returns and investor returns. For example, although the S&P 500® Index gained 9% over the 20-year period ending December 2013, the average equity mutual fund investor was up only 5% during the same period, according to the 2014 Quantitative Analysis of Investor Behavior report from Dalbar.

This gap is largely the result of investors making impulsive or emotional decisions (just as Keiko was tempted by Allison’s stock). In fact, Keiko’s portfolio would likely fare better if she kept her investment plan rooted in her own needs and goals — as you’ll see from a closer look at the two friends’ lives and portfolios now.

Different lives, different allocations

Allison is a successful lawyer, married with two daughters, ages 11 and 13. Her husband Eli runs a small web design firm from his home office. They have little debt and more than $2 million in savings ($1.5 million in retirement assets and $500,000 in taxable accounts). In the long term, Allison and Eli want to maximize their portfolio’s return; in the short term, they need cash to pay for their kids’ college education. Their current portfolio is spread across tax-deferred and taxable accounts.

Meanwhile, Keiko’s situation is quite different. She’s the chief technology officer of a start-up. She has three children, ages 9 to 14, and the youngest has special needs. Her husband, Mike, recently left his job as an investment banker and took a part-time teaching position at a local community college so that he could better coordinate the care and education of their youngest.

Their savings are slightly lower than Allison and Eli’s: The family has $1.2 million ($500,000 in taxable accounts and $700,000 in retirement assets). They’ve been tapping some of the taxable accounts to supplement their newly lowered income — although they’re anticipating that Keiko could walk away from her job with a big payout in a couple of years. Keiko wants to generate enough income to support her family’s needs.

A portfolio critique

Both families’ portfolios could benefit from rethinking, given their different objectives.

Allison and Eli: Greater diversification 

Equities constitute 85% of the family’s assets, and their portfolio is not well diversified — especially considering that equity correlations have risen over the past couple of years. A broader diversification to non-traditional asset classes could be beneficial.

Also, because their daughters are approaching their college years, Allison and Eli may want to consider more stable income in their portfolio since they haven’t saved separately for college expenses. Thus a bigger fixed income stake makes sense.

Allison wants to stick with her hot stock, but the trouble is she’s “anchoring” her view of it; that is, she’s focusing on the stellar 35% return back in 2013 and believes that recent poor performance provides an opportunity to invest at a discount. She should evaluate each investment based on its risk profile, not its past performance.

Keiko and Mike: Generate income

Keiko and Mike have a prudent allocation, which is a good start. They need to preserve capital while Keiko is working at the startup, and they need to generate more income from their portfolio now that Mike’s salary is lower. To that end, they should favor dividend-paying stocks (domestic and international) and seek other sources of income such as real estate investment trusts (REITs) and master limited partnerships (MLPs). Within their fixed income allocation, they should try to maximize tax efficiencies by putting tax-free muni bonds in their taxable account and corporate bonds in their retirement accounts.

Keiko would be wise to resist the temptation to follow in Allison’s investing footsteps. Her priority should be balancing her family’s short-term need for capital preservation with their longer-term need to generate income from their portfolio. Keiko and Mike have a child with special needs and need to continue to save for retirement.

What you can do next

Keiko and Allison illustrate a hypothetical situation, but one with real-life echoes. We encourage investors to develop a sound plan that is appropriate for their specific circumstances — not anyone else’s.

Consider the following questions in developing a plan, and periodically revisit your plan to determine if your needs and objectives have changed.

  • Define what your financial goals really are — and reassess if your first answer is, “Getting a better return than my friend.”


  • Don’t buy an investment based solely on how it performed last year, or on how much money it made for another investor.


  • Develop an asset allocation strategy that is designed to balance risk and return.

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About LRPC’s Monday Morning Minute

Lawton Retirement Plan Consultants, LLC (LRPC’s) Monday Morning Minute is crafted to provide decision-maker’s with important information about the economy, investments and corporate retirement plans in a format that allows a reader to consume the information in less than 60 seconds. As an independent, objective investment adviser, LRPC has access to many sources of research and shares the best and most relevant information with its readers each week.

About Lawton Retirement Plan Consultants, LLC

Lawton Retirement Plan Consultants, LLC is a Milwaukee, Wisconsin-based independent, objective Registered Investment Advisory (RIA) firm providing investment advisory, fiduciary compliance, employee education, vendor management and plan design services to retirement plan sponsors. The firm currently has contracts in place to provide consulting services on more than $400 million in plan assets. For more information, please contact Robert C. Lawton at (414) 828-4015 or bob@lawtonrpc.com or visit the firm’s website at https://www.lawtonrpc.com. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser.

Important Disclosures

This information was developed as a general guide to educate plan sponsors and is not intended as authoritative guidance, tax, legal or investment advice. Each plan has unique requirements and you should consult your attorney or tax adviser for guidance on your specific situation. In no way does Lawton Retirement Plan Consultants, LLC assure that, by using the information provided, plan sponsor will be in compliance with ERISA regulations. Investors should carefully consider investment objectives, risks, charges and expenses. The statements in this publication are the opinions and beliefs of the commentator expressed when the commentary was made and are not intended to represent that person’s opinions and beliefs at any other time. The commentary does not necessarily reflect the opinion of Lawton Retirement Plan Consultants, LLC and should not be construed as recommendations or investment advice. Lawton Retirement Plan Consultants, LLC offers no tax, legal or accounting advice and any advice contained herein is not specific to any individual, entity or retirement plan, but rather general in nature and, therefore, should not be relied upon for specific investment situations. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser and accepts clients outside of Wisconsin based upon applicable state registration regulations and the “de minimus” exception.

Additional Important Disclosures

Past performance is no guarantee of future results. The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed. Examples provided are for illustrative purposes only and are not intended to be reflective of results you can expect to achieve. This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner or investment manager. Risks of REITs are similar to those associated with direct ownership of real estate, such as changes in real estate values and property taxes, interest rates, cash flow of underlying real estate assets, supply and demand, and the management skill and creditworthiness of the issuer. International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets. Investing in emerging markets may accentuate this risk. Diversification strategies do not ensure a profit and do not protect against losses in declining markets. Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. High-yield bonds and lower-rated securities are subject to greater credit risk, default risk and liquidity risk. Master limited partnerships are considered pass-through entities for tax purposes and therefore have special tax considerations. Commodity-related products, including futures, carry a high level of risk and are not suitable for all investors. Commodity-related products may be extremely volatile, illiquid and can be significantly affected by underlying commodity prices, world events, import controls, worldwide competition, government regulations and economic conditions, regardless of the length of time shares are held. Investments in commodity-related products may subject the fund to significantly greater volatility than investments in traditional securities and involve substantial risks, including risk of loss of a significant portion of their principal value. Indexes are unmanaged, do not incur management fees, costs or expenses, and cannot be invested in directly. The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.